Enea AB

STO:ENEA

Earnings Call Transcript 2019-Q4

[Operator]

Welcome to the Enea AB Q4 Reports 2019. [Operator Instructions] Today, I'm pleased to present CEO, Jan Häglund. Please begin.

[Jan Häglund, President & CEO]

Thank you very much. This is Jan Häglund, CEO of Enea. I'm sitting here in Sweden, Stockholm, with Björn Westberg, CFO of Enea. We're here to present the annual statement of 2019 and, of course, details of the full -- fourth quarter.The agenda for today will be me going through a shorter production, a summary, a summary of the results and also some of our investment focus going forward. And Björn will be going through the financial details, and I'll be rounding up with the way forward and outlook.On the third page here, you see a summary of the fourth quarter results as well as the full year. It's very pleasing to note then that the fourth quarter revenues came in at SEK 261 million, which in fact, is the highest ever quarter for Enea. And for the full year, we achieved SEK 1.012 billion in revenues, which is a record for us, the first time, in fact that Enea goes above SEK 1 billion of revenues.The operating margin for the quarter was 21.8% and then for the full year, 25.5%. The difference here between the fourth quarter and the full year is entirely explained by an effect of cost reservations for a long-term incentive program related to, in fact, an increase of the share price. So that explains the difference here between the quarter and the full year.The earnings per share for the quarter was SEK 1.32 and for the full year SEK, 8.47. And here, it should be noted then that in the fourth quarter, we had an effect of a onetime cost for redemption of a bond. This was announced already in Q3. In Q4, we executed the redemption of a bond of SEK 500 million, and we did this to achieve a more efficient capital structure and, in fact, then this gives us a positive EPS effect already from this year 2020.Our net debt to EBITDA in the fourth quarter was 0.63, which gives us a solid balance sheet and a solid position for continued investment.And finally, we continue to invest in R&D. We see a lot of growth opportunities. In fact, we are increasing the investments in R&D. And I'll be coming back to those focus areas. We invest some 16.5% of revenues during the year. And on top of that, we do capitalize also some.Moving to the next slide. We see the -- this is the evolution or rather transformation of Enea during the last couple of years. I think it's pretty clear from this that Enea has been undergoing a huge change going only a few years from being dominated by our Operating System Solutions as well as Global Services to a company dominated by Network Solutions, high up in the value chain with a broader customer range and a broader offering also to the market. We've done this transformation also with huge increases in revenue, passing SEK 1 billion now in 2019 and also with an increase in operating profit, EBIT, as you see here on the solid line. We're very pleased with this transformation. And going forward, this remains the strategy of the company. We do expect continued decline in revenues from our legacy business, the Operating System Solutions, but we do see a number of long-term growth opportunities in Network Solutions, which is why we will be putting our investment focus going forward.The next slide, we summarize a bit of the events in the quarter. We have communicated to the market our offering in 5G data management. The 5G market, which I'll be coming back to, is very hot. There's a lot of activity. And during the quarter then, we have been more clear to our customers about where our investment focus is. And we have released a number of products then, a suite of products focusing on a subset called data management, which is part of the 5G core, which is a market taking off as we estimate late this year and into next coming years. We've also announced new product capabilities. We were, in fact, first in the world to offer optimization of Apple TV streaming. This just solidifies Enea's #1 position in this interesting market of video optimization, something very important for operators across the world, both to optimize the end-user experience but also the cost for the increasing use of video across the world.We had a Capital Markets Day on November 5. A very well-attended Capital Markets Day, more than 17 -- 70 institutional investors attended. A lot of interest in our company. Of course, we're very pleased to see that interest. And we will, going forward, also be focusing to make sure that the capital markets, both in Sweden and in other countries, also get as much information as possible about Enea. And as mentioned before, during the fourth quarter, we also did an early redemption of a bond loan of SEK 500 million, which does give us a positive earnings per share contribution already from 2020.On the next slide, I summarize a bit of our investment focus. Because I think it's fair to say that Enea has more long-term growth opportunities than ever. We are -- thanks to the change of the company during the last couple of years, we have the capabilities and we're addressing customers and markets with a lot of change and a lot of opportunity. And that's why we have decided to continue to invest and, in fact, increase investments in our virtualization platforms and in the area of 5G Data Management based on our cloud data management position and based on our Policy and Access Control position. We do these increased investments out of our strong R&D design centers, primarily in Eastern Europe, in places like Romania and Croatia and also in India, where we have very strong teams and very interesting balance between competence and cost.At the same time, we have seen, during a long time for the company, that revenues from our legacy business in operating systems are declining, and we are adjusting the organization accordingly. We can free up competence and we have freed up competence for a number of the new investment areas, but we've also decided to optimize on costs and R&D centers, which is why we have announced head count reductions in this area as well as impact other areas to optimize for the amount of sites. This affects the sites in Sweden as well in Germany, and we are planning to take restructuring costs of an estimated SEK 15 million in the first quarter of 2020. All in all, we do this to increase investments to capture long-term opportunities, but to do it in an efficient way with the best possible use of capital.I promised to say a few words about the 5G market. So on the next slide here, we see the evolution in 5G and the main steps that this will take. 5G is already a hot topic in the news and in demonstrations and in some markets including Korea, other Asian countries as well as the United States, there are already commercial launches. Those are characterized by what's seen here on the left, upgrade of the radio infrastructure. However, with the need to support new applications like augmented reality, virtual reality, gaming, smart factories, connected vehicles, there is a need to continue to evolve the architecture. That's also, in fact, driven by the better use of the 5G radio spectrum by better service differentiation, and also this new architecture called 5G core is optimized to mix software from different vendors in a much smoother way, paving the way for smaller software vendors focused on cloud software like Enea.So this new market, the 5G core market, we estimate that the first selections here will happen during this year, but the main market will take off during coming years. It's always difficult to estimate exactly how fast this will go, but this view, our view, is shared by many analysts in the industry.And as mentioned before then, Enea will focus on the 5G Data Management part of this market. So on the next slide here, we try to detail a bit how our investment focus is. We're moving from a market where data in current 3G and 4G networks has been locked into vendor-specific silos. The new standard 5G core opens up for a completely new way of thinking about this. You can see it as an app store of different applications from different vendors, including Enea, with applications using a data infrastructure by many referred to as a network data layer. Enea's offering is both in the network data layer as well as in the application layer. And we have a number of applications then that are under trial and under discussion with Tier 1 operators across the world.So all in all, this new architecture and these new offerings give lower costs, much more consistent data, better scalability and also better service agility for customers. So we see this market as very promising. And we have a good position here that we tend to -- that we intend to exploit during the coming years. So all in all, we're very positive about the development in this area.That was a quick snapshot on our investment going forward. Now I'll leave it over to you, Björn, to give us details about the financial results.

[Björn Westberg, Chief Financial Officer]

Thank you, Jan. This Slide 10 shows revenue for the most recent 5 quarters. Revenue grew by 10% in the quarter and amounted to SEK 261 million, which is the highest revenue ever for Enea in a quarter. Currency effect was 3%. The increase is mainly driven by new software licenses in the Network Solutions Product group. Our recently acquired Policy and Access Control business, which was acquired 1st of March, generated most of the growth. This quarter is an example of the variations by quarter, as no large order was taken this quarter compared to other quarters of 2019.Looking at the organic growth, we need to look at 3 quarters, Q2 to Q4 as well as acquisitions both in Q1 '18 and Q1 2019. It is flattish, which means that we have been able to offset the decline in operating systems with increased sales mainly in Network Solutions. Also, our acquired Policy and Access Control business has exceeded our initial expectations.Looking at the full year numbers, we achieved more than SEK 1 billion first time ever. This is a result of successful strategy execution through the software business in Network Solutions.Next slide, we look at EBIT and EBIT margin. And to summarize the year, all quarters in the year had more than 20% EBIT margin. We have been able to generate good margins from our acquisitions, mitigating the impact of the sales reduction in operating systems. EBIT margin this quarter was close to 22% in spite of negative effect, the highest relative share of D&A together with unusually high cost for the share incentive programs. Latter is mainly due to 2 factors. We have 3 ongoing programs compared to normally 2 and also higher personnel costs due to a share price increase, as these shares are take -- or taxed as salary income for the employees. EPS for the quarter was lower than Q4 2018, mainly due to the bond loan or the redemption costs. EPS for the full year was the highest ever as a result of the increased sales and EBIT margin of more than 25%.On the next slide, Worldwide Software sales continues to grow, and it's, by far, our largest business area, very much driven this quarter by the Policy and Access Control business. The growth was only 6%, as we have no large order in the quarter. Key Accounts failed [indiscernible] only 26% compared to 39% 2 years back, although the acquired Policy and Access Control business was a large part of the sales on Key Accounts. Global Services increased by 2%.Next slide. On this slide, starting with operating systems, as mentioned, revenue continued to decline in line with our communication during recent years. It declined about 11% in the quarter due to a reduction in sales from one of our Key Accounts. Network Solutions, by far, the largest product group now, representing 62% of total revenue, increased by 24%, driven by the Policy and Access Control business. The growth of Global Services of 2% in combination with the growth in Network Solutions more than offset the decrease in operating systems, generating a total increase of 10% for the group.Next slide. On Slide 15, we present the revenue per region, Asia, being the smallest market, accounted for 13% of the revenue in the quarter and increased by 24%. We have some semi-large orders this quarter in Asia. The Policy and Access Control business has the largest part of its customer in the U.S. and EMEA, which was the main driver for the increases in these regions.On the next slide, financial position. We had a stable cash flow in Q4, contributing to full year operating cash flow of SEK 245 million, an increase by 45%. The net debt position is now down to SEK 216 million as a result of stable cash flow in combination with the directed share issue in August. All the financing-related activities this year have generated an efficient financing structure, but the 2 parts are: one, low financing cost from quarter 1 2020, much lower than 2019; low net debt-to-EBITDA rates by year-end. Certainly, more flexibility to raise new financing without the restrictions in credit structure. The strength of balance sheet is also reflected in the equity to assets ratio, which increased to 67% from 51% previous year.To conclude, we are very well positioned to invest in both organic growth and potential nonorganic opportunities. Thank you, Jan.

[Jan Häglund, President & CEO]

Excellent. Thank you, Björn. So rounding up then with a summary of way forward and outlook.Strategy execution highlights. Enea is well positioned towards interesting markets. And noting the 5G market as well as the cybersecurity market, a lot is going on, and this gives long-term growth opportunities. We have business models based on software, and we intend to stay with that with a high share of recurring revenues and high gross margins. Our go-to-market model remains based on both direct sales and direct touch and understanding with customers, but also working a lot through partners indirectly, which gives us a good reach, a good global reach with limited cost and investments. Our growth strategy is primarily based on organic growth and investments. And as mentioned before, I believe that we have more growth opportunities long term than ever, which is why we're deciding to increase investments in a number of areas. We have a track record of growth. In fact, this is yet another quarter of growing revenues. Financial position has been strengthened. And as Björn mentioned, we are now to levels where we have freedom to act both organically but also inorganically, and we do continue to seek a complementary acquisition target. And we have a management and leadership and competence structure, which is both global, international and very well founded in the industry, also something necessary in order to play in the competitive global markets that Enea does.A number of things that are proof points of our execution during this year. We act as a market leader in video optimization, and we showed that through being first with the new streaming service, Apple TV. We have increased R&D investments in a number of growth areas including 5G and 5G Data Management. We have now launched also a number of new products to the market, very timely now, ahead of the Mobile World Congress happening later this month. And we have, as previously communicated, restructured our capital structure to a much more efficient but also cost-effective with lower interest rates.All in all, then, we continue to invest for long-term growth. We have a positive outlook on the market where we act, including telecommunications and cybersecurity with changes in 5G. We had a declining business in the legacy parts of Enea, especially operating systems. And as talked about before, we've taken actions to make sure that we continue to be as cost-efficient in those parts of the business, freeing up capital and freeing up resources for new investment.All in all, together with the Board, we have set a goal for the full year of 2020 to achieve revenue growth on 2019 and to maintain an operating margin above 20%.With that, I thank you for your attention and leave the word back to our moderator. Thank you.

[Operator]

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

[Ramil Koria, Analyst]

I actually have a few questions, but perhaps we'll do them one by one. So starting off on the cost side. I was thinking about sort of the cost savings that you expect from the OSS R&D reduction and also how the R&D scale up in primarily Network Solutions play into that. How sort of the different sizes of the -- I guess, if you want to call them the 2 different programs, add up on the P&L, say, throughout 2020? Should R&D net come up or net come down?

[Björn Westberg, Chief Financial Officer]

Thanks, Ramil. So starting with -- I mean there were -- there are different components here. But that the estimated cost will be around SEK 15 million, and that will be taken in the first quarter. And we will, of course, see a decrease in R&D in these credit lines. At the same time, we are investing -- as Jan mentioned, we have the best portfolio ever for the future, and so we're investing in 3 areas, as Jan presented in the previous -- in the slide before. So overall, we are investing a lot, lot very much -- as the presentation increase, but still, we are increasing next year -- this year, sorry, this year 2019.

[Ramil Koria, Analyst]

And then perhaps on a more philosophical point of view, why are you ramping up R&D investments ahead of 5G and NFV rollouts? I mean we've known this for quite some time. Is there anything that has happened? Are you looking to improve your existing product line? Or is this to expand sort of the portfolio? Some flavor on that will be great.

[Jan Häglund, President & CEO]

Yes, Jan here. No, it's correct. I mean this is a competitive market, and we see opportunities in this market. We have also -- we are expanding our portfolio compared to what we've had before, and that was also announced in our data management offering. So the domain that we addressed in 5G is wider than the domain that we have been addressing previously in 4G. So all in all, to meet that competitive pressure and making sure that we are early enough for the early evaluation, these are long-sales cycles in this market. We have decided then to capture that by increasing investments.

[Ramil Koria, Analyst]

And then in the report, you mentioned that the ambition is to see these investments, I guess, you could call them turn profitable in 2021. What kind of sort of visibility do you have on that? Is that based on projections of the 5G core market gaining steam? Or is it more about sort you seeing tenders being initiated today and perhaps closed in late 2020 or early 2021?

[Jan Häglund, President & CEO]

Yes, predicting market speed is something which I think we all know has uncertainty, but our best predictions, which I think are shared by many analysts, is that these markets, both virtualization market and 5G market starts to take off during this year, at least with vendor selection, and then move on into coming years. We want to be clear that this year, these are investments, meaning that costs in these areas are higher than our estimated revenues. But we believe that already during the next year, we'll be able to get a net contribution to our earnings from these areas.

[Ramil Koria, Analyst]

And then just finally on the M&A side. I mean the balance sheet is obviously quite strong now following the bond redemption. You're sort of increasing R&D investments. Isn't there a rationale for sort of deploying the balance sheet and acquire products instead of going the other way around?

[Jan Häglund, President & CEO]

The date as we have communicated many times, the date, for our long-term growth is organic. We have not only opportunities with the capabilities we have and the market that we are addressing, but we have it more than ever. So that's why we see organic growth opportunities, and that's why we make sure that we invest enough into that. Having said that, we have done a number of successful acquisitions in the past. We know how to do that, and we have been selective but successful in that. We continue to seek acquisition target that can complement our portfolio. And the balance sheet allows us for that flexibility to act when the right opportunity occurs.

[Operator]

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

[Simon Granath, Research Analyst]

Congrats on a solid quarter in spite of the absence of any larger orders. And firstly, you have previously talked about some market uncertainties primarily relating to Huawei. Have these issues now been resolved? Or do you feel like the market has been somewhat slow during the quarter? I mean for instance, we have seen somewhat weaker development for Ericsson in Q4. So if you could provide some color on that, it would be great.

[Jan Häglund, President & CEO]

Thank you, Simon. Yes, we have previously commented on the fact that geopolitical uncertainties create potential delays on the market. And I think uncertainty and delay is not good for anyone. And in previous quarters, we communicated that, that also has had some effect on us, indirect effects since the delayed investment decisions can also cause delays for us. And I think we continue -- I mean we can all read about this in the newspaper that some of the 5G investments are limited by regulators, and there is still a discussion going on, especially in Europe, about how to think about that, what vendors are allowed, et cetera. Hopefully, these uncertainties can go away as quickly as possible. I think that would be not only good for the industry, but also good for Europe. And whether that and how quickly that will happen is very difficult to predict. I think we believe that these uncertainties will remain for some time.

[Simon Granath, Research Analyst]

Okay. Perfect. And also a couple of questions relating to your Policy and Access Control unit. Has this -- firstly, has this entity recorded a similar margin in Q4 as in the previous quarters? And it will also be great if you could comment on what has been driving sales for this units -- unit? Does it mainly relate to the company's organic development? Or does it mainly relate to sales synergies that have been strong? And also, on that note, do you feel like you can find even further sales synergies between the Policy and Access Control units and any, as a whole, regarding cross-selling of products, et cetera?

[Björn Westberg, Chief Financial Officer]

Yes. I'll take the first question there, Simon. So we are very happy with the development of the Policy and Access Control business, and we see that overall, they have a better margin than the group average. Jan?

[Jan Häglund, President & CEO]

Yes. And I think we can say that the main part of the positive development is organic, meaning a strong development of the position with bank houses of the world of this portfolio. That means that we still have more to do when it comes to, for example, cross-selling, which would be then to utilize our existing other customer relations to also position this portfolio. And that's something we're working on. So yes, there's more to do. So we have -- I have, in general, a positive view on both the competence and the market position we have through this new acquisition.

[Operator]

And our next question comes from the line of Viktor Westman at Redeye.

[Viktor Westman, Analyst]

I have a question on the mobile video segment there. You mentioned no larger deals there. I was just thinking if you can discuss the dependency on larger deals in general. And I also think that previously, you said that you have about 20% recurring revenue in this business. So if there were no new deals, it should have declined a lot more, I'm thinking. Can you comment on that?

[Jan Häglund, President & CEO]

No, but I think -- thank you, Viktor, for the question. We've been quite clear that with Network Solutions comes also dependency of large orders, and they can vary between different quarters. So our business has become a little bit more lumpy than it has been in the past in Q4. For example, last year, we had one of those large orders. And there was not a similar type of order in Q4 of 2019. So that's -- I think that's what the comparison that Björn highlighted in the view here.I mean going forward, we will have this also. We will have lumpiness in our business with large orders varying over the year. Having said that, we have a positive view. We maintain a positive view on the video optimization market. Video continues to grow across the world. And with 5G now entering, it will only mean more traffic and more video in networks, creating opportunities for a market leader like Enea.

[Björn Westberg, Chief Financial Officer]

I also mentioned, I think, in my presentation that we have some sort of semi-large orders, and then -- and, of course, I mean we have a very large customer base. There are semi-large orders and that could be -- in many cases, that's the existing customers expand the licenses for instance.

[Viktor Westman, Analyst]

Okay. Very good. And one last question on the savings program there. You mentioned Germany and you mentioned Sweden. Could you specify a bit more what these are? And how much is so-called the legacy business? And any -- is there any other stuff in there?

[Jan Häglund, President & CEO]

I mean we work to make sure that we invest capital, we invest OpEx and also competence in the best possible way for the company. And I mean the operating systems, legacy business, has been going down, and we continue to see a decline in that. So we -- that's why we're taking action now to rightsize the organization. This will have an effect on head count here in Sweden, less than 10 people. In Germany, it's more in relation of structuring in a smart way our data 5G development making sure that we focus on the right amount of design centers. And in this case, we decided that a small design center, also less than 10 people in Germany. It can be phased out to achieve higher efficiency, better cost structures and also more critical mass in the remaining designs that is primarily in Eastern Europe.

[Operator]

[Operator Instructions] Okay, so no further questions coming through. I'll hand back to our speakers for the closing comments.

[Jan Häglund, President & CEO]

Well, again, thank you, everyone, for attending, and thank you very much for the interest in Enea. As said, we maintain a positive view on the markets we operate in. A lot is going on. And there's a very high activity both in our company, of course, but also in the industry. With the 5G just around the corner, we're working hard to position ourselves, and we'll soon be heading down to the Mobile World Congress, where the whole industry will be gathering. And we'll be speaking about our offering as an independent software company with a western-based development base, positioning ourselves for the new world of cloud micro services and new services. And so we just invite you to stay tuned to our development. And again, thank you for your interest in our company.