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Summary
- Electro Optic Systems Holdings Ltd. reported an operating loss after tax for half-year ended 30 June 2020, primarily due to deferred revenue in 2H CY2020 and 2021.
- The pandemic led to higher supply chain costs, delays in product delivery, reduced supplier response levels, and postponement in contract negotiation and customer access.
- COVID-19-induced lockdowns caused production disruption and lower efficiency. However, the Company managed to post a 31.3% growth in revenue.
- Electro Optic expects its FY2020 profit to be in the range of A$20 million to A$30 million EBIT and profitability is anticipated to return from 2021 but at a quicker pace.
ASX 300 listed leading technology company, Electro Optic Systems Holdings Ltd. (ASX:EOS) was formed in 1983 and currently operates in space and defence markets through two research centres in Australia. The Company has major production facilities in Australia as well as the US.
EOS reported its 1H 2020 results following which the stock took a tumble on the ASX. At the end of the day’s trading session on 31 August, EOS share price quoted at A$5.570, down 10.161%.
Let us look at the financial performance of EOS during the first half and assess why the stock took a significant hit.
EOS reported revenue from ordinary activities of A$75.437 million, up 31.3%, and net cash used by operations totalling A$62.557 million for the half-year period. The Company’s cash balance totalled A$128.136 million on 30 June 2020.
The half-year sector revenue for EOS Defence Systems was recorded at A$68.4 million indicating a growth of 21% over the corresponding prior period, notwithstanding the impact of COVID-19 on the deferral of revenue into the remaining half of 2020 and 2021. Moreover, loss before income tax for the same sector stood at A$14.3 million compared to a profit of A$10.9 million in the previous corresponding period.
Revenue for EM Solutions for the half-year was A$8.6 million with an operating profit of A$1.6 million, indicating strong performance, in line with the expectations of the management at the time of acquisition.
Furthermore, EOS raised A$138 million in new capital through a fully underwritten institutional placement and Share Purchase Plan in April 2020.
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Impact of COVID-19
EOS’s operations in terms of production output, profitability, revenue generation, etc. during the quarter ended 31 March 2020, were in line with the management’s expectations at the commencement of the period. However, significant changes were made to EOS’s plans for the remainder of 2020 and 2021 due to the COVID-19 related events in the last seven days of the quarter.
Importantly, EOS’s delivery chain, which typically requires 4-6 weeks and involves around 35 staff was broken in multiple places due to a national lockdown and the impact of COVID-19 one week before standard deliveries could commence for a major delivery contract on 24 March 2020.
It is now anticipated that access would open from September, wherein the earliest commencement of deliveries would be from October which is further expected to defer cash receipts to the fourth quarter of 2020.
With the continuous evolution in the COVID-19 situation in Australia as well as globally, the Company experienced headwinds as two out of four of its production facilities (one staff member in the US and three in the UAE) experienced COVID-19 positive test outcomes till date.
EOS has been impacted by COVID-19 in various ways, comprising rising supply chain costs, diminishing supplier responsiveness, delays in product delivery, postponements in contract negotiation and execution, access to customers and inadequacies in staff utilisation.
The Company has been proactive in taking all practical COVID-19 preventative measures as well as measures to reduce its impact on operational performance while preserving positive operating energy.
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Order Backlog and Updated Guidance
Currently, the EMS order backlog stands at A$24 million for the next two years, and EOS has a strong sales pipeline of A$174 million on a risk-weighted basis over three years across all products and geographies, including North America and Europe.
For the Defence Systems vertical, the order backlog currently stands at A$570 million, and the strong sales pipeline along with normal rates of conversion are expected to increase the order backlog in due course of 2021 significantly.
Pipeline and Backlog (Source: ASX Announcement 31 August 2020)
EOS anticipates FY2020 profit to fall in the range of A$20 million to A$30 million EBIT. The impacts of COVID-19 are injecting volatility into the timing of contracts being signed and delivered, causing revenue and profit outcomes for the full year to be difficult to predict, notwithstanding factory output is still meeting forecasts.
The sales pipeline has grown to A$3.1 billion on a risk-weighted basis. However, the outlook for FY2021 is to strengthen growth as activity delayed from FY2020 is stuck, previous work build-up is managed, and pipeline works are honoured.
More significantly, several events unfolding in the present scenario are expected to drive favourable tailwind for all the activities of the Company. Some of these include the following:
- Strong commitment to maintain or increase defence spending amongst almost all Australian allies driven by escalating regional and geopolitical tensions.
- COVID-19 recovery plans typically consisting of accelerating employment in production, with resilient programs in the globally located facilities of EOS.
- Stronger emphasis on the superior technology and cost-effective performance of EOS products driven by increased deployment of asymmetric military technologies such as drones and hypersonic attack against Australia and its allies.
- EOS’s momentum towards having production and supply centres in the Americas, Australia, Asia, and the Middle East is an advantage amid the fragile nature of global supply chains revealed by COVID-19.
Net loss after tax of A$14.262 million, revenue deferment due to COVID-19, and a possible share price correction following a ~6% rise the previous day, likely hurt Electro Optic’s share price.
While EOS’ for 1H FY2020 was affected by the dislocation in the supply chain influenced by COVID-19, there remains significant optimism for the Company in the future as the uncertainties gradually wipe off and the supply chain operations get back to normal. A rise in defence spending worldwide, the Company’s intent on having production centres in multiple geographies, a substantial cash balance, and a sales pipeline of ~A$3.1 billion (risk-weighted), are expected to aid EOS share price gains in the future.
