Solid State (LSE:SOLI) — Review of Interim Results and Prospects

0:03 Good morning, ladies and gentlemen, and welcome to the SOLID STATE results presentation. Before we begin, we would like to submit the following poll, which you will see on your screens. Throughout this presentation, investors will be in listen only mode. However, questions are encouraged and can be submitted at any time via the q and a tab situated on the right hand corner of your screen or if anyone has dialed in via solid state at walbrook p r dot com. The company may not be in a position to answer every question it receives during the presentation. However, the company will review all questions submitted today and publish responses where appropriate. These will be available via your investor me company dashboard.

0:41 Finally, we would like to remind you that this presentation is being recorded. I would now like to hand you over to chief executive, Gary Marsh chief financial officer, Peter James and John McMichael, managing director of Solstad, the group's components division. Gentlemen? Thank you, Tom. Yep. Thank you to our existing shareholders for joining us on what is our now eleventh presentation for Investor Meet company. Also welcome new people to to SOLID STATE. We hope you find the presentation informative, and we look forward to taking your questions at the end. So the group benefits from a stable and experienced executive management team. As you can see, Peter and I are presenting to you today.

1:28 I think an important point to mention at the start is over the last five years, we worked hard as part of our strategy to build a strong senior leadership team, both at group and divisional level. And we'll cover this in a bit more detail in some later slides.

1:46 SOLID STATE is the trusted provider of electronic technology for demanding applications. The group is split into two divisions, systems and components, as you can see here. We'll provide you with divisional review a little later in the presentation, but suffice it to say, the two divisions are highly complementary. Our structure is such that we've got good resilience and diversity without losing focus on our core competencies, our core competencies being solving customers' problems in a way that allows them to innovate. This often requires solutions, specialist or demanding environments where the group has extensive know how and experience. Our heritage provides solid foundations. We deliver value to customers through expertise and innovation.

2:36 Critical to everything we do is our workforce. We benefit from having a stable, highly skilled and loyal resource. A great deal of time, money and effort is spent ensuring we hire the best, we train and motivate the team to be the best, ensuring that our leadership teams have the flexibility to operate at the highest level.

2:56 We've now got over 400 employees in 14 locations across multiple countries, And our focus on employee well-being continues to evolve with even better benefits and support packages being put in place. Our mission is to build an agile business with ever increasing scale and resilience for the shared benefits of all of our stakeholders with our primary measure of scale being earnings per share.

3:27 I'm pleased to report the group has delivered a further set of record financial results for for the period. We've made further progress on the execution of our growth strategy, building on the strong performance we've seen over recent years. Our track record demonstrates the resilience our model has created in what has been a fairly tough environment. We've had Brexit, COVID, and lastly, the geopolitical instability. Our core markets have held up well, and we've delivered a record first half to the year despite these uncertainties. We continue to work with customers to leverage our specialty designing capabilities, placing the group in a strong position in our target growth markets. We remain ambitious with a growth strategy focused on developing group talent, product innovation and further internationalization of our operations to deliver on our 2,030 goals.

4:24 The first half result combined with a strong order book and prospect pipeline gives the directors confidence in meeting the expectations for the full year, which we upgraded recently at our October trading update.

4:41 So what have we achieved over the last five years? Significant growth in revenues and profits by successfully executing on our strategy, improving operating margins by more than two fifty basis points to 30% improvement,

4:55 with adjusted EPS reflecting more than 20% compound annual growth. As you can see over this time frame, we've delivered significant growth in total shareholder return through a combination of organic growth and strategic bolt on acquisitions. We set out our ambitions to 2030 to become an international leader of sustainably engineered components and systems, continuing to innovate, providing customers with our trusted technology of their demanding applications. Through further development of complementary technologies and own brand products, which we'll come on to a bit more detail on a bit later in the presentation, we aspire to achieve 12% operating margins. And most importantly, maintain our track record of delivery of greater than 20% compound annual growth in total shareholder return.

5:47 I'll now hand you over to Peter, who will do some of the financial highlights in the period. Thanks, Gary. So the first half, as as Gary said, has been an exceptionally strong period, with revenue growth of close to 50%. That reflects both robust customer demand, and the delivery of the defense contracts we announced in November 22. We've seen record, organic revenue growth in excess of 35%, and actually pleasingly, we've been able to maintain the operating margins consistent with the full year '23, which has translated in record first half profits. Those profits have translated into strong cash generation and falling net debt. Despite the normalization of some of the order schedules starting to come through, the order book has remained resilient with good design activity and contract awards.

6:39 The order book, pleasingly has increased back over a 100,000,000 post period end. As we've reported, we continue to pay a progressive dividend. It drives good business disciplines, and that shows, just shy of 8% increase period on period. So coming on to to revenue in a little more detail, you can see there the, the impact of a full period of custom power, the acquisition we did last year, so that's an additional four months in this period compared to the prior year, and the impact of the growth in defense and security in our systems division. There's been further growth in other systems markets, and we've seen an FX headwind. And I'll come on to a little more detail whilst the reported number in components is down compared to the prior year. If we look at the next slide, this shows five half year periods for components revenue in US dollar equivalents.

7:35 And if you look in the middle bar there, that reflects where we'd secured inventory to mitigate the challenges of shortages. So we had very strong demand in the first half of last year that normalized in the second half. And pleasingly, it's broadly flat this year and the first half of this year. So we've maintained that level of trading with the second half of last year. Coming on to, profitability. So, yeah, actually, divisions, have performed well. If we look there, the volume growth, has really driven the the key positive variance and that reflects custom power and the security and defense demand we've seen. The margin, is really a mix factor. Underlying margins of both divisions have continued to trend positively, but the mix with the additional defense revenues, which are more akin to component margins than systems, have been diluted.

8:34 We've invested in, yeah, the full year overhead of custom power, but also additional overhead investments. A significant proportion of that circa 2,500,000 is variable overhead, performance related pay, commissions, and variable, staff costs. We've also decommissioned a legacy production capability, which was highly energy intensive, and that's resulted in some additional depreciation and amortization in the period. That cash profit that you can see there has translated into to strong cash generation. Net debt this time last year was at a peak of 16,100,000 having completed the acquisition of Custom Power. We saw that fall to just over 8,000,000 come last year end, and that's continued to fall this period to just under 4,000,000.

9:28 So, yeah, the dividend this year was paid in the first half just ahead of the half year, whereas last year, it was paid at the beginning of the second half. Investing activities, that reflects our capital investment to upgrade our engineering and office space in our Crewe Cairn facility in this period. And financing activities is two key elements in there. One is the payment of interest, and the other is the right of use asset payments for property leases.

9:57 So moving on to to the balance sheet, at year end when for those that attended our year end presentation, we talked about inventories being exceptionally high as we've got the product in to to deliver for the defense contracts. That started to unwind and has come down. Correspondingly, payables have come down as we paid for that inventory, And the strong billings in the period, you can see there, are reflected in increased receivables up a million pounds. Net debt, key elements there. In the period, we've paid the final deferred consideration elements for active silicon and custom power, so there's no more deferred consideration due. And we've seen, the debt the bank debt being paid down as well. So the remaining net debt of just shy of 4,000,000 is a is the remaining term loan offset by the cash we've got with banks.

10:52 Sure. I'll hand over to John McMichael who will take you through a bit of a divisional review. Thanks, Pete. So we saw we would just look at some of the highlights in each division, for the half year for you. And if we look at components first, the Solstad brand was launched really as a much needed overhaul to the look and feel of the brand. But more importantly, it was to provide a coherent framework with common values across all of the components, divisions, businesses.

11:23 And this removed the artificial barriers and presents really a unified front, and that reflects the restructured business. In short, it makes the business understandable to the outside world, and it brings all the employees together with a single identity. Work on the JuraCool strategy, that's our own brand product, has been accelerated through the addition of resources and most notably that of a commercial manager who's got significant experience in bringing brands to market within the electronics industry. As a result, the addition of distributors for the Duracool products around the world has been brought forward, and that gives us the force multiplier effect of having someone else selling on our behalf.

12:10 And then just briefly looking at the systems side of the business, a systems division seen good demand across a range of markets, including medical and energy. However, this period's results have been dominated by the unprecedented demand in the security and defense market and the previously announced contracts. The security and defense program actually reflects more than five years of work to get this customer to adopt the communications technology that we're selling. And while there are future opportunities for significant follow on business there, these are not yet secured and therefore they're not reflected in the forecasts. The division is now focused on longer life programs and own brand product that will secure multiyear revenue streams with tier one customers such as the contract we announced in the late summer with Saab.

13:06 And furthermore, the systems has benefited from a full period of custom power, and we touch on that a bit later in the presentation.

13:17 If we look at the the next slide, our key offerings, you can see that these slides quite clearly explain how we differentiate and serve our customers through our diverse product offering, our specialist knowledge, and our trusted relationships. The graphics, I think, demonstrate nicely how we now have multiple touch points within major applications. And this gives us considerable advantage over competitors who have a less diverse product offering and indeed it makes us much more valuable to our customer base. If I could give an example of how the two divisions are able to combine to get greater visibility and consequently win business and how we link up businesses to solve problems. The example is we have a UK subcontract manufacturer that works very closely and with and trusts SOLID STATE. They gave SOLID STATE lead about a company that makes air filtering masks.

14:13 That company was struggling to get an ATEX approved battery pack. So SOLID STATE PLC able to make contact with that company at the components level and then work with STATE PLAYT Batteries to devise a solution. Neither company could have won that alone and that business is expected to be valued at around about 1,100,000. And then just to emphasize this, a second example is a project within autonomy where we have a tier one customer that we've done a number of smaller projects with over the last few years. And having demonstrated our capability, quality, and expertise, we're now bidding to supply an embedded computing image capture and processing system. It's similar to the TFL program that we won previously for those who followed us.

15:01 We would not have been in a position to bid for this project without the combined capabilities of active silicon and steer tight. And again, this program is a multiyear program in the industrial sector, which is expected to be worth in excess of 1,000,000 just for the initial phase.

15:26 So those of you that know us will already know that we have four key pillars to our strategy. The investment in and development of talent, and that's evidenced quite clearly here by the addition of the five engineering heads noted on the slide.

15:44 And secondly, our strategy is about broadening our complementary product and technology profile. And here, our UK success has resulted in three major suppliers actually expanding the franchise territories for us to include The USA. Third is that they are continuing to internationalize the group. Here, The USA restructure of the components business has resulted in us expanding one of our core UK business units into The USA. And the fourth pillar, developing our own brand product portfolio. Here, the custom power brand is being developed to include own brand leading edge battery packs, and greater emphasis is being given to developing the Duracool brand as well.

16:32 Our key strategic pillars not only define how we run the group to achieve organic growth in our target markets, but they also underpin our approach to acquisition targeting.

16:43 Where we identify that a strategic acquisition is the right strategy to derisk the delivery of growth or to improve our market or technology penetration, then we use the strategic pillars to help inform that acquisition targeting just as we did with the acquisition of Custom Power.

17:03 By comparing a potential acquisition to the four pillars, we're quickly able to determine whether the target is a good strategic fit and whether it will further our goals. Of course, this doesn't mean that we've stopped being opportunistic or or that we would ignore a business that didn't meet all of the pillars shown here. As we get bigger, there could well be opportunities that would allow us to, for example, remove cost or increase market share or improve PBT, all of which would help us in our quest to maintain that 20% compound growth in total shareholder return.

17:40 And then just to put a bit more detail on the Custom Power business that we acquired over a year ago, The integration of Custom Power is now largely complete. The really good news is that we've received the US Department of Commerce clearance on the export status of the technology that we acquired, and we do not have any export control restrictions.

18:04 What that really means is that we have now been able to start and get The UK and USA engineering teams to collaborate where that's appropriate. And positively, albeit it's early days, we've secured a significant new customer with an industrial global client and that requires a smart pack for a cordless scanner.

18:26 Here, our ability to design the pack to meet the quality and performance was absolutely critical. Our ability to manufacture the pack initially in The USA whilst having a European supply base was a key point of differentiation that helps us to win that project. The design work has started and we expect deliveries on that in the latter part of f y twenty four five.

18:52 The development of the senior team is ongoing. We've made good progress already adding two very high caliber team members who are already making a difference to the team, notably a head of finance and a new COO. Work is underway to adopt the custom power brand in The UK. We've also made significant strides in developing our portfolio of own brand, lithium ion phosphate packs. These packs that you can see on the screen are designed to be lead acid replacements. And as you can see, they come in the traditional form factor like a battery for their car with a range of different power capabilities. And the last battery that you can see on the right there is actually a 48 volt module that's being trialed in low speed vehicles, typically the vehicle that you can see there on the right hand side.

19:48 To you, Gary. Thanks, John. So in summary, component lead times are improving, but some long lead time items continue to dictate schedules and extend programs. Continue to see a strong pipeline and design demand across our target markets. This gives us confidence in the midterm, albeit we remain cautious as we enter 2024 given current macroeconomic and geopolitical instability. We're looking to exploit significant opportunities with a number of our Tier one customers. This will require continued investment and potential for additional production capacity in our systems business as we enter the New Year. We've upgraded the current year forecast based on the strength of our open order book and the record start to the year.

20:38 And looking forward, the growth drivers in our technology and engineering expertise remain resilient across our target markets. We're confident we can continue to deliver strong growth over the mid and longer term to 2030 as we seek to 20% combined annual growth in TSR. That concludes the presentation. Happy to now take questions. Yes. Super. Thank you, Gary, Pete, John. Now if we can turn to the questions, we have had a number of questions submitted ahead of the presentation, but please do continue to submit using the Q and A tab in the top right hand corner of your screen. Additionally, your feedback is important. So immediately after the presentation has ended, you will be redirected for the opportunity to provide that feedback.

21:23 John, maybe we could just start with you. Andrew asks, how does the rebranding of the components division to SOLICED align with the company's overall market positioning strategy? Yeah. It's a fair question. So the the rationale behind changing the components business to SOLID STATE was about bringing all of the various companies together within that division. And what we've learned from that is that the the entire group will look at rebranding in terms of giving us a common look and feel and common attributes across the business. So you will see us rolling out over the coming periods some level of rebranding for the rest of the business. It was it was a very interesting exercise to go through. It was done by a third party very insightful about how the business can draw together.

22:18 So you you will see that expand and you will see it drawing the group more closely together. Super. Thank you. And and maybe if we can stick with you for a sec. We've got two questions, which relate to component lead times. Yeah. Christopher says, can you provide more details on how the improving component lead times are expected to impact revenue and margins? And the other question was, do shorter component lead times present greater opportunities? Maybe you can talk around those particular Absolutely. So, certainly, are improving component lead times, but it's not a panacea. Older technologies are still on long lead times. They have come down. They've come down from perhaps fifty weeks to about thirty six weeks, whereas the newer component technologies, there's been a lot of investment. Those lead times have come down from what was, again, about fifty weeks down to about sixteen weeks, in some cases, eight weeks.

23:21 The impact on margin of the component lead times coming in has actually been virtually zero. Margins were maintained through the shortage periods with some margins increasing. Margins have been maintained now that lead times are coming in. There's been no move by manufacturers to reduce or increase pricing. So if there's a significant degree of of stability still in the marketplace where component shortages have been impacting it. Is there another part to that question? I can't see it on the screen. Yeah. In terms of opportunity, it's it's a quite a difficult question to answer. It's not the the lead times themselves that are impacting the opportunity.

24:16 If you look at our order book, where the lead times are fifty two weeks, you cannot impact the current year by taking more business. The product just isn't available. So what we refer to is turns business. So where we're able to take new business and turn that into a billing in the same period, we refer to that as turns business. So the opportunity for turns business has certainly improved, but we are seeing destocking and that does mean that our order book has come in somewhat so that customers are returning to a much more normalized order period. So so some opportunity in terms, but not dramatic opportunities in terms of new business. That's driven by our design in activity.

25:09 I think what it does impact in we monitor our design funnel is, obviously, as John said, we've got very extended lead times. It just it does elongate the whole process of turning a design into production where lead times are short, you can do that. And electronics is all about innovation. So it is impacting that. And hopefully, lead times return to pre COVID levels, that cycle can improve. Great. Okay. Thank you. And we do have another question related to lead times, but it's to do with the NATO order. Andrew asks, you mentioned a five year lead time for the NATO order. Is is this typical for such contracts? It seems a large investment if the outcome is uncertain. It isn't it isn't a five year lead time.

25:55 The lead times actually on the on the the radios are actually quite short. It's been a five year design cycle of having the product adopted, not a lead time. Yeah. Fine. Great. Okay. Pete, if we could just put a couple of questions to you very quickly. Given previous references to working capital management, can you update on the current working capital position? Yeah. Absolutely. So, yeah, at year end, we had very significant inventories. They have unwound pretty significantly through the first half. There are opportunities for further unwind, in the second half. However, that said, if you'd asked me this time last year whether I'd have in excess of £5,000,000 worth of inventory for a commercial opportunity with a security and defense customer, I'd have said no. So, yeah, we're intrinsically cautious. If John and Matthew can find a significant commercial opportunity that we need to invest in, we're well placed to do that. So, yeah, we try and set cautious expectations, and hopefully, there are some some nice opportunities to invest in, but, there certainly are upside opportunities on unwinding inventory.

27:08 Okay. And and actually, that plays into a question Christopher has just submitted, which is given the strong cash generation, what areas are being prioritized for future investment? If there's any detail you can add to that. So I think, yeah, in in terms of activities, there's yeah. The group invests in organic initiatives as well as acquisitive initiatives. We had a slide that John talked to in terms of of m and a. We absolutely have a pipeline of m and a. Yeah. Gary talks about having a willing buyer, willing seller, so it's actually quite hard to predict exactly when they will will come to the table. But, certainly, there's a reasonable amount of work to look at that. The m and I know there's another question on here, Tom, about m and a. M and a projects are about, as John said, where it reduces risk compared to doing it organically.

28:03 If we look at the organic opportunities we're investing in, it's really about the own brand portfolio. So Duracool on the component side and own brand products on the system side. So, yeah, on the slide there, you saw the custom power branded products. We'll look to bring those back to The UK, and the the rollout of the custom power brand more widely in The UK as well will be something we look to do over the the year ahead. Yep. Okay. We'll come back to m and a if that's alright because we we do have a couple of questions on that. But, while we've got you, Pete, maybe we can just look at two questions relating to margins. Yeah. Have from Lawrence. And, please, could you outline the drivers of improving underlying operating margin to double figures? But also a question which is slightly more general, but maybe you could add some color, which was what are the general trends in underlying margins? So two aspects of the margin question.

28:57 Yeah. Yeah. So in in the period, we've seen yeah. We talked about significant security and defense, deliveries, which are more akin to the margins we typically see in the components business, which are mid to high twenties. If we were to normalize for that, actually, the underlying margins across all of the business units and divisions are are trending positively, and certainly are stable. So the the effect in the current period is a mix effect. However, the operating margins have been, again, stable period on period. So 9.2% was the the operating margins in the fill in the full year, which is the same at the end of the first half. And that reflects the operational gearing benefits we've seen.

29:45 In terms of how we're going to drive it forward in the in the midterm towards double figures, and to to meet our ambition of seeking to get towards 12%, Operational gearing is clearly an important part of of driving operating margins, but also improving the mix. So own brand product is clearly critical in the components, side of the business. And, yeah, on the system side, it's about projects and programs that have longer through life with greater engineering expertise that's recognized and valued by customers. And that's the, yeah, isn't broke, don't fix it type approach. It's doing what doing more of what we've done over the last three or four years, to deliver the successes we've had today.

30:33 It's also introducing these, like, training and support. So the radios we're supplying, we've got four experienced special forces personnel now that are doing training on these radios. They're devices, and they need to be utilized fully. And that gives us a sort of post sale revenue stream, income stream from that. So we'd look to do more of that as we go forward. Yes. Great. Okay. We've touched on security and defense a couple of times. Is the security increase in security and defense work structural increase, which could be long term? I think, yeah, as John talked about, there certainly are opportunities for for follow on orders, which are are are really quite exciting prospects.

31:22 Yeah. The the NATO countries are really focused on on what their budgets are, and I think it's well publicized that there is increased spending on security and defense. Yeah. I think if we look back previously, there's certainly been, yeah, good levels of spending. It's increased pretty significantly, and I think that's likely to maintain for for the next sort of mid to longer term as well. So So I I certainly think there are significant opportunities in that sector, and I think it's likely to be resilient in the midterm. I think with, you know, with with some more shortage on on greater budgets for defense and security, There will be programs that will come to fruition that wouldn't otherwise do that with smaller budgets and very much the focus is on technology in defense and security market. That's where the investments are going. So that plays well to the SOLID STATE.

32:18 And I think earlier, Gary, you pointed out that, in fact, this increase in security and defense spending isn't immediately in response to what we're seeing geopolitically in the news right now, is it? So No. There's I mean, there's there's been since about 2014, there's been increased increased defense expenditure across the NATO countries. You can look at that online and see the let's see what the budgets have increased generally across all the NATO countries. Yes. Great. Super. Thank you. Right. So coming on to M and A. Ian asked, can you discuss the company's approach to evaluating and pursuing acquisition opportunities and how they align with your ambitions? I think John covered that well in the we have the four pillars of our strategy. We'd look to see how that acquisition is fit going with that.

33:06 I think key to us currently is own brand complementary products internationalizing the group. It's not to say we won't look at other acquisition opportunities, but we have a mix of pipeline of various sizes. But, you know, we are we are very fussy. We we look at those businesses. If they don't if they don't have the right fit, we won't pursue them. And we've had a few of those in the last six months or so. We have got somewhere where we are progressing. And, you know, we but we do rigorous due diligence. We looked at 47 businesses in North America before we acquired Custom Power, and we would carry on that rigorous due diligence as we're looking at expanding operations and acquisition targeting in The EU.

34:00 Super. And maybe could you give us a very quick update on the Custom Power? Obviously, that was a very major event of last year. And obviously, the integration and cross selling opportunities are of interest to investors. Maybe you could just give us two seconds on that. I think we covered that, hopefully, in that slide. But now that the export control clearance has been given by the Bureau of Commerce in The U. S, we can look to do that. So there's significant skills that we didn't have as a group in software, in the battery pack, in the battery management systems, in pack heating, in various controls of of the packs. As they get larger, the the demands on them is that you're handing a lot much greater power than you would do in a smaller pack, so we can share that that knowledge. We they've got good expertise in UAVs in The USA.

35:00 We've got expertise in energy, and that's an area we work in so we can cross fertilize there. And certainly, new introductions of own brand in that we saw in the slide there for low speed vehicles is something we'd look to bring across into Europe. Super. And final question from Nigel. One for you, Pete. Am I right to understand that forecast revenue in '25 is below '24 as stated in the latest RNS? Yes. It's flat, essentially. So, yeah, the revenue consensus that the analysts have published is is flat year on year, and I think that's against the backdrop of, yeah, the security and defense contracts we fulfilled in the first half have been particularly significant.

35:51 And, therefore, yeah, the level of growth to mitigate those is is not insignificant. Yeah. Great. Super. Alright. Well, look. Thank you, Gary, Peter, and John for updating investors today. Could ask investors not to close this session as you will now be automatically redirected for the opportunity to provide your feedback. If anyone has further questions or would like additional information on SOLID STATE, please do get in contact via solid state at Warbrook PR dot com. Many thanks for attending, and we look forward to updating you again soon. Thank you. Thank you.