Oxford Instruments' (OXINF) CEO Ian Barkshire on Q2 2016 Results - Earnings Call Transcript

| About: Oxford Instruments (OXINF)

Oxford Instruments PLC (OTCPK:OXINF) Q2 2016 Earnings Conference Call November 15, 2016 4:30 AM ET

Executives

Ian Barkshire - CEO

Gavin Hill - CFO

Analysts

Henry Carver - Peel Hunt

Ian Barkshire

Hello. Good morning, ladies and gentlemen. Welcome to Oxford Instruments Half Year Results. In terms of the agenda for today, I’ll take you through the highlights for the half year before handing over to Gavin, who will take you through the financial results. I’ll then go through the operational review including the priorities that I’ve identified in my first six months of Chief Executive and then I’ll wrap up with our outlook.

Moving straight on to the highlight, we delivered a stable performance despite challenging market with revenue growth in the half year supported by currency. As a result of our continued focus on self-help we have improve performance in a number of our businesses. In NanoTechnology Tools we saw improved profit, stronger margins and an increased order book reflecting the success of new product and also operational efficiencies.

Revenue growth in the service of our own product was offset with lower sales in our healthcare business and Gavin will go through some more details within his section on this matter. Order book for future deliveries across the group is significantly ahead of the prior year and we continue to invest in our future growth and have increased by research and development spend by 12% in the first half.

I’ll hand you over to Gavin who’ll take you through the financial results.

Gavin Hill

Thank you, Ian. Good morning, everyone. In this section I’m going to run through the key financial statements and give a little color as to the significant drivers and variances that have impacted the half year results. Starting with the income statement. Reported revenue increased by 4.1%. The recent devaluation of Sterling against the U.S. Dollar, Euro and Japanese Yen increased reported revenue by £80 million. On a constant currency basis revenue fell by 6.9%. Adjusted operating profit fell by 5% to £19 million with operating margin falling from 12.1% to 11.1%.

Currency FX have increased reported adjusted operating profit by £1.7 million on a constant currency basis, adjusted operating profit fell by 13.5%. Net finance costs fell by £400,000 to £3.3 million with marginally low financing costs and a full pension financing charges. Adjusted profit before tax fell by 3.7% to £15.7 million with the margin declining by 70 basis points to 9.2%. Amortization of acquired intangibles fell to £8.1 million with the exclusion of the Omicron business. Non-recurring and acquisition related items totaled £1.7 million. Acquisition related costs were £900,000 comprising professional fees and differed consideration on acquisition commitments inherited from the Andor acquisition.

In addition, we wrote down development costs of £900,000 or £700,000 as we redirect resources to prioritized project. The mark-to-market of currency hedges was a loss of £6.4 million. This reflects the fair value of currency derivatives that are hedging future transactional currency exposures to the group. The unrealized loss is attributable to a fall in sterling at the balance sheet date against the U.S. dollar, the euro and Japanese yen against the blended rate achieved on forward contracts that will mature over the next 18 months.

After the unrealized foreign exchange loss the street [ph] recorded a small loss before tax of £500,000. Continuing adjusted basic EPS fell by 1.4%. And finally the Board has declared interim dividend of £0.370 in line with last year.

Looking at revenue by sector, here we can see the positive impacts of currency of £18 million. Half the fall in NanoTechnology Tools is due to removal of Omicron revenue of £2 million with a small decline in NanoAnalysis and Asylum making up the rest. The expected move on to lower priced contracts in the Superconducting Wire business has contributed to a constant-currency fall of 14.3% in industrial products. We've increased revenue from service of our own products about 8% at constant-currency. However lower sales from healthcare more than offset this growth resulting in a small contraction in service revenue of 0.9%.

Moving to revenue by territory. The reduction in Superconducting Wire revenue has impacted the Europe and North America geographical segment. In Europe constant-currency growth was a negative 4.2%, excluding the impacts of wire, constant-currency revenue growth was flat. In North America the decline of 14.7% was partly due to wire and lower levels of academic funding which have impacted across the portfolio. We've had a good period in Asia with constant-currency growth of just under 1% driven by strong growth in China.

The order book has grown by 19% since last year, 5% at constant-currency. Constant currency growth within NanoTechnology Tools was 7% and 15% from service, Industrial Products fell by 10%. The order book now stands at just over a £162 million.

Moving to profit, here we can see on this chart, the main drivers for the reduction and adjusted profit before tax, from £16.3 million to £15.7 million. Decline in volume has fed into lower profit of £3.4 million. Currency transaction and translation gains led to a benefit of 1.7 million. The proportion of total profits from NanoTechnology Tools and service sectors increased slightly leading to a positive effect on profit. And finally as previously mentioned finance costs fell by £400,000.

Looking at adjusted profit by sector, the margin from NanoTechnology Tools improved by a 120 basis points, assisted by reduced losses from Omicron, as it now sits within the new joint venture with Scienta and continued improvement across the portfolio. In industrial products, rise in margin within Industrial Analysis was more than offset by the expected flow in Superconducting Wires margin resulting in a total fall of 50 basis points to 3.2%.

Our healthcare business in the U.S. offers refurbished imaging systems, mobile imaging systems and maintenance services for MRI and CT scanners. The change in software licensing policy by one of the larger original equipment manufacturers has reduced the number of refurbished systems traded in the year. In addition an unusually large number of imaging systems was sold prior to the end of last year. This has been the main driver behind the fall in service profit of £3.3 million and a reduction in margin to 17%. We now expect that the sales volume of refurbish imaging systems and mobile units will be low in current and future years.

Turning to the cash flow, we can see that the business made an adjusted EBITDA of just under £25 million. Operating cash flow was just under £4 million of floating an outflow of working capital of £17 million. While the business normally sees a working capital outflow for the half year, this year it was impacted by three principal factors. First, an increase in inventories of £5 million reflects working progress and inventory building prior to the second half, across NanoTechnology Tools and industrial product ahead of anticipated shipments.

Second, within the healthcare business, we’ve had buildup of refurbished imaging inventory following the unusually high level of sales at the end of last year. And finally, we have seen a reduction in payables due to the phasing of payment compared to the year-end and the transfer of manufacturing production in-house. Total R&D expenditure was £15.1 million of which £4 million has been capitalized. The pension payments of 3.5 million reflects payment to the UK define benefit and recovery plan. Tax paid was £700,000 reflecting utilization of brought forward tax losses.

Acquisition cash flow of £6.8 million is almost entirely due to the deferred consideration for the acquisition of Medical Imaging Resources. Net debt rose to £141.1 million due to working capital outflow and acquisition related cash flows. This represents a net debt to EBITDA leverage of 2.6 times comfortably within our covenant of 3.5 times and in line with guidance given at the year-end. Since the half year-end, the group has paid differed consideration on an inherited Andor related earn-out of £3.1 million, this is the final consideration relating to historic acquisitions.

Given this payment and an expected reduction in working capital during the second half, we expect net debt at the year-end to end a little higher than the previous year. The business has a large exposure to foreign currency fluctuations facing translational and transactional currency exposures. Our total currency exposure is detailed on this chart. For the half year in sterling equivalent, we have net exposures of US$31 million, €8 million and ¥6 million. As many of the manufacturing sites are based in the UK, we have a short sterling exposure of £25 million.

The group maintains a hedging program against its net transaction exposure using internal projections of expected currency trading transactions expected to realize over a period extending from 12 months to 24 months ahead. We’ve seen weakening of sterling against our major trading currencies. If currencies were to continue at current levels and assuming a constant mix of currency results, we expect a currency benefit of approximately £7 million to operating profit in the 2017-’18 financial year.

So in summary, a stable year with trading and net debt broadly in line with where we expected. And with that I’ll hand back to Ian.

Ian Barkshire

Thank you Gavin. I would like to start the operations review with a reminder of our three sectors and how our business is organized. The NanoTechnology Tools sector provides a highest technology product we typically sell to direct end-customers with strong market intimacy and high barriers to entry.

The sector comprises of two divisions, NanoCharacterisation which includes our NanoAnalysis and/or technology and Asylum businesses, and NanoSolutions which includes our NanoScience, plasma technology, and our minority share of the Scienta Omicron joint venture. Our customers in respect are exploring the fundamentals of science through to the practical application of NanoTechnology in the broad range of commercial applications. We count many noble [indiscernible] and Blue Chip corporates amongst our customers.

Our Industrial Products sector offers more standard solutions to a broad range of industrial customers and also high technology components to third parties. This sector comprises our Industrial Analysis, Super Conducting Wire and X-Ray Technology businesses. And finally our service sector addresses the aftermarket for our own products and the revenues from third parties CT and MRI scanners under our HealthCare brand.

Now looking at a breakdown of revenues across the sectors, over half of our revenue comes from NanoTechnology Tools, a quarter from Industrial Products, with remained coming from service. If you take a look at our end market, the distribution of revenue has remained relatively unchanged compared to the previous year end with just over half of revenue coming from academic and commercial research customers. Within NanoTechnology Tools this is dominated by commercial research in academia with now around a quarter revenues coming from customers in the bio and life science arenas.

Industrial Products remains dominated by two areas the supply of MRI wire and the analysis within metals in construction markets. The contribution from super conducting wire continues to reduce as a portion of the revenues from this sector.

Now moving on to a more detailed review by sector starting with NanoTechnology Tools. Our NanoTechnology Tool sector continues to show improvement with increased profitability and order book despite a backlog of reduced academic funding and weaker industrial markets across North America and Europe. We continue to see strong revenue growth in China, and the strength of our brand and the success of our recent product launches have enabled us to maintain pricing, driving improved margins across the sector. Within NanoAnalysis we delivered a strong performance maintaining market share to existing products and new product launches. The introduction of application specific solutions continues to create more value for our customers and also broadens our customer base.

Andor technology continues to show good progress with improved profitability driven by strong product launches right across the portfolio and continued business efficiency. In the period we completed the transfer of our Canadian manufacturing facility to our Belfast factory. Asylum research had a slower half year primarily due to the reduced academic funding in the U.S. and Europe markets. We responded by reducing costs within that business units but we continue to invest in a range of new products and solutions to bring our high performing systems to a broader range of customers and applications. Plasma Technology continued to show good recovery in the periods, increased orders and operational efficiency. NanoScience grew revenues supported by the global increase in constant technology funding. And we further cemented our market and technical leadership in this growth area, we’ve increased sales of our Triton and Optistat Dry products.

The ScientaOmicron joint venture continues to perform in line with our expectations. Moving on to look at progress and the initiatives within the sector. And here I’ve chosen examples that characterize the direction of travel that I will be driving across the group, whereby we focus on products that deliver unprecedented performance and ease of use. Providing increased capabilities and productivity to our customers.

So within Andor, we recently launched our Dragonfly microscopy platform. Dragonfly let’s researchers capture sharper, higher contrast images at significantly higher speeds. It utilizes our unique optimal illumination system and when combined with our highly light sensitive cameras delivers exceptionally performance resolution and sensitivity. As an example, if we look at this image of the hippocampus part of the brain, the part of the brain responsible for memory. The speed and sensitivity of our solution enables a researcher capture large data sets covering the entire sample area of interest whilst retaining the required resolution to observe the mechanisms and characteristics of portions passing between the nerve cells which control the formation of memory.

Now this particular study was investigating the causes of Alzheimer’s, but this technology has the capability to provide more insights into a wide range of diseases, not just those related to the brain. And two further examples in NanoTechnology. Our top image depicts our AZtecClean product from our NanoAnalysis business. It's a good example of where we’ve used our customer intimacy and technical capabilities to develop software packages that deliver applications specific solutions. This product enables our customers within the automotive industry and related supply chain the ability to certify the cleanliness of their components to ISO standards.

The image below show our next generation Triton cryogenic system which is a good example of where we have extended the capabilities of our existing products. Here we are increasingly providing integrated measurement and analysis systems in combination with the market leading cryogenic platforms. This significantly increases our customer’s productivity.

Moving on to our next sector, Industrial Products. And here revenue was down due to the demand for superconducting wire from our customers to manufacture MRI systems and continued weakness in the metals and construction markets. However, the launch of new products combined with efficiencies across the sector that delivered an improved profitability from the industrial portfolio, if we exclude the decline from the superconducting wire components.

In our industrial analysis business we have continued to make margin improvements despite the challenging market softness through a combination of new products, improved reach to markets and further self-help actions that have increased our efficiency. In our superconducting wire business, in the first half of the year we successfully completed a major contract for one MRI customer and successfully renegotiated the continuation of our long term supply agreement with another customer in MRI.

In our X-Ray Technology business, we increased revenues in the period and continue to see interest in our X-Ray sources across medical and industrial applications. However, we do continue to be impacted by the softening in our customer's owned end markets.

Looking at progress within industrial products and here again I’ve picked a couple of examples that emphasis our increased customer and market focus. The top picture shows our Pulsar system which we have successfully grown sales in both Academia and across a broad range of commercial applications. As we go over the AZtec example, here again we are tailoring our existing hardware to provide application specific solution through software and data interpretation.

In this particular example, we are hoping traders that practically value coffee batches by measuring the percentage of the more highly prized Arabica [ph] beans by using a unique chemical fingerprint with an easy to use affordable system. The second picture here shows our innovative Hero Window which enables customers to analyze hot metals up to 400 degree centigrade using our handheld analyzers, dramatically increasing their productivity with removing the needs to allowing the samples to cool prior to analysis.

If we move on to our third sector Service, within the service sector as Gavin already mentioned, we saw a constant currency increase of 14.6% in our in our order book and we continue to see an increase in revenues from the support and additional services related to our NanoTechnology Tools and Industrial Products.

However, as Gavin already outlined, we saw a reduction in revenue and operating profit from our healthcare business due to lower volume and sales of refurnished systems relative to the previous year. I remain confident that service will be a growth sector within the group over the medium term and our focus will on providing more support to help our customers. And by way of example, we have launched a number of new web stores across the U.S., Europe and China, offering a range of consumables for our own products and application related services. Also we're increasingly using data logging within our products and remote diagnostics at customer sites. This provides proactive service intervention, increased customer productivity and an improved operational efficiency within our service teams.

So, that's a roundup of our three sectors, what I'd now like to do is to touch on the priorities that I identified within my first six months as Chief Executive with the objective of returning the group to long term growth. I remain confident that the increasing role of nanotechnology in both research and the broadening range of industrial markets will provide long term growth opportunities for all products. But in order to translate this into a long term shareholder value, I have identified a number of key areas for improvement and that we will now make core capabilities across the group.

Firstly, we'll enhance our customer market focus to develop even deeper relationships with our customers to ensure that our products better meet their current and future needs. This will enable us to better identify growth trends in both existing and new market segments where we can provide additional value to customers. AZtecClean which I mentioned earlier is a good example of progress in the right direction. We'll increasingly focus our capital investment and resources to align with these growth segment where we have the opportunity to build sustainable market leading positions.

We will continue to build in our heritage of product innovation, investing in our customer's future by further aligning our R&D roadmaps with their needs and Dragonfly is a good example of this. To create more opportunities and accelerate the delivery of our research and development we will increasingly use and exploit the technologies and capabilities and synergies from across the group.

Also, we will increasingly enhance deliver enhanced product solutions that will help our customers to achieve their outcomes efficiently and effectively. For some customers this will mean the presentation of results without the need for further intervention or interpretation; for other customers this will mean higher performing easier to use instruments that will increase their capabilities and productivity. Triton is a good example of where we now provide complete measurement systems, not just the cryogenic hardware.

And furthermost and importantly we will seek to make operational excellence a core capability across the group, this will include how we manufacturer and deliver our products and services to our customers and in combination with our market leading product it will provide the opportunity to drive efficiencies and productivity gains to enhance our customers' experience and improve our profitability.

So, that completes the operational review including the progress that we've made in the half year. Looking ahead to the second half, revenue and order book are ahead of last year, but given slower academic funding in North America and Europe and lower sales in our OI Healthcare business, we expect to deliver current full year performance in line with last year.

Looking further ahead, we expect the currency benefit of approximately £7 million to operating profit in the 2017-2018 financial year. And as I already stated increasing role of NanoTechnology in both research and across the broadening range of industrial applications, it will continue to deliver long-term sustainable growth opportunities for our products and solutions. In the shorter term, we will continue to focus on self-help initiatives to improve our ongoing performance.

Thank you very much for your attention. Gavin and I very happy to open the floor to any questions. And that is being recorded, if you could just mentioned your name before question that will be helpful.

Question-and-Answer Session

Q - Unidentified Analyst

[Indiscernible].

Ian Barkshire

The most significant relevant will be the Wire business and then the HealthCare business and then across NanoTechnology Tools that I mentioned, it’s broadly across the portfolio weakness in Academic funding is impacted.

Unidentified Analyst

Probably down like 3%, 4% top of replicate [ph].

Ian Barkshire

Yes.

Unidentified Analyst

And I guess the wider question is, is this kind of constrained academic funding environment seems to be quite a long-term dynamic that we’ve been facing now. And so I’m just trying to get a feel for how we are convinced this is actually going to turn at some point and when that would be?

Gavin Hill

I think it’s very difficult to predict the timings when governments will release money, even if they say they are going to release it. But I would say is that we saw quite strong peeks in the U.S. So the comparative years were quite tough. But we are seeing as an increase funding for research in Asia, in particular Japan and also in China where we’ve seen significant growth in China. In Europe and in America our prospects for future always are looking very positive and there is lots of customers who are very interesting buying our products, they are still awaiting funding, which they believe they will get, but we won’t know until it’s actually release.

Unidentified Analyst

Okay. And I mean is the NanoTechnology business still in terms of the next three, four years very much contingent on growth and academic funding or is the potential for commercial funding start to drive that business?

Gavin Hill

Absolutely, I mean, I mentioned it’s significantly dominated by research, it’s both split between academic and commercial applications. And interestingly in our very high technology products, which one might believe would only be in Universities, we have many Blue Chip corporates who are investing in exactly the same technologies, where it be the fabrication of the next generation semiconductor devices or quantum computers. The only difference between the corporate labs and academic ones, is they don’t publish their results and that they’re better funded.

Unidentified Analyst

Okay. Thanks very much.

Henry Carver

Thanks, its Henry Carver from Peel Hunt. Just a couple of questions on sort of the four key areas that you’re driving improvement. In terms of the enhanced product sort of solutions that you talked about, what is the rough split at the moment between -- what is that sort of full solution that you’re providing and more just the tools and the materials?

Ian Barkshire

Well it very much splits differently by business and the type of product that we have. What I want to drive increasingly across the group is driving productivity and adding more value to customers. So depending on what the customer is doing, if they are a PHD research, they won’t want to push button black box, but they will certainly want to get to their results more quickly.

So for example in our NanoScience business where it takes -- it used to take 12 hours or overnight to cool your sample down, we’ve now launched a rapid transfer, so you can cool your sample down to ultra-low temperatures in 30 minutes. This means that they can look at many, many quantum devices in a day rather than just one.

So other customers like in the automotive industry and in the hard disk industry, they want lower trained operatives to be able to get accurate valuable answers immediately with a push of a button. And so the same technology can be used in a range at different applications. And this will one of our drives to broaden our customer base and add more value to those customers.

Henry Carver

So the waiting at the moment is presumably towards the former?

Ian Barkshire

It just depends on different businesses. Some businesses are stronger in one and more dominance in I the other. What I would like to do and we’ll be driving is increasing the performance of those products across the whole group.

Henry Carver

Just more broadly do you think you can deliver those sort of sustainable growth plans that you were talking about on the existing also Oxford Instruments footprint or do you think there are going to have to be some material changes made, any comment?

Ian Barkshire

Yes, thank you for that question. I think Oxford Instrument history we have migrated from one technology to another over the years we will continue to make sure that our portfolio is relevant to the needs of our customers and we will continue to look for a new technologies or capabilities that match ongoing growth trends within markets.

Unidentified Analyst

Good morning, Michael [indiscernible] from Investec I think that last question answered or dealt with the first of mine and second one was, could you remind us please, a financial question, could you remind us please the criteria for the FX hits, I see you got about 3.5 million above the line in first half as well as the 6.4 below the line. What exactly drives the [indiscernible] of those and what should we be expecting if anything?

Gavin Hill

The 3.5 million for the half year is a different between the actual average rates that we actually book revenue at and the actually hedge rate that we actually achieved because of the devaluations, sterling is therefore a loss, it’s a profit. That will therefore repeat itself in the second half of the year, although it will be a little a different because of the hedge rates of the second half maybe slightly difference. The rates of the 6.4 million FX reflects hedges outstanding that will mature over the next 12 months so not all of them will mature within this year, although I expect the majority of them to mature in this year.

Unidentified Analyst

Can you -- just wanted to go through the HealthCare as you saw in the first half. I’m slightly confused by the 26% down to 17% margin, I appreciate your probably over performed in last year and you probably underperformed this year. A little bridge to that margin will be helpful. And again can you just quantify kind of fees through into second half and then into next year, can you just gives us a little help as to how much we should be removing from our numbers for next year please? That would be really helpful.

Ian Barkshire

Sure. I think it's just worth giving some clarity as to the situation. The software licenses, to operate [indiscernible] machine is owned by the OEM. Traditionally there have been no transfer or skips in government license. We have been very recently informed as the market has by one of the OEMs that there will be transfer restrictions on that license and any new purchaser of the equipment will have to purchase a new license. Whilst the market take account of what the impact will be and the recalibration of product prices, we are not selling that manufactures equipment, but we will continue to sell other manufactures equipment.

In terms of the impact year-over-year we’re looking at about $3 million and that's probably the amount we expect to carry forward going forward. In terms of the impacts our margin, the impacts on margin is quiet high from 26% down to 17% because the profit flows straight through from renew downs to profit, so it's exaggerated. Also as I did say in presentation, there were a large number of -- highly unusual number of sales made at the end of last year and again you got that impact coming through.

Unidentified Analyst

Is there a risk the other OEMs have the same strategy? [Indiscernible].

Ian Barkshire

There is the possibility, in terms of what that actually means, we don’t believe the market for second hand refurbished equipment will go away. It will slip, it will still be there. For example in Europe where we don’t currently operate, but in that market you are unable to have an exclusive license, you have to be either transfer that license. So we believe the impacts in the U.S. will be just a recalibration of product prices where the equipment price will come down because you are just reflecting it across the software, but it's going to take a little while for that to transpire and come through to the market.

Unidentified Analyst

And second question is on Asia, you said that China was stronger and I think you related to Japan doing okay. You only grew by 1% organic, so what's not good in Asia?

Ian Barkshire

In Asia, other territories Korea we are not quite so strong as other regions, but we have very significant growth in China. And Japan is gearing off, you’ve probably see recent news and what we’re seeing in Japan is a lot of industrial companies, high-tech companies also purchasing equipment.

Unidentified Analyst

And just what is the doubt, when you say performance in line, actually is that profits or earnings?

Ian Barkshire

Yes that's profits. Operating profits.

Unidentified Analyst

And last from me and on your pension deficit, which is going to expire [ph] the 12 million to 13 million, what assumption are you are making currently on bond yields just to make sure we’re in the right place?

Ian Barkshire

We are using the standard bond yields that we have used traditionally. As always I think the latest bond yields just excludes universities. So it’s a standard yield.

Unidentified Analyst

[Indiscernible] I had a few questions. One is, with your strategy it does points to more R&D, I’m kind of consensus that actually the R&D has been rising quite a bit over the last couple of years and I can vendors [ph] come into the mix on that. Just wondering what the or if there is a target level for R&D across the group and like what you said today.

The second question is on the movement in working capital, it’s quite a big move on the payable side I think in the last two years it’s come down from, I think the balance sheet move at 120 down to 89 million is what I’m trying to understand a little bit more, is whether there has been a structural change in terms of how you pay your supplies or anything like that?

Can you tell us what your order impact was in the first half, I trying to the calculations on the new order book, actually just saw new orders weren’t quite as bad as revenues were suggesting, I just wanted to make sure kind of that’s right?

Ian Barkshire

Okay, I’ll take first question on R&D and whether we have a target. We have increased R&D, we will continually increase our focus on where we spend the R&D to make sure that it's driven towards customer needs. We have set a target for any individual business or across the group, we look at our opportunities and we’ll seek to fund them as best we can.

Gavin do you want to pick up the movement in working capital?

Gavin Hill

Yes, at the yearend the group managed it's payables like -- I think many companies it manages health back payables post period of time. At the half year that did not occur, not to such great extend and so we saw a reduction in payables. The trend we saw was not dissimilar to what we’ve seen previously for the group, but it was just a little higher. In terms of your question on orders, orders on a reported basis during last half year and this half year was fairly flat.

Unidentified Analyst

Thank you.

Ian Barkshire

Any last questions? Okay, thank you very much.

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