Hexagon Composites ASA

OSE:HEX

Earnings Call Transcript 2018-Q4

[David Bandele, Chief Financial Officer]

Welcome, everyone, to Hexagon Composites' Quarter 4 and Preliminary Full Year 2018 Earnings Broadcast. As usual, my pleasure to take you through the group highlights. We will also touch on the Agility transaction update. I will go through the summary group financials. Jon Erik will join me for the outlook. We'll both be available for questions and answers. Also, I'd just like to point out that the Appendix to this presentation, which is available on our website, you will find more details about the segment financials and also the pro forma financials for 2018, looking at Hexagon and Agility on a combined basis. So please take time to view those at a later time. So without further ado, highlights for quarter 4 2018, top billing goes to our work on Agility Fuel Solutions. We both signed the agreement in quarter 4 and, subsequently, completed just after the year-end a NOK 1 billion acquisition of Agility. And this is by far the largest acquisition in Hexagon Composites' history, and we really look forward to generating value in the years to come. This will then become by far Hexagon's largest segment. Strong quarterly revenue for 2018. So the strongest quarterly revenue, actually, driven by Mobile Pipeline. It's actually Mobile Pipelines' second highest quarter of all time. So a fantastic quarter there, primarily driven by North America. But also, we've increased some of our applications. We have done our work or provided our systems for our pipeline intervention amongst other things. Also, in the rest of the world, in the same quarter, we took an order for the U.K. market for NOK 65 million and that will have delivery in 2019. Strong Agility Fuel Solutions profitability. The Heavy-Duty Truck sales cycle has also had a strong quarter 4, and we're really pleased to extend our long-term agreement with New Flyer in the U.S. for a total value of NOK 640 million. And this is primarily for CNG, compressed natural gas, bus systems. It's a hot and getting hotter market in hydrogen. We have increased our deliveries to heavy-duty applications and also very pleased to receive U.S. Department of Transport permit for actually high-pressure hydrogen transportation systems. So the -- here, we enable the infrastructure that you will require in order to utilize hydrogen, get hydrogen to the point of application. So also making waves in the U.S. for hydrogen. I wanted to update on the Agility transaction. Obviously, this is a key milestone for Hexagon Composites. The illustrations here look at the effect of 2018 accounts as if Agility was purchased at the start of the year. So on a combined basis, based on 2018, on the left-hand side, you can see revenues would go up to NOK 2.9 billion. So more or less, doubling revenues. And on the right-hand side, we see EBITDA, we would record then around about NOK 364 million. So doubling revenues and double-digit EBITDA margin, we really look forward to reporting that in 2019. So we will move away from equity accounting as I've shown, and we'll consolidate Agility's results from 2019 onwards. Just to mention, we see some one-offs in quarter 1 that we'll post. One is a gain on the transaction, net of fees, are estimated to be around NOK 72 million. We would also post a connected deferred tax accrual on that gain of NOK 17 million. In terms of the accounting, the purchase price allocation, that exercise is ongoing. And of course, that exercise will then determine the split between the depreciable part of the intangibles and the non-depreciable part, which is the goodwill. So more to come in quarter 1 2019. So back to the fourth quarter 2018. Again, just to emphasize, Agility's figures are not in this quarter. We recorded, starting with revenues on the left, on the right-hand side, the orange, NOK 426.8 million in revenue, that's an increase of NOK 68 million over same quarter last year or 19% growth, and that growth is really coming from Mobile Pipelines. If you move to the center, we recorded EBITDA of NOK 55.2 million for a 13% EBITDA margin. Worth noting that in the NOK 55.2 million, we did have a remaining and last and final earnout reversal. This is to do with the earnout in the 2016 xperion transaction. So our obligations are fully removed as of this point, the end of the year. And just to touch on that again, those obligations stemmed from a very high case for xperion, which included a certain emerging market, a new market for both xperion and Hexagon at the time. Unfortunately, that new market has -- unfortunately or fortunately, that new market is not accessible due to political reasons, but maybe that will become accessible in the future. If it does, we don't have any obligations to the former seller of xperion. Also, in the quarter, we had the hydrogen dilution. So we continue to ramp up the organization. Hydrogen is our game changer of the future. At the moment, it requires a lot of investment. And that dilutive effect was negative NOK 14 million. So when you add the 2 up, there's a plus NOK 4 million impact in the EBITDA for 2018 quarter 4. Moving over to the right for net profit, we posted a very healthy NOK 27.3 million net profit. It's slightly down from last year, and I can explain. Firstly, we did take an asset impairment charge of minus NOK 16 million, funnily enough, connected to xperion as well. So when we purchased xperion, there were some assets that have remained idle. They will find a use, but we will use them for low-volume manufacture. But as part of our Q4 processes, we have written them down to -- by minus NOK 16 million. The Agility joint venture contribution line, you will see a effect of plus NOK 31 million year-over-year. So fantastic results from Agility, and you can see them below the line. Financial charges of plus NOK 9 million, mainly positive currency effects and the negatives are tax. We had a normal tax bill in this quarter 2018. But if you recall, in quarter 4 '17, we had the U.S. tax reforms from the Trump administration. And that actually generated a tax credit same quarter last year. This is an important picture because to the right, we isolate the impacts of hydrogen. Remember, hydrogen has a different profile at the moment. The rest of the business, on the right-hand side, you see posting 13% and healthy EBITDA margins. So the business operating results of Agility. On the ground, it's been a fantastic year as you see the 5 quarters' picture. Right on the far right, Agility posting USD 52 million revenue, $7.9 million adjusted EBITDA and for adjusted EBITDA margin of 15%. So very strong. And you can see, the second half of the year, quarter 3 '18 and quarter 4 '18, really dominated by the rebound in heavy-duty truck sales. For the year, there's been continued increase in the Transit Bus volumes, strong Refuse Truck volumes as well and good liquidity all around. So for Agility, it's been a very good year. Balance sheet. Again, before Agility, we have increased the balance sheet mainly due to certain assets. We brought in the Digital Wave acquisition as well. And to the right-hand side, we can see that we've increased our net interest-bearing debt from NOK 326 million to NOK 383 million, again, primarily due to the Digital Wave acquisition still maintaining a very healthy balance sheet, 59% equity ratio. Looking at the cash movements. In quarter 4 '18, we've started with NOK 125 million balance. Underlying cash flow from operations, excluding working capital movements, was plus NOK 33 million. The operating working capital changes were positive, plus NOK 88 million. You will recall in quarter 3, we built up a lot of inventory so -- and we saw that inventory sold by Mobile Pipelines from quarter 4, for example. To the right of that, we actually also invested in Mobile Pipeline assets in a leasing pool. So we have around about minus NOK 54 million worth of assets there. These assets are available for resale or short-term leasing. At the moment, they are on short-term rentals as we speak. We also spent NOK 34 million in normal CapEx and development, NOK 64 million was the Digital Wave acquisition and we have part funded that by drawing on loans of NOK 44 million. So let's just take a view of the full year 2018. Again, this is unaudited. And again, this is obviously before the Agility transaction, which will only kick in, in 2019. On the revenue side, we have increased by 4% to just under NOK 1.5 billion. Mobile Pipelines saw 40% year-over-year growth. So fantastic growth in that segment. However, that was cushioned by lower hydrogen revenues. And this is lower commercial revenues on the transportation side but, however, more development revenues. And obviously, transportation products are products for sale as normal. On the development side, these are usually 2 or 3 years for which you have to record certain milestones. So you record the revenue at a slower rate. Also, we had lower light-duty volumes for the year. Again, we were impacted by this worldwide harmonized light-vehicle testing procedure, WLTP. Certainly, that was useful in quarter 3. That was quite substantial. We had almost no sales to our major customer in Europe. And in quarter 4, we have rebounded, but there are still -- been some effect there.Moving on to EBITDA, in the middle. We recorded NOK 234.6 million or a 16% EBITDA margin. Again, 2 impacts impacting that number. The earnout reversal in total for the year was NOK 109 million, and the hydrogen dilution impact total for the year was minus NOK 55 million. We also note that in the 2017 figure that also included some positive one-offs of NOK 27 million. So very good change year-over-year on the EBITDA side. When we look to the net profit, we've more than doubled net profit and recorded a NOK 145.5 million. And that includes absorbing that asset impairment charge we talked about of NOK 16 million. The Agility contribution year-over-year is NOK 34 million positive. We did have a very positive foreign exchange impact. In total, the financial charge line is plus NOK 45 million. And the tax difference, same reasons as I gave in quarter 4, was minus NOK 43 million year-over-year. So very pleased with the bottom line performance there. Let's look at Agility Fuel Solutions full year. I'll start with the charts -- top charts. We will see, and these are in U.S. dollar millions, Agility grew revenues by 10% to $174 million and grew adjusted EBITDA by 36% to $20 million for a 12% margin. So really, a lot of volume, economies of scale that has been influencing the profitability in Agility. On the bottom hand -- sorry, on the bottom of the -- the bottom chart, we'll show how we take Agility's results as a full reconciliation in the Appendix. Basically, it means we take the results, take 50% of them, turn them into NOK, we get to NOK 31.8 million in profit. But we also have a intangible amortization piece. So we have a net performance from Agility of NOK 18.4 million for the year coming below the line. So Agility, again, year-over-year growth in Refuse, Bus and Powertrain, which is more or less the propane systems and, obviously, the strong rebound we mentioned in the second half of the year on heavy-duty truck sales. Again, some of that was influenced by the introduction of the Cummins 12-liter new engine, low-NOx engine. And that has allowed the demand to come through once again. Point to note, Transit Bus systems in terms of Agility, this is their largest business unit. And in that large business unit also grew 20%. That's fantastic. And the Refuse Truck systems also grew 21%. And remember, Transit Bus and Refuse systems very heavily are driven by environmental factors over economic factors. Powertrain Systems grew by 84%. But of course, this is still in startup mode. So that was only brought in, in middle of 2017. So 2018. Has it been 1 year already? In terms of our financial scorecard, I will start with this. Hexagon, strength in the group is that we have this business unit core, Hydrogen. Very exciting growth driver, game changer for the future. At the moment, it's a dilutive business as we grow that. But we can still have that Hydrogen business unit as well as very healthy other business units that allows us to fund the Hydrogen. And when we look at our doubled EBIT -- double-digit, sorry, EBITDA margins for the non-hydrogen segments, I think this really gives some strength to Hexagon. So absorbing the Hydrogen growth and investment for the future has been key. The 40% revenue growth in Mobile Pipelines is the highlight. 36% adjusted EBITDA growth in Agility. So this accretive investment doubling our revenues going forward is something, as I said, we're very excited to in '19. We have record production volumes in LPG and 21% EBITDA margin. So not bad. And we've more than doubled our net profit to NOK 146 million, at all times maintaining a strong balance sheet. So in 2018, we stood here and we really sharpened our focus on the hydrogen opportunities. Some of the results of that were largest 0 production contracts. In total, NOK 1.8 billion in the hydrogen sector. And in 2019, with the Agility acquisition, we look forward to like increasing the value and, basically, our portfolio solutions for ultimately cleaner air. And on that lovely topic, I welcome Jon Erik.

[Jon Erik Engeset, President & CEO]

So thank you, David. Good morning, everyone. By going from 50% to 100% of Agility Fuel Solutions, we really completed the mission that we set out in 2016, taking the heavy and medium duty segments from being a product supplier, tank supplier to being a fully integrated system supplier. And we feel very good about the timing of that. The Global 0 emission transportation trend is getting stronger quarter-by-quarter, and we consider that as the main driver for this business unit today. U.S. production in natural gas has gone up by 40% over the last 10 years. And that increase will continue in the future years. The infrastructure, if not in all areas of the world, at least in many, notably in the U.S. and in Europe, is readily available and the technology is mature. So the adoption rates there for heavy, medium duty will be stimulated by availability of resources, economics and the environmental agenda. So far, Agility has delivered more than 60,000 vehicles, most in the U.S., but also plenty in Europe. The business is spread across 4 main segments: heavy-duty trucks; medium duty, school buses, transportation vans, et cetera; transit buses, the largest segment; and last but not least, refuse trucks where the adoption rate has now assumed 80% in the U.S. And we are also across all main technology platforms at this stage. The main one still remains natural gas and biogas. But we also have system solutions now for hydrogen. What we've not discussed at length so far, we will revert with more information after Q1. We actually have solutions for battery electric and hybrid applications, and we also have a business for propane. As mentioned, the environmental agenda is now the main driver. And looking at Q1 for Agility, we see continued very strong growth in the European Transit Bus segment. We see a continued strong markets for buses and for refuse trucks in North America. David mentioned the long-term agreement with New Flyer, which has been renewed. And the positive trend regarding the heavy-duty transportation trucks will continue from second half of 2018 into 2019. So a very encouraging start of Hexagon's full ownership of Agility. Hydrogen. So I recommend all of you to take a look at the Annual KPMG Automotive Executive Survey. It is available on the web. So many interesting pieces of information there. But regarding hydrogen, this is again a confirmation that the leading automotive executives, they assume fuel cell electric vehicles to have an increasing and a very important role in the future mix of technologies and power sources for automotive. And it also confirms what we have stated many times in this room, namely that there will not be 1 technology winning, there will be a combination of several technologies. In addition to Japan and China, now the third major Asian economy, South Korea, has announced the major shift to hydrogen in their energy supply. The South Korean government has plans to secure more than 80,000 fuel cell electric vehicles by 2022 and 1.8 million by 2030, a commitment by the South Korean President. 2,000 hydrogen buses by 2022 and more than 300 hydrogen fueling stations in the same time line. Hyundai aiming at producing 700,000 fuel cell systems annually, going 10 years into the future. We have also mentioned the maritime opportunity. And we see now real projects coming on stream. Obviously, this is a long lead time development. But there are now 4 concrete projects in Norway enjoying significant public funding. So with a high likelihood of realization. And we expect to see more and more of those coming and also spreading to other areas. We, through our joint venture with Nel and Powercell Hyon, are actively participating in 2 of these projects at this stage. And we look forward to developing that business further. CNG Light-Duty Vehicles. So as you will remember from the last couple of quarters, we had a major hiccup with the so-called WLTP testing procedure for light-duty vehicles in the third and fourth quarter of last year. Those issues have now been resolved. It will take a little time before the steep ramp-up that we saw in the beginning last year will resume. But that is definitely what we expect. The first quarter of this year we expect will be similar to the first quarter of 2018, and then we expect a steep increase in the segment in the following quarters. We are very optimistic about the possibility or the opportunities in this particular segment in 2019. LPG. A good start to this year as well. We have mentioned on several occasions that we have run an investment program. We have extended the factory at Raufoss, and we have also made major investments in new technology to support and differentiate our product. We haven't said a lot about exactly what those improvements are, but now the investment program is complete, on time and on budget. We expect it to be fully ramped up from Q2. And really, what we have focused on with this investment is to reduce the so-called permeation. So one of the very few arguments for steel cylinder is that the membrane is completely tied. With this new investment, we are also reducing the permeation rates for composites, thanks to very, very marginal number approaching 0. So no longer an argument to use steel because of permeation. Mobile Pipeline. We are -- we continue to be encouraged to see that our products find their way to new applications and to new customers. The fundamentals are strong. The backlog for Q1 is very good. We have a new order from our largest customer, Certarus. What is particularly encouraging at this stage is that after 2 years of drought, we see projects coming also in the rest of the world again. So David mentioned, we had a delivery to the U.K. And we are optimistic that we will see more deliveries now to the rest of the world for Mobile Pipelines. All in all, we are at this stage optimistic, quite encouraged by what we see. The macro conditions are very favorable. We expect Q1 to be good, mainly driven by Agility and Mobile Pipelines. And we will continue to see a significant dilutive effect from the Hydrogen business. But we are very confident that we are doing the right thing and that we will get payback on those investments in a few years down the road. So with those comments, David, if you will come back onstage, then we welcome some questions.

[Halvor Strand Nygård, Analyst]

Halvor Nygård from SEB. On the LDV side, we saw -- or last quarter, you show the dash line with the steep ramp-up of volumes in Germany. However, that now seems a bit delayed, and you're now saying Q2 will be the quarter of steep ramp-up. What gives you now comfort that, that is happening in Q3 -- Q2 and not as delayed further?

[Jon Erik Engeset, President & CEO]

The market resumed in Q4. We will see continued strong growth from Q4 to Q1. But to continue that growth curve that was disrupted, we will need another quarter for the automotive companies to ramp up their production again. So they have had major disruptions, and they just need their time to get back to speed.

[Halvor Strand Nygård, Analyst]

And on the adoption rate, you showed a quite strong growth within Transit Bus, Refuse Trucks and so on. But in your forecast, what do you expect adoption rate will be within heavy duty? Right now, it's maybe 1% to 2%. But what kind of forecast do you have for Agility in the adoption rate?

[Jon Erik Engeset, President & CEO]

We don't have an official number on that at this stage. What I can say is that if you go back to 2014, then people were talking about 20% to 30% adoption by 2025. That is obviously not going to happen, but I think it's fair to say that the current adoption is at a very marginal level. And with the abundance of natural gas, we should see a significant increase in adoption in the coming years.

[Halvor Strand Nygård, Analyst]

All right. And lastly, on the growth path you're now on and that you expect going forward as well across all segments, what do you see as the largest constraints or risks through that growth profile? Is it the balance sheet and capital? Is it people? Or is it market opportunities? Or what do you see as the greatest constraints or risks to achieve that?

[Jon Erik Engeset, President & CEO]

As you know, our business portfolio is quite diverse. So there are different risks and opportunities in different segments. I think overall, a sharp drop in oil price will be a disruption factor, if that will happen. On the other hand, the environmental momentum we don't think is going to stop in the coming years. So we have a more balanced risk profile in that sense now than we had a few years ago. So in terms of our organizational capability, I would say, the ability to attract the right talent and to integrate fast enough in order to be able to deliver on these market opportunities in a very responsible way is the main limiting factor. But we're working hard on that and growing the organization to accommodate those opportunities.

[Unknown Analyst]

You did not mention anything about potential competitors. I guess with the kind of growth that you see in some of your markets, there must be some competitors on their way here.

[Jon Erik Engeset, President & CEO]

Certainly. We have a number of competitors already. And we think that especially the hydrogen opportunity is going to attract competition. However, we have had a very painful learning curve over more than 15 years in that segment. So we're not sure if all those attracted to that opportunity really understand the demands of the technology. So we think that if we focus on our things, we have a fair chance of staying ahead of the competition. On the -- in the other areas, we've seen actually less competition in recent years. And we would say that the main competitors are now largely serious competitors, focused on profitability and such competitors that we prefer to have, but worthy competitors, indeed.

[Unknown Analyst]

Is there a patent protection which is significant in some of these markets?

[Jon Erik Engeset, President & CEO]

We have several patents. But there are also a lot of things we chose not to patent because the moment you patent, you need to document and then you make it easier for your competitor to work around the patent. So a lot of our IPR is strictly internal and that is quite important to us. So I think I have commented on that before. But to make 1 tank is possible for competent composite engineers to take it from prototype to industrialization and sharing the consistency of quality, keeping in mind that this is gas under pressure, that's where the challenge is and that is not a trivial challenge.

[Unknown Analyst]

What will you say is the percentage cost of a fuel system compared to conventional system?

[Jon Erik Engeset, President & CEO]

Oh, again, a very complex question because there are so many segments and different answers for each segment and technology. But what I can say is that the fuel system is a very significant component of an alternative fuel vehicle. So we have to work hard and the rest of the industry has to work hard in order to continue to drive that cost down.

[Operator]

And we don't have any questions from the web audience today.

[Jon Erik Engeset, President & CEO]

All right. Any more questions here? If not, thank you very much for being with us. Have a good day.