Enea AB

STO:ENEA

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, welcome to the Enea AB Q3 Report 2019. Today, I'm pleased to present CEO, Jan Häglund. [Operator Instructions] Jan, please begin.

[Jan Häglund, President & CEO]

Thank you very much. This is Jan Häglund, CEO of Enea. And I'm sitting here with Björn Westberg, CFO of Enea. And we're pleased here to present to you the results of the third quarter 2019. On the second slide here, we outlined the agenda. I will be going through an introduction with the overall financial and also a short strategic update. I will hand over to Björn, who will take us through the details of the financial results, and then I will wrap up with a short statement of where we are heading going forward. On Page 3, we summarized the financial results of Enea. I am happy to say that we have closed the quarter of solid growth in revenues and profits. Revenues for the third quarter came in at SEK 250.2 million and an operating margin of 25.4%. The revenue grew by 19% relative to the same quarter last year. For the period, meaning then January to September 2019, our revenues came in at SEK 751.2 million, representing a 27% growth at an operating margin of 26.8%. It can be noted that we had no significant nonrecurring items during the quarter. Enea is a company of today 658 employees in many places across the world, significant parts of this are in R&D and mainly in Western Europe and partly in India. And we continue to invest in R&D in the quarter, which amounted to 16% of our revenue in R&D investment. And we do that to pave the way for future organic growth. The next slide, I'll summarize a bit of the key events in the quarter. Our new business unit for quality and access control that came into the company in March delivers ahead of our initial expectations. We closed a significant deal with a large German operator in the area of what's called AAA, Authentication, Authorization and Accounting. It's particularly pleasing to see that we closed this deal in direction relation with the German operator, which means then that we start to complement our sales model, which until now has been only through indirect sales. The direct sales relation gives us valuable contacts with its large and competent customer. Enea is the leader in video traffic management. In fact, we have #1 position on the market. During the quarter, we closed a new significant contract worth USD 2.3 million with a Southeast Asian operator. Based on this contract and based on our project, we will help the customer here not only to reduce costs, to handle growing traffic but also to increase end-user experience for video traffic, which is growing in importance for many operators across the world. I've previously talked about the new and emerging market for access virtualization. There is a lot of market traction for Enea and for our new solution in virtualization software. In the quarter, we announced the contract with a customer, CMC Networks, who is an enterprise operator in the Middle East and Africa. We will help that operator as part of their so-called SD WAN, software-defined wide-area network solution. And we are very pleased to have this customer and to help them going forward. On this product also, we had progress during the recent SDN NFV Congress in Holland, in the Hague, where Enea, together with partners, also showed how our software works in an ecosystem together with other applications, also open source application. This is important because it widens the range of different applications and choice for our customers. And also, it enables lower cost for SD WAN solutions. Early in the quarter, we announced a large multiyear contract with one of our Key Accounts in the area of operating systems. This account is very important for us, has been very important, and we're very pleased then to close a 4-year contract worth EUR 21.2 million. It's a 4-year contract that then gives us predictable revenue. It has a declining revenue profile, which gives us then the possibility to plan ahead for these revenues and to adjust our operations accordingly. And finally, the news during the quarter about the directed share issue was announced in August, and this successful directed share issue gave us proceeds of SEK 271 million gross. And we have then since used them to redeem a SEK 500 million bond that was issued in 2018. Due to the relatively high interest rate of that bond, this change now in capital structure will lower Enea's capital cost going forward, and we see that the change then will, in total, have a positive earnings per share impact already from 2020. On the next slide, Slide 5, you can see the large transformation that Enea has been going through as a company during recent years. Just 2 years back, the majority of revenues came from the area of Operating Systems. 46% was in that area. In this quarter now, the third quarter of 2019, Operating Systems remain an important area for Enea. It remains an area of significant revenue and profitability. However, as you clearly see here, the dominating area is now our Network Solutions area, which has grown to a total in this quarter of 62% of the revenue base. Just compared with the last -- with the same quarter last year, this represents a growth of 38% in the area of Network Solutions. In particular, the new Policy and Access Control business unit has contributed to this new and growing revenue. And as I've stated before, this new unit has also developed ahead of our initial expectations. But even without that, it's noteworthy that the area of Network Solutions also grew organically by 6% based on new traffic management and cybersecurity contracts. I should also make a note here that based on the fact now that Network Solutions is our dominating revenue, we will continue to see variations between quarters due to the nature of this area. Large deals can come in certain quarters, which then can give higher variations than Enea has experienced before.On the next slide, Slide 6, we just summarize what Enea is all about. I said this before that Enea, we want to position Enea as the world-leading supplier of innovative software components for telecommunications and cybersecurity. With that, meaning that we continue to invest in innovation. We are a pure-play software company. We provide primarily components that are part of systems that either customers or system vendors put together. And we point out 2 markets that we focus on: telecommunications and cybersecurity. On Slide 7, we're even more explicit then on the 6 areas of product and operations within these 2 markets. In 3 of these areas, we already have a leading position, for example, real-time operating systems for radio networks, video traffic management for core networks as well as embedded Deep Packet Inspection, an area then used by communication providers and also by enterprises in particular for cybersecurity. The 3 other areas are more new markets or more emerging opportunities for Enea, highlighted on the next slide, Slide 8. I thought I would just go a little bit deeper into those areas and say what they are all about and why we believe that they are interesting opportunities for future organic growth. On Slide 9, we take them one by one. Edge virtualization platform, as mentioned before, it's a growing market for virtualization, meaning separation of hardware and software not only then in the upper parts of the network but also now coming very close to end users and enterprises. And that's what we call access virtualization. The first and leading use case for this market is SD WAN, software-defined wide-area networks, which then is a big trend in particular in enterprise communication. And Enea's role and position is to provide virtualization software to enable a solution where there is no longer lock-in to one single provider but where there is a choice of different hardware platforms and also different software applications on top of our virtualization software. Enea then uses -- we use our competence in small-scale virtualization and operating systems to grow into this market. And as said before, we're also pleased to announce now the first customers that are taking -- that we are working with in this area. The second area, cloud data management is an area that we expect to grow with the new 5G core market. The new 5G core market is part of the development of 5G. Initial development of 5G is right now focused on radio expansion, but we expect that from 2020 and 2021, there will be more transformation based on a new standard called 5G core. And part of this standard is to consolidate data into what's often referred to as a network data layer, and many leading customers are providing and prioritizing this development. Enea has recognized 4 innovations and early market leadership in this area. And we are engaged with several Tier 1 operators to discuss and try this concept. Also a very promising area for the future. The last area here I want to point out is then the evolution of quality and access control, an area where Enea is already active, but this area also evolves significantly with the emergence of the new 5G core standard from 2020 and 2021. And we expect then subscribers to grow from those date. And there is a new standard, and this standard also points out a new way to structure and build software, often referred to as cloud-native applications, meaning software built directly for the cloud. This opens up for software specialists like Enea to take a role in this market to provide application. And this is our target then, to grow then the portfolio from Policy and Access Control into a wider subscriber management software profile -- software portfolio for 5G core. And also in this area, we are working with leading Tier 1 operators to discuss the plans and the technology going forward. So this was a quick snapshot of some of our investment areas or in fact the key investments for Enea going forward. With that, I'll move forward and, on Slide 10 then, introduce Björn Westberg, CFO. And Björn, please take us through some of the details in the numbers.

[Björn Westberg, Chief Financial Officer]

Thank you, Jan. Next slide, 11, just revenue for the most recent 5 quarters. Revenue grew by 19% in the quarter and amounted to SEK 250 million, which is the highest revenue ever for Enea in a third quarter. Currency effect was 3%. The increase is mainly driven by the software licenses in the Network Solutions product group. Our recently acquired Policy and Access Control business, which was acquired 1st of March, generating most of the growth. Excluding that business, organic growth of 2%, that's the increase in Network Solutions offsets the decline in Operating System Solutions. And I'll come back to this later in the presentation. Slide 12, record operating profit in the third quarter, which is also actually the highest operating profit in a third quarter mainly driven by the increase in revenue. The operating margin was more than 25%, slightly higher than the same quarter last year. The depreciation and amortization increased, affecting gross margin negatively. But the overall EBIT margin increased in spite of this, so operating is bound to increase on 10% when compared to the sales increase of 19%. Next slide, 13, Worldwide Software Sales continues to grow and is by far our largest business area, very much driven this quarter by the Policy and Access Control business. Key Accounts share of the total is now representing only 28% compared to 41%, 2 years back. And comparing the third quarter 2019 with the third quarter 2018, Key Accounts increased its share as Key Accounts also have more product lines outside operating systems. And that is an effect of the acquisition of the Policy and Access Control business. Global Services increased by 17 -- 7%, partly helped by the currency tailwind. On the next slide, 14, starting with Operating Systems. As mentioned, revenue continued to decline in line with our communication in recent years, a decline of 7% due to shift from our Key Accounts to more open source solutions. Network Solutions, by far the largest product group, representing 62% of total revenues, as Jan mentioned before, increased by 38% driven by the Policy and Access Control business in combination of 6% organic growth for the other product lines. The growth on Global Services of 7% in combination with the growth in Network Solutions more than offset the decrease in Operating Systems, generating a total increase of 90% for the group. Next slide, 15. In Slide 15, we present the revenue by region. Asia, being the smallest market, accounted for 13% of the revenue in the quarter and increased by more than 100%. We had some large orders this quarter in Asia, like Jan mentioned previously, core video traffic management by a Southeast Asian operator. This is an example of variations by quarter. We see it as largely the potential to increase revenue in Asia with our wider offering. The Policy and Access Control business has the largest part with its customers in U.S. and EMEA. It was the main driver for the increases in these regions. The large order for AAA, that German operating, was one of the main orders in the EMEA market. Next slide, financial position. We had a stable cash flow in the third quarter both before and after changes in working capital with gross proceeds of SEK 271 million in August from a directed share issue, equaling 9% dilution after issue. This had all continues to get impact from the net debt position, which is now down to SEK 277 million. That also includes the remaining purchase price for the Policy and Access Control business amounting to SEK 46 million, and that is to be paid end November this year. The strength in balance sheet also is affected in the financial KPIs. Net debt/EBITDA was reduced to 0.67. And equity ratio has increased to 59%. We did also redeem the bond loan of SEK 500 million in combination with a new bank loan of SEK 250 million in October. This will lead to an even more efficient financial structure, reduced capital costs and positive first impact already from next year. To conclude, we are in position to execute our growth plan. Jan?

[Jan Häglund, President & CEO]

Thank you very much, Björn. So going forward then, Slide 18, we'll summarize a bit of how we believe we are positioned for Q2 profitable growth. First of all, our market position. We have selected markets, specifically telecommunications and cybersecurity, where we see a lot of potential, a lot of change, in particular, 5G emerging and cybersecurity threat and what they mean in terms of investments. We work with leading operators, and our target is to gain top position in key niche segments of these 2 large markets. Our business model is based on being a pure-play software company, which means high gross margins and also significant recurring revenues. We do not have the hardware legacy base that we need to consider or that makes us to take unnecessary compromise. Our go-to-market model is a combination of indirect sales and direct sales. We have a direct sales force, but the majority of our sales is indirect, and this gives us with relatively small investment reach to a wide customer base. We intend to continue to combine this direct and indirect sales model. And in terms of growth strategy, we invest, as stated before, in innovation and technology leadership. We continue to invest in current products as well as in new product areas. And we continue to set aside a significant part of our earnings to R&D investments or organic growth. Our track record, we believe, is based on innovation since many years, providing unique technology and also executing on our strategy, expanding portfolio and business and also financial development. In fact, we've had 21 subsequent quarters of growth. The financial position, as Björn stated, is based on the robust balance sheet and attractive revenue mix that also has been changing significantly during the recent years, significant earnings capacity and strong cash flows. And then finally, the management team, especially with the changes in the company during recent year with a broader portfolio, this has also meant a broader and more experienced management team based in several places across the world, working close to key markets with deep technical market and customer understanding. On Slide 19, you see that the strategy is -- has been executed during the quarter, and I think the 5 news items that I stated in the beginning of this call have a direct relation to our strategy. The new direct sales of Policy and Access Control complement our go-to-market model. Our video traffic management momentum on the market as well as the access virtualization market traction are both part of our growth strategy. And our financial position is strengthened by the 4-year frame contract, which gives us, although declining, still predictable revenue from one of our Key Accounts. And the directed share issue also gives us a more efficient capital structure in particular then with lower interest costs. So wrapping up on Slide 20. We maintain our outlook for 2019 to achieve revenue growth over 2018 and to achieve an operating margin exceeding 20%. With that, we are through our presentation, and I'd like to hand over to the moderator and see if there are any questions for us. Thank you very much.

[Operator]

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

[Ramil Koria, Analyst]

Congrats on a good report. Just 2 questions. Maybe I could do both at the same time, I think. So first off, is it fair to assume that Key Accounts, excluding the sort of capabilities through the Atos acquisition declined somewhere around 7%, i.e., in line with the operating and -- or the SaaS segment? And then secondly, if we try to assume that Policy and Access Control business with Key Accounts will decline in line with sort of the legacy business with sort of these 2 specific accounts?

[Björn Westberg, Chief Financial Officer]

Thanks for the question. I'll take the first one. And so I guess it's a fair assumption that as the Key Accounts accounts for the absolutely larger part of Operating Systems, to assume something similar. That's right.

[Jan Häglund, President & CEO]

On the second question then, I don't think that conclusion is possible to draw immediately like that. And the fact that Operating Systems declined with Key Accounts has to do with introduction of open sources solutions as complements or replacements of the proprietary operating systems, and that's something we have talked about before. And for the new Policy and Access Control business, we had a position with our Key Accounts, but we also work through other system providers. But the dynamics of that business is quite different, so it's not possible to make that direct link.

[Operator]

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

[Simon Granath, Research Analyst]

Congratulations on a solid quarter. Firstly, you mentioned that the delayed projects with Huawei has affected the quarter negatively. Could you please elaborate a little bit on which geographical areas and which products that have been affected due to this? And also when did this negative occurrence start off here? Was it in the beginning part of the quarter or in the latter part of it?

[Jan Häglund, President & CEO]

Okay. Thank you. Yes, that is correct that in the report, we make a note of the fact that since we work with all system providers, in particular integrating our traffic management solutions in projects where a large system provider provides a full mobile network, and then in many cases, then Enea is selected for the video traffic management part. We then suffer from delays if the system provider suffers from delays. And we've seen examples then due to the geopolitical uncertainty where Huawei in particular then have suffered some changes today during the quarter. And we believe that the main impact has been during the second half of this year. Exactly how this continues, it's very difficult to predict, but we are prepared for continued changes and delays in projects involving Huawei. But the fact that we work with many system providers I believe makes us quite robust on the market from the long-term perspective. So that's why we also make a note that we don't see a risk for our long-term position and strength in the area of -- for video traffic management.

[Simon Granath, Research Analyst]

Understood. And as a second question, you have announced several new SD WAN agreements during the quarter. And when can we expect the revenues to trickle in into your financials from these 2?

[Jan Häglund, President & CEO]

Yes, it's correct that we start to announce customers in the area of virtualization of access platforms where SD WAN is the target application. Our revenue model is based on getting revenue from the devices operational in the field, which means then that our revenues will grow with the deployment of our customers. That means that with the revenues during this year, we expect them to be limited, and then they would start to grow as customers move out into the field during next year.

[Simon Granath, Research Analyst]

Perfect. And also as a third question, if I may, if the performance from Atos is extraordinary strong from a historical perspective, and do you feel like this is sustainable going forward?

[Jan Häglund, President & CEO]

We have the units that we acquired from Atos and Policy and Access Control. These are very competent units with both strong relation to service providers, also to system providers and with a strong R&D base. And as stated, the performance this year has been exceeding our initial expectations that we made. And going forward, this remains an important area for us. And as I've pointed out, it also is an investment area where we see opportunities not only in 4G networks but also in 5G network. And we will use the competence and assets we have here to both broaden the customer base and broaden the portfolio.

[Operator]

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

[Viktor Westman, Analyst]

Can you comment on the gross margin trend? You have a negative trend throughout 2019 here. And is there something in this hot business that is dragging down the gross margin?

[Björn Westberg, Chief Financial Officer]

Thanks, Viktor. Yes, as noted and also commented in the report, the gross margin is coming down a little bit. And the main reason for that, first, we have the amortization from the purchase price, like customer contract is amortized in like 8 years. And then we have -- then also -- I mean when we make acquisitions, we've done -- we normally capitalize and then like we have a 5-year amortization plan for the new capitalization. And that increases at the first years after acquisition. So we will see that the gross margin relate -- D&A, depreciation and amortization, will increase relatively to the same going forward until they have more balance. And that happens, of course, after 5 years had passed with one acquisition across. So it will increase going forward.

[Viktor Westman, Analyst]

Yes. Okay. And a question for Jan also. If you can comment on the 5G market in general. We heard many people saying that 5G is happening a lot faster than expected. Is that your view as well?

[Jan Häglund, President & CEO]

Well, I don't have any other view on the 5G market than other people and companies that have been out there and talking about 5G. However, I want to point out that the early market for 5G is mainly radio expansion, where the current networks then are expanded with new frequencies, new capabilities and new -- sort of new baseband capabilities far out into the network. Enea has not addressed that part of the 5G market. We are focusing higher up in the network, what we call the core network. And there, the 5G investments will be a little bit later. I pointed out here that we expect that market to grow from 2020/2021 primarily based on something called the 5G core standard. So I hope that clarifies our view of the market.

[Operator]

As there are no further questions, I'll hand it back to the speakers.

[Jan Häglund, President & CEO]

Okay. Then thank you, everyone, for listening in today. As said, we are pleased to have delivered a result that we believe shows a solid growth in revenues and profitability. And we're very happy that you were able to listen in here today and follow Enea. Thank you very much.

[Operator]

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