Enea AB

STO:ENEA

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen, welcome to Enea interim report for January to March 2020. [Operator Instructions]Today, I am pleased to present CEO, Jan Häglund; and CFO, Björn Westberg. Please begin your meeting.

[Jan Häglund, President & CEO]

Thank you very much. So welcome, everyone. And thank you for joining this interim report. My name is Jan Häglund, CEO of Enea, and I will be joined also in this call by Björn Westberg, CFO.On Page 2, we have an agenda for today's call. I will be giving an introduction to our results and also some of the key news in the quarter. Björn will be taking us through more details of the financial results, and then I will wrap up with an updated way forward and outlook.So next page, please. Enea in the period of January to March 2020 presents a total revenues of SEK 227 million, which is 6% down from last year. But here it can be noted that last year, 240 also -- SEK 240 million included a settlement of SEK 20 million with one of our larger accounts.Our operating margin for this quarter landed on 18.3%, excluding nonrecurring items, slightly below our long-term ambition of 20%. Our operating cash flow continues strong at SEK 62 million in the quarter. Earnings per share came in at SEK 0.8, impacted by a onetime restructuring cost of SEK 18 million that we also announced in the previous quarter.Our net debt-to-EBITDA was 0.58, an even lower value then also sequentially. And Enea continues to invest in R&D. Here, we show the total R&D investment, both OpEx and CapEx, at 28.2%.Next page, please. So we're having this presentation, of course, in the middle of one of the biggest crisis that the world has seen, the corona pandemic. So we'll take the chance here to comment a bit on how we see the market development and the impact for Enea. I mean, in general, the market is impacted, although it's fair to say that telecommunication has a lower hit financially than many other industries. And the reason is that telecommuting and digitalization have increased as more people work remotely. I think all of us in this call can testify to that. Many markets have also seen traffic volumes increasing significantly, both in mobile and fixed networks. In some cases, up to a 50% increase.The corona pandemic has led to some delays in specific projects and investment decisions. We see that with some of our customers, and we also believe this is a market trend. This has to do with practical difficulties to handle networks. Manual work can be difficult and therefore, needs to be reprioritized. And it can also have to do with that short-term focus will shift some of the short-term priorities also when it comes to investments.Having said that, we believe that the increased need for telecommunication, the increased need for capacity will continue to drive the evolution forward, in particular towards 5G, which is the long-term solution, both to new functionality and also to more capacity. So although there will be a risk for short-term delay, we believe that the evolution towards 5G will continue.What this means for Enea then? Well, the majority of our business is stable, supported by a very high degree of recurring revenue in our business. As a company, we are not dependent on hardware production, and we have been able to transform the company fully into business continuity through work from home and also use of IT tools. That, I would say, has gone even above expectations.We have a very strong financial position, and this gives us the stability in a period of macroeconomic uncertainty. And given this and also what I commented about the long-term prospects, we believe that opportunities remain for Enea, and we, therefore, chose to continue to invest into key areas like 5G and cybersecurity.Next slide, please. So I'll comment on some of the other key events during the first quarter. The first event actually did not happen in the quarter, it happened now early in April, which was a closure of a large 5G contract worth USD 15 million to USD 20 million, in an area called 5G cloud network data layer. We closed this with a Tier 1 North American operator. I'll be coming back to this, but a significant event did not have a financial impact during the first quarter but has a strategic importance for Enea going forward.During the quarter, we launched a new 5G product, the result of organic R&D development in our company. This product is called the Unified Data Manager and is a key part of 4G and 5G portfolio that we now have broadened compared to before. All our products are, what's called cloud-native, built from scratch for cloud deployment.During the quarter, we also launched a commercial offer for unlimited licenses for voice over WiFi as a response and as a help to our customers who have seen a surge in work from home, and therefore, also a voice over WiFi usage.We have complemented our portfolio in what's called SD-WAN, software-defined wide area networks. And the latest addition to this portfolio is an evaluation kit that helps the customers to quicker and easier evaluate this technology that we can -- that many people often refer to as second-generation SD-WAN.And then finally, we have concluded restructuring in Sweden and Germany to optimize R&D. This was announced in the previous quarter. It has associated a restructuring cost of SEK 18 million, but it puts us on a more efficient path going forward with a more efficient R&D organization and also a lower cost structure.Next slide, please. So I promised to come back quickly to the contract that we closed now early April with a North American Tier 1 operator. The Enea product here is called Stratum. Stratum is a data back-end product. It is a high availability product with very high capacity and entirely built for cloud deployment, which gives cost advantages to customers choosing this solution. In this case then, the product will be deployed as the data back-end order, the spine, if you want, in the data structure, where many applications from several different suppliers will be connecting into this back end. This is the way that many operators, we believe, will choose to build their 5G networks. And the fact that we have now closed this important 5G contract with a North American operator, we hope will serve as a reference to other customers following into their choices and selections of 5G deployments.Next slide, please. So let me just, before I hand over to Björn, quickly touch again on the market situation and also the increases of traffic that the corona pandemic have led to. There have been many reports of increased traffic in many countries across the world. To the left here, you see some of the reports with operators, for example, in Spain and also Italy, reporting on quite heavily -- heavy spikes in their networks. We have also seen some operators announcing that they need to invest in fact to meet these traffic increases. And we've actually seen some countries, including the European Union also, that have taken measures to limit, for example, video streaming to cope with the situation.Enea has solutions to help with this. We are a market leader in traffic management, in video optimization, and we have solutions also for handling congestion in radio access network. So we are working with operators across the world to help, to handle customer control traffic spikes. So we will, of course, use this technology going forward to continue to see how we can help operators to alleviate the situation and make sure that we deliver also and that they can deliver good quality of experience to their customers.With that, I'll hand over to Björn to give us more detail of the financial results. Thank you.

[Björn Westberg, Chief Financial Officer]

Thanks, Jan. We go to Slide 9. This slide shows revenue for the most recent 5 quarters. Total revenue amounted to SEK 227 million, which a larger part was recurring, providing a stable base for our business. Revenue declined by 6% in the quarter. Currency effect was 2%. Decrease is mainly due to no major orders in the quarter in combination the very strong first quarter last year, which included 2 large orders, plus a SEK 20 million settlement with a key account. This quarter is an example of variations by quarter, where some projects have been delayed, potentially as a result due to the corona pandemic.Next Slide 10. In spite of absence of large orders, achieved 18.3% EBIT margin, excluding NRI. We executed our planned efficiency programs, which will positively affect OpEx going forward. The related NRI cost was SEK 80 million for already executed programs in the quarter. Excluding NRI, OpEx decreased by 4% in spite a full quarter for the Policy and Access Control business and not a full effect of the efficiency programs.EPS for the quarter was SEK 0.80, affected by the lack of larger orders and the nonrecurring items for the efficiency program of SEK 80 million. We do, however, see a very positive effect on the financial net, asset financing cost is much lower than last year.Next slide. On Slide 11, starting with operating systems. As mentioned, revenue continued to decline, in line with our communication during recent years. The decline was 34% during the SEK 20 million settlement last year. Excluding that settlement, the decline was 9%, which is a more relevant number to consider, as we continue to see the effect of our Key Accounts closing open source solutions for the last few years.Network Solutions, by far, largest product group now, representing 61% of total revenues, increased by 4%, driven by the Policy and Access Control and Deep Packet Inspection businesses, in spite of new large orders in the quarter.Software Development Services named Global Services grew by 7%. We continue to win new customers in several industries based on our track record of high competence and competitive costs.Slide 12 represents revenue per region. EMEA increased by 10%, mainly driven by a solid development of the Policy and Access Control business and the Deep Packet Inspection businesses. Americas and Asia declined sales as there were no large orders as was the case for the first quarter last year.Next page, solid financial position. We continue to generate good cash flows. The operating cash flow amounted to SEK 62 million. We have now in place a very efficient financing structure with a net debt-to-EBITDA of 0.58 and the low financing cost, as mentioned. The strong balance sheet is also reflected in the equity-to-asset ratio, which increased to 68% from 49% previous year.To conclude, we are, even in this turbulent global environment, very well positioned to invest both organic growth and potential nonorganic opportunities.Back to Jan.

[Jan Häglund, President & CEO]

Thank you, Björn. So I'll just be wrapping up if we move to Slide 15, Page 15, by summarizing how we see our position. We believe, as Björn said, that we are well positioned for long-term growth. Our market position is strong in the areas where we act, 5G data management, mobile traffic management and DPI, Deep Packet Inspection, for cybersecurity are some of the areas where we have a confirmed #1 position on the market. And coming back to the big 5G order now in North America, I think it further solidifies that position.Our financial situation, we believe, is strong based on cash flows, low net debt, which also is a good position to have now in a period of macroeconomic uncertainty.Our growth strategy continues to be based on investments in telecommunications and cybersecurity, more specifically into 5G data management, 5G core applications and virtualization platforms. And we believe that we have an efficient go-to-market model, where we can combine direct business relations like the one that I mentioned before with established and strong partner sales to reach a broader market and to give us a robust and broad customer base. These are the pillars and foundations for Enea's continued operation.So next and final page. So market outlook for 2020. Well, there is no doubt that there is increased uncertainty on the market in the short and medium term due to the coronavirus pandemic. Having said that, we continue to have a positive outlook for software in telecom and enterprise networks. We believe, in fact, that telecom and enterprise networking probably have a more -- has more important and strategic position for society than ever before. In this situation, we choose to retain our target of an operating margin over 20%, but we do believe that there will be consequences, negative consequences of the corona pandemic on our sales in 2020.With that, we are through what we intended to present today. Thank you very much. Back to the operator.

[Operator]

[Operator Instructions] Our first question comes from the line of Ramil Koria from SEB.

[Ramil Koria, Analyst]

Quite frankly, I think we're lacking some numbers on the impact from the pandemic. I mean what's the actual impact here in Q1? We know for a fact that comparables were quite difficult with 2 big orders in Q1 '19, but what's the sort of -- what have you seen during the quarter more specifically in terms of how customers are behaving?

[Jan Häglund, President & CEO]

Well, I can comment on that first, Ramil. First of all, I think it's very difficult to give an exact number because none of us will know what would have happened if the corona pandemic would not have occurred in the world. So the comparable number is tough. And there is no doubt that we have seen certain projects delayed because of customers' practical difficulties in their networks. And we have also seen that potentially investment decisions have been pushed forward or at least put at risk. But to quantify that, Ramil, is difficult. So we chose to say that the majority of our business is stable, has not been impacted and then there are potential individual projects that have been delayed potentially. Going forward, however, we see that most likely, these 2 effects delayed projects as well as potentially changed or delayed investment decisions are likely to happen on the market during the corona pandemic continued development.

[Ramil Koria, Analyst]

No, that's fair. I mean we can all recon, it's difficult to quantify. But put it this way then, what's the trend that you've seen January to February to March? I mean have you seen any sort of canceled discussions going into March and perhaps also April? What flavor can you provide us in terms of -- how should we model Q2 basically and perhaps to some extent Q3 as well and how much does it will impact you?

[Jan Häglund, President & CEO]

But I think the main part of our business remains stable. I think that's important to point out. The main part of our business is not impacted by the corona pandemic because we continue to serve customers either in recurring revenues and long-term contracts or in fact, with software, which is critical for their operation, where this is a high priority for their continued operation. Having said that, as you know, who has been following Enea, we also, from time to time, have larger contracts that we are able to announce. We did not announce any of these major contracts during the first quarter. And I think some of these major contracts are more difficult to predict going forward. When and if will they happen because they are due to priority discussions within operators and can also practically be delayed if customers choose to delay them because of practical difficulties to work in networks.

[Ramil Koria, Analyst]

Okay. So basically, the way I should see it, given what you're saying is that Q2 hasn't been super affected by the pandemic per se, but your comments are perhaps more related to future outlook and perhaps postponed investments from some of your customers for the remainder of 2020. Is that sort of the way I should read it?

[Jan Häglund, President & CEO]

Well, I mean, we're clear in the last page here that we believe that there is -- there will be a negative impact on our revenues from the pandemic for the reasons that I mentioned before. I think all our quarters, including the second quarter, we have a large part of our revenues, which are recurring or stable. I mean we normally say that more than 50% of our revenues are recurring. And then we have made some announcements already in the second quarter of 2 contracts, of which one has a direct positive impact in the second quarter. So I think those are the basis for how to think about and how to model the second quarter. But again, I want to be clear that with this uncertainty right now, it's more uncertain than ever, I think, to predict the market for anyone. And we do believe that there is a negative impact compared to the situation where the pandemic would not have occurred.

[Ramil Koria, Analyst]

Okay. And then just looking on the different regions, it seems like Asia is in relative terms weaker, whilst the EMEA region seems quite strong in Q1. Should we expect that to reverse going into Q2 given how sort of pandemic has developed since Q1? Or how should we reason around that?

[Jan Häglund, President & CEO]

I wouldn't read too much into the future from that development. In the first quarter, we had some good development in EMEA, as Björn said, based on solid business in Policy and Access Control and also in our Deep Packet Inspection branches. The relative comparison to last year for Asia and Americas was impacted by the fact that we did not announce any major contracts in quarter 1. As our business also varies then with these major contracts, there will be variations in coming quarters and that variation can also hit differently in different regions. I wouldn't directly correlate it to the development of the pandemic.

[Ramil Koria, Analyst]

And then let's see what I have more. So can you -- are you seeing anything on your service offering, which seemingly is holding up quite good growing? Was it 7% in the quarter? Is there anything we should expect there in terms of customers potentially delaying service contracts with you or what have you?

[Jan Häglund, President & CEO]

Well, I made a comment in the CEO statement about this. So if we talk about then our software development services, here, we serve into many different industries. We act both in Europe as well as in the U.S. The business mix here is a little bit different. We work in everything from telecommunications, automotive and airplane industry. If we look at specifically the U.S., there, we have a slightly higher ratio of resource consultants. And here, we expect that the demand for this kind of services will probably be impacted more than other parts of our services business, specifically in Europe. So that's why I made a special mention of U.S. in my initial statement.

[Ramil Koria, Analyst]

Then please just perhaps to be on -- please just remind me of seasonality going into Q2. How should we sort of model the seasonality going into the quarter?

[Björn Westberg, Chief Financial Officer]

I mean we don't have very large operations due to seasonality in the business, although it's much more related to, as Jan mentioned, that a number of new large orders, as you see, but that's more relevant. And then, of course, we have some impact, especially in the third quarter regarding related to the whole indications. But overall, it's not so much seasonality in the business.

[Ramil Koria, Analyst]

And characterizations to sales are quite significant in the quarter. Is there anything underlying there?

[Björn Westberg, Chief Financial Officer]

I think there are 2 components into that. One is that we have a full quarter of the Policy and Access Control business, and of course, we will, therefore, capitalize more compared to last year due to that. Secondly, we are investing in -- you can say, in 3 product lines and especially developing now for the 5G. We are increasing investment in these areas. So that's the situation.

[Operator]

The next question comes from the line of Simon Granath from ABG.

[Simon Granath, Research Analyst]

I hope all is well. And first, just a quick question on the restructuring program. Have all the costs relating to this program now been taken?

[Jan Häglund, President & CEO]

Yes. Yes. So for what we announced in the previous quarter, the restructuring of R&D to give us a more efficient R&D organization and also lower cost, specifically Sweden and Germany, all those costs have been taken now, yes.

[Simon Granath, Research Analyst]

Okay. Perfectly clear. And also regarding the 5G contract that you recently obtained, how important was it for you to win this contract? Why do you think that you won it? And was there a large procurement regarding the contract? Just some comments around the contract would be very helpful.

[Jan Häglund, President & CEO]

Yes, it was very important to win. I mean all contracts are important to win. But this one in particular, I mean, it's large in size. It was taken in direct relation, so it means also that we have a direct relation with this customer going forward. And competition is high in our industry, and in particular, this is part of future 5G networks. So there are many different alternatives that operators have. But this then customer chose Enea for its future data management infrastructure based on our product strategy. And so we're very happy about that. And we hope that this will not only help us to work with an advanced customer to bring the offering forward but also serve as a good reference for other potential customers going forward.

[Simon Granath, Research Analyst]

Okay. Perhaps you could also make a smaller comment on your M&A activities amid COVID-19. Are you seeing more attractive prices? Are you getting more active due to the current environment?

[Jan Häglund, President & CEO]

Well, I mean, M&A and complementary acquisitions remains part of Enea's strategy. We've done this successfully in the past a number of times. And we believe that we have a financial position that allows us also to take those measures when we have the right opportunities. And then, of course, the current situation creates uncertainty also on the M&A market, I think many can testify to that. And that can both be a risk and an opportunity. So I can't really comment more than that at this time, Simon.

[Simon Granath, Research Analyst]

That's fair enough. And as a final question, we previously talked about that you're feeling a greater demand for several larger products due to the increased data traffic in the network regardless whether corona is affecting or not. But are you experiencing any lower demand for any of your products due to the COVID-19 situation? And perhaps we should keep the discussion through all products, except the Operating System Solutions?

[Jan Häglund, President & CEO]

No. I don't think we can say that we see lower demand for the products. I think the risks that we have talked about before are more related to individual projects that for various reasons can be delayed in these situations or investments where operators may be revisiting their priorities, not just for us but, I think, in general. I think those are the 2 main risks that we see. There is nothing in our portfolio that becomes less strategic. I would say the contrary, all our products are part of telecom infrastructure, which -- for which the important is increasing going forward. And that's the reason why we continue to have a positive outlook on the markets for telecommunication and enterprise communication solutions.

[Operator]

[Operator Instructions] Our next question comes from the line of Viktor Westman from Redeye.

[Viktor Westman, Analyst]

First one is on the new deal in 5G network data layer. You have said -- from your survey that very few customers have considered to -- how they're going to solve this -- their data with the 5G. And I hear similar things from competition. And I was just wondering why is that and how can you change that?

[Jan Häglund, President & CEO]

Yes. It's a big question. But I think we have consistently said that we believe that the market for 5G has already started, but it has started with radio expansion. So when we read about 5G deployments, it's mainly about expanding of radio infrastructure into new frequency spectrum, and that is not an area where Enea primarily plays. However, the next wave will be expansions and investments into what's called the core networks, which are the central parts of the network. And here, we have previously said that we believe that, that market will start during this year, specifically, probably late this year and then continue to grow into the coming years. So what we see here is an example of a very early operator who takes early steps because they want to be early in 5G deployment. Having said that then, I think the survey, as you point out, shows that many other operators are still not in that stage, they are still considering, still watching and still deciding when and how to act on their 5G deployment. But we still believe then, as I mentioned before, that the way for the future is through 5G. 5G is, long term, the only way to get the kind of capacity and the kind -- to meet the kind of market demands that we see and that might even have been accelerated by the current crisis with remote working and other kind of market drivers being accelerated.

[Viktor Westman, Analyst]

Okay. Good. And on the -- you mentioned fewer larger orders in Q1 or no larger order. Can you just define for what a large order in size? Is that SEK 10-plus millions? Or what is...

[Jan Häglund, President & CEO]

Yes. I mean the benchmark that we normally set for ourselves is that we try to publish teams of the order of SEK 10 million and above individual new orders significantly. We do not publish any of those during the first quarter with the financial impact on the first quarter as we pointed out before.

[Viktor Westman, Analyst]

And can you say something about the smaller orders because you got a lot of smaller orders in your business as well? Were those more or less in Q1 compared to last year?

[Jan Häglund, President & CEO]

Well, I mean, if you look at our results, despite not having any of these, what we call major orders, we came in at a result that if you take away the onetime settlement for last -- that happened in quarter 1 last year, our result was in line with or, in fact, slightly higher this quarter. And this is then, of course, a result of many -- a lot of business that we do. And again, a reflection of that the majority of Enea's business remains stable despite the corona pandemic crisis.

[Operator]

There are no further questions registered, so I hand back to the speakers for any closing remarks.

[Jan Häglund, President & CEO]

Now with that, I'd just like to thank you for your attendance. We, of course, live in uncertain times where it becomes more difficult than ever to predict the future. But long term, we believe that Enea has the position for the future. Our investments are in the right areas, 5G, cybersecurity. And although we do see a negative effect this year, we believe that we are still well positioned for future growth. And we thank you for your support and interest.

[Operator]

This now concludes our conference call. Thank you all very much for attending. You may now disconnect your lines.