EDAG Engineering Group AG

XETRA:ED4

Earnings Call Transcript 2020-Q3

[Cosimo De Carlo, CEO & Member of Executive Board]

Good morning, ladies and gentlemen, and welcome to our Q3 earnings call. I'm here together with my colleague, Holger Merz, who will give you the financial details on the first 9 months of 2020 later on.As usual, I would like to give you an update on our market environment at the beginning. As already indicated during our H1 call, the second quarter showed the worst effect of the global COVID-19 pandemic so far. We have experienced a sequential improvement in our business environment since mid-June, which continued to evolve over the complete third quarter. The easing of corona restrictions in almost all countries worldwide led to a slight recovery in global car sales volumes with September even showing growth for Europe, the U.S. and especially in China. However, on a year-over-year basis, global car sales are still severely hit by the pandemic and far below the previous year's level.As a result of this negative economic impact, most of our customers are still operating in a crisis mode. With a focus of their investments almost on automotive mega trends, such as e-mobility, connectivity and software.Let me give you a few more insights on the current ESP market environment. In the third quarter, we have noticed a sequentially better overall market compared to Q2. The number of RFQs is rising, which have interpreted as a first sign of a market recovery. However, especially our German customers are still very careful with all the placements and outsourcing of cheap work packages. This leads to a continued volatile utilization and pricing pressure in Germany. The good news is that EDAG has successfully developed its international business, with new customers from Asia, Europe and the U.S., we are very well on track to meet our strategic goal to grow our international footprint and market share.Nevertheless, as infection numbers are rapidly growing over the last weeks, the overall situation is still very fragile and heavily depending on the development of the COVID-19 pandemic. In this situation, we continue to operate scenario based, which ensures a maximum of flexibility in any direction, whilst we keep our costs fully under control. The success of this strategy is underlined by our Q3 numbers. So let's move on the key highlights of the first 3 quarters of 2020.The 9 months revenues were down by 17.3%. Q2 was still down about 22% due to the weak order intake in the first 2 quarters. The good news is that we managed to become profitable again even on a much lower revenue level. The adjusted EBIT in Q3 was at 4.8%, which shows that our immediate measures to lower the cost base were effective. After 9 months, adjusted EBIT levels at minus 1.6% due to the weak Q2.Another good news and a first indicator for a market recovery is the strong order intake, which has more than doubled quarter-on-quarter. Holger Merz will give you the details in a few minutes.On free cash flow after 9 months is extraordinary strong with EUR 103.4 million. This is, once again, proving the effectiveness of all measures we could talk. Moreover, we have managed to significantly lower our net financial debt compared to the previous year.Finally, let me quick highlight on our EDAG Tech Summit, which took place end of October. We have presented the world premiere of the ready-to-drive and ready-to-work EDAG CityBot, artificial intelligence prototype, the first stage of artificial intelligence live in action in our laboratory. For this occasion, we have brought together several aspects of future-related topics such as smart city, autonomous driving, artificial intelligence and other exciting items from the EDAG 360-degree engineering. We have many virtual meetings with interest parties from all over the world. And feedback from our customers was accelerated goods. With our Tech Summit and the presented innovative software solutions, EDAG is even strongly recognized as the leading innovative engineering service provider to the global mobility industry.So overall, ladies and gentlemen, the figures for Q3 show a very good momentum and clearly support our strategy of internationalization, innovation, flexibility and cost control. Our innovative strength has been proven once again, and we are working with full power to get out of the corona pandemic stronger than even before.So far from my side, for the moment, please let me now pass on to Holger Merz, who will provide you with the financial details on our 9 months figures 2020.

[Holger Merz, CFO & Member of Executive Board]

Thank you, Cosimo, and good morning, ladies and gentlemen. As Cosimo already mentioned, revenues after 9 months were down by 17.3% to EUR 482.9 million.Looking at our 3 segments, we see a mixed picture. Our biggest segment, Vehicle Engineering, was down by 19%, especially due to the already communicated project cancellations earlier this year. Production Solutions shows a decline of 14.5%. The good news here is that the speed of revenues decline at Production Solutions was significantly reduced compared to the previous year. Electrics/Electronics, on the other hand, had only a minor decrease of 2.8%. Although the overall market situation for Electrics/Electronics is very well, our biggest customers in this segment showed several delays in the awarding of contracts.At the next slide, we show our revenues split by region. As already highlighted in our half year call, we have won several new customers outside Germany. As a consequence, sales with customers outside Germany are constantly growing despite the impact of the corona pandemic. After 9 months, the international revenue share is up to almost 38% after 31% in the previous year. Our new clients require many vehicle engineering competencies, which is good for the utilization of our capacities also in Germany. Overall, we expect our revenues to grow outside Germany over the coming quarters.Let us have a quick view on our order intake by quarter at the next slide. Due to the weak order intake in the first 2 quarters, our revenues were down in Q2 and Q3. In Q3, on the other hand side, our order intake was much better and even more than 30% above the previous year's third quarter. Quarter-over-quarter, order intake has more than doubled. This is the first positive indicator for the future development of our revenues.The very sound order intake in Q3 was mainly coming from the international customers. As Cosimo said in the beginning, we recorded a strong upswing in the number of RFQs in Q3, also from our German customers. However, by now, order intake with German customers remain muted. Overall, and despite the satisfying order intake in Q3, the total order intake for the first 9 months is still some EUR 46 million below the previous year's figure. So for the rest of the year, revenues are expected to be muted and the return to former levels should not be exceeded too early.Let us move to the next slide, where we show the development of the adjusted EBIT. Overall, the adjusted EBIT was at minus EUR 7.7 million, which corresponds to a margin of minus 1.6%. Here again, Q3 looks much better than Q2, although revenues in Q3 were down by about 22%. We have managed to become profitable on a much lower revenue base. This development clearly proves that all measures that we immediately took to cut costs are working very well.Let's have a quick view on our EAT and equity at Slide 9. Corresponding to the development of our adjusted EBIT, earnings after tax are negative after 9 months. Here again, the one effects resulting from IFRS 9 and our restructuring costs play a decisive role. Looking ahead, we do not expect earnings after tax to recover until end of the year. This assumption is based on 2 points. First, as announced during our H1 call, we have decided upon a major performance improvement program. In the event that the package of measures is implemented in full, we anticipate one-off costs of up to EUR 12 million. These costs will, of course, impact our EAT. In Q3, we have already implemented restructuring measures in the amount of about EUR 6 million, so up to about further EUR 6 million will affect the Q4 numbers.Secondly, as already experienced last year, we expect the December to be a very weak month, even weaker than in 2019. This development will also weigh on our earnings in Q4. The equity ratio decreased year-on-year and is now at 17%. The decrease is, of course, caused by the net loss of the first 3 quarters.Let's move on the development of headcount and CapEx at the next slide. The overall headcount decreased by 610 to 8,013 employees compared to the end of September 2019. Within the third quarter, headcount decreased by 76 employees as we are currently only hiring where absolutely necessary and using normal fluctuation to reduce our cost base.Looking at the number of employees in our 3 segments, we are posting a decrease in Vehicle Engineering and at Production Solutions. In Electrics/Electronics, on the other hand side, we have recorded a slight increase as the overall market in this segment is still intact. Our CapEx has been significantly reduced to EUR 10.8 million, which corresponds to a CapEx ratio of 2.2% of revenue. We do expect that CapEx ratio to remain low for the rest of the year.At the next slide, we show the development of our trade working capital. As we carried out in our last call, cash management and working capital management is of utmost importance in the current environment. We have managed to significantly reduce our trade working capital to EUR 4.7 million compared to almost EUR 178 million in the previous year. This is a really huge and extraordinary movement. Once the overall business is picking up again, we will also build up working capital accordingly. So this picture should change over the next quarter stabilize.An extremely positive development is shown at the next slide. Compared to the previous year's figures, the operating and the free cash flow have significantly increased in Q3, but also over the 9-month period. We are posting a record free cash flow of EUR 103.4 million after 9 months. This will result based on 2 factors. First, all of our immediate cash management measures are successful in showing their effectiveness. Secondly, we have received down payments from some of our customers.Overall, we are more than satisfied with these excellent results. Before coming to our outlook, we show the development of our net financial debt at the next slide. Overall, we have managed a massive reduction of our net financial debt. The net debt, including leasing at the end of September, was down by more than EUR 160 million compared to the end of September 2019 to EUR 136.9 million. The net financial debt without leasing is, in fact, no debt anymore. We have become cash positive with plus EUR 9.3 million at the end of September. Moreover, we had about EUR 100 million of available credit lines at the reporting date. So based on the figures at the end of September, EDAG is in a very comfortable and strong financial position.Please let me give you a few more insights why we signed the additional EUR 60 million KfW-credit yesterday. The most important point is, of course, securing liquidity. Cash is king in these demanding and challenging times.One condition of the KfW loan is that most of our financing banks guarantees their credit lines for the term of the KfW credits, which is 2 years. So by signing EUR 16 million credit, we have secured about a further EUR 80 million of credit lines for 2 years. So we made sure that the EDAG Group maintains a strong financial position for longer time.As the corona pandemic is getting worse since October, nobody knows how long and how hard the further economic impact will be. We are, therefore, operating scenario based, which ensures a maximum of flexibility in any direction whilst we keep our costs fully under control. This addition in KfW credit line, we are preparing our company for further scenarios and safeguard liquidity for all cases.One scenario could be a quicker than expected recovery with a strong order intake and additional opportunities to invest. In that case, we will need additional liquidity, which is now available. Another scenario could be a longer than expected economic downturn. Although in that case, liquidity could become essential. So the second important point for us is to sign the credit was to be financially prepared for any scenario. However, even for the case that we finally do not need the money and we have to pay a small amount of interest, we would consider those interest payments as a kind of insurance premium for the current uncertain time. So overall, with a new contract, we made sure that EDAG remains financially strong, flexible and prepared for a strong recovery.Finally, let us come to our outlook for 2020. Due to the continued extraordinary and extremely high dynamics and uncertainties, we have maintained our outlook mainly as stated during our last call. Overall, we expect a decline in sales and earnings for the financial year 2020 compared to the previous year, which is in the worst case, can have a material impact on the earnings situation.On the basis of the negative earnings after tax at September 30, 2020, and the year-on-year decline in order intake as well as the restructuring expenses to be taken into account in the fourth quarter, it cannot be assumed that the accumulated loss after taxes can be compensated during the fourth quarter.We continually monitor possible effects on the business and take comprehensive measures to ensure the protection of our employees and the continuation of business operations in the group companies.Ladies and gentlemen, concluding, please let me state the following. The EDAG Group is navigating safely through the current uncertain environment. The management took immediate decisions to counterbalance negative effects evolving from the corona pandemic. Our financial results, especially the cash flow and the net debt are an excellent proof for the efficiency of our measures. In Q3, we have delivered what we have communicated before. The figures were even better than expected. We and our employees have had to take hard and painful steps, and there are some more to come in the fourth quarter. However, the management will take all necessary measures to secure our market position. Moreover, we remain absolutely confident that our strategy of internationalization and digital transformation is the right one to emerge stronger than before from the corona pandemic.Ladies and gentlemen, thank you, once again, for joining our call today. We are now looking forward to answering your questions.

[Operator]

We can now take our first question from Marc Tonn from Warburg.

[Marc-René Tonn]

A couple of questions from my side. First would be on free cash flow, which was obviously a big surprise. It was tremendously positive in the third quarter. And as you mentioned, working capital and customer prepayments have been main drivers here. If you could give us some indication on how you would expect this figure to play out in the quarters ahead? Do you expect already, let's say, some kind of, let's say, major reversal of these positive effects in the fourth quarter? Will this be more something which we will see in 2021? That's the first question to free cash flow.And second question, we've seen this very strong order intake in the third quarter. Perhaps you would give us also some indication. Is this also, let's say, more driven by the international business? Or is it also the case that the, let's say, more traditional or German European customers are also getting a bit more active in this regard? And also that's coming to the international business when we look at the revenue generation, which we have seen there was that particularly strong quarter, which was, let's say, massively up on last year when I see it correctly, i.e. almost doubling from last year, to be honest. I was suppose if you could give us some indication whether you would expect this level of more than EUR 40 million in the quarterly revenue? Is it a run rate? Or was it an exceptionally good quarter, recovering something from Q2? Or is it something, which you also assume for the quarters ahead?

[Holger Merz, CFO & Member of Executive Board]

Okay. Then I'll start with your first question regarding the free cash flow and good operating cash flow in the third quarter. As I mentioned before, we had a good cash management implemented and also we received some down payments from our customers. But we think in the following quarters, the situation will return. Then especially also when corona pandemic is over and sales revenue rise, again, then we expect working capital will increase, and that means that our cash flow will go down a little bit. And then also our debts will go up, and that's exactly also some of the reasons why we decided to sign an KfW credit.

[Cosimo De Carlo, CEO & Member of Executive Board]

Concerning the other questions, concerning order intake and the development of the, let's say, international business. Yes, the very good order intake is a result of the international strategy that we started 2 years ago. So we don't have any big change from the German customers in this context. The market, especially in Germany, remains extreme volatile. And that's the reason why the German customers are not, let's say, try to put on the market, big orders for the next years. So the main influence of a very good order intake in Q3 is mainly generated by international customers.Yes, you are right. In terms of if we analyze quarter-to-quarter, the third quarter was exceptionally good for the international part of the business. As we said in the call, after the first 9 months, we reached 38% of the business outside Germany. And even 44% if we consider only Q3. Of course, Q3 was exceptionally good, but we wanted to go ahead with this strategy. And we wanted to further develop the international business. It was always our strategy in the last 2 years, and we are really focusing on this. All the management team are really focusing on this part because this is the only part that we needed to do, close, of course, to perform a better portfolio in terms of softer digitalization. But with this strategy, we are convinced that in the future, we'll have a very good balanced portfolio, and make sure that we can really balance and counterpart any kind of crisis or volatility, which is still on the market in the automotive market today.

[Marc-René Tonn]

Okay. And just as a follow-up to that, I think this business also is helping you to improve utilization of sales back utilization at your German facilities. Is it something you're expecting to continue? Or are you also considering to ramping up new engineering facilities abroad in the future?

[Cosimo De Carlo, CEO & Member of Executive Board]

We have, of course, a double tax to do. First of all, we need to increase our utilization in Germany. The utilization in the third quarter was better than utilization of the second quarter. I think we had utilization, which was about 10%, 12% lesser than the normal value. We were in second quarter at about 20% less of the normal value. So we need to improve utilization in Germany. So it's a task that we're starting Q3, but we need to continue to do that in a better way. That's the first focus we have.The second focus, of course, we see that international business is becoming better. We don't see at the moment the necessity to open new offices or, let's say, facilities worldwide. I think we are on a very good base in terms of international footprint. And the international business is also an opportunity to increase our utilization in Germany because quite often, when we acquire international business for customers outside Germany, a very good part of the work is generated in Germany. So we have a double positive effect. First of all, increase of utilization in Germany. And on the other side, increase and improvement of capability and knowledge from our facilities worldwide.

[Marc-René Tonn]

Just lastly, short-term work. And could you give us some indication on how much, let's say, support you have from this team in the third quarter and perhaps also compared to second quarter, but was the figure there?

[Holger Merz, CFO & Member of Executive Board]

Yes. I take this question. In September, about 480 employees, that means full-time equivalents in Germany were in short time work. This corresponds to approximately 10,500 days. The good news is that the curve on short-term work is flattening out. And if you compare it to the second quarter, then we see a clear improvement also in the utilization. Utilization, as Cosimo mentioned, in the third quarter was about 10% to 12% from -- away from the normal level and in comparison from -- to April to June, we had a drop from about 20%. And so you see a clear improvement of utilization. And also we have less people in short time work.

[Operator]

[Operator Instructions] We can now take our next question from Christoph Laskawi from Deutsche Bank.

[Christoph Laskawi, Research Analyst]

The first one also on the international business. You did quite a good job in increasing the share and growing revenues there. Thinking more long to -- or mid to long term, do you expect the revenue -- the business to be recurring when the larger projects are done? Could you comment on the average contract length? And would you expect, say, a normalized business as you see with the Germans? Or could it be that once you set up a program for say the Chinese EV players that they will try to do it in-house right after? That's the first question.

[Cosimo De Carlo, CEO & Member of Executive Board]

Okay. So of course, our intention is to have a long-term customer bases outside Germany. So it was really -- as I presented in my plan more than 2 years ago, it was a clear focus to increase the international business on a stable way. So we want to continue like this, and, let's say, create long-term relationships with our customers also outside Germany. In order to keep this kind of ratio, which is necessary, healthy for the future of our company. First of all, because we know that the automotive industry has been globalized. And the footprint and the weight of the international business in automotive will be in the next years stronger -- probably stronger outside Germany than in Germany. That's the reason why we have to be there because we have to be where the automotive music is played.On the other side, does not that mean that we -- let's say, don't want to do business anymore with the general customers. These are very important for our portfolio, for our competence base. And we hope that the German customers do better in the future than in these years because in this case, we are ready. And I think also with them, we can still generate an added value in the future. Added value is generated also by the -- our strategy in terms that we are performing and achieving in terms of portfolio. We are increasing our business in Electrics/Electronics. We are increasing our capability in software development. And we are convinced that with this capacity and competencies, we will able in the future to support the German customers and international customers. So that's also there are work to do from our side. And by combining the customer portfolio plus competence portfolio, we will get a very good position in the future.

[Christoph Laskawi, Research Analyst]

The second question will be on pricing in Germany. The trend is essentially present that pricing is under pressure for a couple of years now. Also, utilization is not quite when you look at the overall market. You are doing a good job in utilizing your German facilities or workforce also with international contracts. But do you see a point in the near future, at least, where the pricing momentum could turn actually. Or would you say it remains that way for the coming years? And there's really not much you can do about it at this point.

[Cosimo De Carlo, CEO & Member of Executive Board]

Well, let's say, it's a common question that I always answer in this context. So my personal point of view, I think that the price pressure in Germany will remain in the upcoming years. I never expect a huge increase of the pricing. It was never the case in the past. This pressure is becoming, let's say, actual is becoming stronger at the moment. There are many aspects of it. First of all, of course, the lack of utilization we have on the market. So if the market is still underutilized, you always have this kind of price impression.On the other side, it's a typical effect of a transformation of the services of this industry. So we see and we have seen also in the last quarters. It's not something new because the corona only accelerated a process, which was already taking place before this pandemic, which is the reduction of number of derivatives. So in the market, we will have in the future less derivatives. That means our customers will focus more on vehicles with more margin instead of focusing on market share. And that's as a consequence for the work on the market for ESP, which means less derivatives means less works in terms of testing, less work in terms of adaptation of vehicles.On the other side, the good news is that the kind of services that the market is requesting are transforming themselves. So we see more and more need and refuse on the market. I think our sales pipeline is really very promising, but mainly in the softer domains, mainly in these new domains. So of course, everybody is trying to cover this lack of competence on the market. This is the reason why many actors or many competitors of EDAG are trying to attack it.On the other side, I see here the opportunity, let's say, to increase our market share in these areas. But the efficiency in terms of delivery, in terms of cost, it always has been our work. We need to increase our cost base, improve our cost base in order to, let's say, improve our profitability on the market. And that is also possible even if the pricing going down, even by reducing prices, we have the possibility through a very intelligent delivery, let's say, to increase the profitability.

[Christoph Laskawi, Research Analyst]

And do you expect -- I mean, consolidation is much overdue in the market, to be fair. Do you expect it to happen at some point? Or would you say of the small shops therefore, the next couple of years, they will get some volume and they will continue to struggle, but they will be around? Or do you expect it to happen?

[Cosimo De Carlo, CEO & Member of Executive Board]

So consolidation is a point of no return. I do expect consolidation of the market. So we were expecting that already, let's say, last year, because of the transformation of the market. Now with the corona pandemic effects, I think it will be very difficult for small players, let's say, to be alive, to stay alive on the market. I think we will see that probably not now, but we will see the effect of this pandemic. Nobody knows what the effect will be, but in any case, the negative effect of this that we probably see with small companies during the Q1 of 2021. So in the next months, we will see how struggles -- how the small companies will struggle because of that. And that's, of course, an opportunity for the big player like we are, let's say, to increase our -- to increase the market share. But I expect the market to consolidate in any way -- in any case because the customers are demanding for flexibility, demanding for a global delivery and as a small company, as a small engineering service provider will be not possible for you in the future to deliver that.

[Operator]

There are no further questions at this time. I would now like to turn the call back to the host for any additional or closing remarks.

[Cosimo De Carlo, CEO & Member of Executive Board]

Okay. So thank you very much for participating to the call. I wish you a very good day. Thank you for joining us and listening to us. Have a good day. Thank you.

[Holger Merz, CFO & Member of Executive Board]

Bye-bye.