Enea AB (publ) (ENEA) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Enea AB Q2 Report 2020. [Operator Instructions] Today, I'm pleased to present CEO, Jan Häglund. Speaker, please begin.

Thank you very much. This is Jan Häglund, the CEO of Enea. And I'm sitting here in Stockholm, Sweden, with our CFO, Björn Westberg. And we're pleased to present then the second quarter financial results 2020 for you. In this call, we will be summarizing the key events of the quarter, going through at more depth the financial results, and then summarizing the call and also with the financial outlook. On Page 3, we summarize the financial numbers of the quarter. Net sales amounted to SEK 239 million, built up from a strong base of recurring revenue, growth in our largest product group, Network Solutions and an expected decline in our operating system product group. Operating margin came in at a strong 25.3%, excluding nonrecurring items, again, a strong result, and built on a good mix of primarily software revenue and also low cost based on, among other things, the restructuring program that we announced and also executed during the first quarter this year. We further strengthened our financial position with a net debt-to-EBITDA of 0.55. Our earnings per share came out at SEK 2.18, also positively impacted by a lower interest cost this year. Operating cash flow was SEK 68 million. And we continued to invest a significant share of the company revenues into R&D, a total of 25.1%, shared between OpEx and capitalized R&D expenses. And we do this because of the growth prospects and the interesting market opportunities that we address as a company. For the period, sales came out at SEK 461 million; operating margin, 21.9%, which is above our 20% ambition. Earnings per share for the period was SEK 2.98 and operating cash flow, SEK 130 million. The next page, we summarize again the effects on Enea from the corona pandemic. These are the same effects that we already saw and announced in the first quarter. On a general market basis, we see telecommunication and digitalization being even more important for societies and for people than it has ever been before. And I think we have all experienced that in various shapes or forms. We see that very concretely in our networks through measurement of traffic volumes, increased video consumption in many mobile and fixed networks across the world. However, we also see that the corona pandemic has led to delays in specific projects due to practical difficulties in conducting, for example, upgrade projects. And we also see an increased risk awareness, which, to some extent, has led to delayed investment decision. And looking forward into the market of 5G, we believe that 5G continues to be very important for the market, for societies, industries and people. So we believe that deployments will continue, but there is a risk of short-term delays, for example, on the back of delayed standard, delayed spectrum auctions, et cetera. When it comes to Enea, the majority of our business is stable, supported by a high degree of recurring revenue as seen in the second quarter. We, like many other companies, have completely transformed our operation to work from home, and we've been able to do that with full business continuity and, I would say, almost full efficiency. Our financial position remains strong, which creates stability in this period of macroeconomic uncertainty. And we believe that the opportunities remain. We address interesting markets like 5G and cybersecurity, which is why we continue our investments for long-term growth. On the next page, Page 5, we summarize a few of the key events in the quarter. And the main event is most certainly the 2 5G contracts for 5G network data layer that we announced with leading Tier 1 service providers in North America and Germany. I'll be coming back to details of those contracts. We also announced a contract in traffic management, an area where Enea holds a market-leading position, this time with a Tier 1 Middle Eastern mobile operator. Traffic classification is another area of technology and market leadership for Enea. In the quarter, we announced a contract with a German company, Genua, that will embed Enea solution for their cybersecurity solutions. Edge virtualization is an investment area for further future growth in Enea. In the quarter, among new deals, we announced a new Dutch customer, Videns, that will deliver an SD WAN solution based on Enea's NFV Access product. We also were awarded actually twice to be finalist for an innovation award by the renowned analyst company, Light Reading, for 2 products, the Enea Stratum product and the Enea Unified Data Manager product. We're very pleased about this. And again, take it as a proof of our investments and our technology leadership and of the competence of people in our organization. So I promised to say a bit more about the wins in 5G. On Page 6, we summarize this. The win is about network data layer, which is really the backbone or the back end of the 5G core network, which is the new 5G standard based on what's called stand-alone 5G networks. Our product then provides a unique way of doing this, in particular, that we provide complete openness for multi-vendor applications as well as for multi-vendor cloud platforms. We have invested into this area since several years, and the wins now with Tier 1 service providers in North America and Germany is a testimony of the market position that we believe we are achieving. This area is important, not only for us, but also for customers. It will bring significant efficiency and cost benefit with new way of building 5G networks. For us, of course, it means revenues, not just short term but also long term, into the full 5-year contracts of these 2 new deals. On the next page, we just put this into perspective. Our 5G portfolio focuses on 2 areas: One is data management; one is traffic management. In data management, the Stratum product, as mentioned before, realize this is what's often referred to as a network data layer. Enea also has a number of applications, data-intensive applications, for example, for unified data management, for access management, for equipment identity management and for policy management. So these are also products that we are at this time qualifying and demonstrating to the market. In traffic management, we also build on the technology and footprint that we have and take that into 5G, either as a stand-alone offering or embedded together with other solution providers. Now all of this builds on the 5G market and I mentioned also the 5G core standard. On the next page, just to summarize a bit how we see the market development there. Many analysts are looking into when and how quickly this market will evolve. Heavy Reading did a big investigation among operators and concluded that already 74% of the operator base have plans to deploy a multi-vendor 5G core, which then will over time migrate from and replace the current core network infrastructure. We also did our own survey looking into the more exact timing, and we found in our survey that 37% of the answering operators have plans to start to deploy 5G core already within 2 years. And when it comes to the way of doing this, a network data layer, as mentioned before, is a significant part, and actually, more than 50% have plans to deploy this network data layer, which is a new and more efficient way of building up the data infrastructure compared to today's networks. Before concluding, just a few words, on Page 9, on video traffic management, which is an area of strength and market leadership for Enea. We see many operators continuing to take an interest in traffic management, primarily driven by increasing traffic and increasing demand among end users and across the world. We've also -- the reason for deploying video traffic management is really shown to the left here. It's about achieving faster downloads, up to 20% for end users. It's about managing congestion. We measure 15% fewer congested cells in most networks. And it's about managing the capacity, and quite frankly, saving on investments also in the networks. We see up to 20% savings for many operators. So we're pleased to announce new customers in this area. One in the quarter was Zain Kuwait, that decided to deploy an Enea traffic management suite for both 4G and 5G. A customer that we have had for a while is Vodafone Ireland, but they have together with us published the results of the benefits that they have seen and measured quite superior video experience, thanks to the technologies that they have previously deployed. And we've also recently, only a few weeks ago, won a contract with a new customer in Egypt, an operator that will be using Enea's traffic management solution and starting to deploy that solution during the second half of this year. With that market summary, I'll leave it over to Björn for the details on the financial results. Go ahead, Björn.

Thank you, Jan. This Slide 11 shows net sales for the most recent 5 quarters. Net sales amounted to SEK 239 million, which was 4% lower versus last year but 8% increase compared to the first quarter 2020. The current effect was 1%. We had an expected decline in operating systems and an organic growth in Network Solutions, which I will cover in the next slide. So on Slide 12, starting with operating systems. As mentioned, revenue continued to decline in line with our communication during recent years. The decline was 25% due to less sales growth to key accounts, Ericsson and Nokia. That decrease is expected as they both are, since a few years, building their solutions based on open source software. Network Solutions, by far, the largest product group, now representing 2/3 of total sales, had an organic increase by 4%, driven by our steady base of recurring revenues, in combination with sales from new contracts, specifically in solutions for cloud data management. Software Development Services, previously named Global Services, declined by 5%, mainly due to less sales in the U.S. That is partly likely due to the impact of the corona pandemic, as some of our U.S. customers are in industries where the pandemic has a significant impact. This quarter it's even more evident than before that we have transformed the business from a large dependency on [ operating systems ] some years back to a company where we have a wide range of high-quality offerings in Network Solutions. For operating segments, we now have a #1 or top tier position. This is also guidance for us when we are exploring nonorganic growth opportunities. On Slide 13, we present the EBIT development. The EBIT margin was 25% in the second quarter, which is clearly above 20%, which is our objective. Although much higher than the first quarter EBIT margin, it was lower than second quarter last year. Comparing second quarter this year versus last year, the margin was positively affected by lower OpEx and negatively affected by lower cost contribution. Starting with the gross margin, we have specified the gross margin bridge in this slide. Taking out currency effect on working capital and the last year's R&D grant, the second quarter gross margin was 71.5% compared to 73% last year. The 1.5% difference is mainly due to higher depreciation and amortization related to the acquisitions. OpEx decreased by SEK 11 million compared to the second quarter last year in spite of our SEK 4 million increase in cost for share incentive programs. With some impact of less sales and marketing activities due to the pandemic affected cost positively. We see effects of the implemented efficiency program in combination with a higher level of our spend in products being capitalized. As many -- as all of you know, we have never had such promising development portfolio as we have now. EPS for the quarter was SEK 2.18, which is a significant improvement compared to the first quarter 2020. We continue to see the positive effect on the net result related to much lower financing cost as a result of the bond redemption last year. Going to next slide. We continue to generate good cash flows. The operating cash flow amounted to SEK 68 million, that we compare to quarter 2 last year. And now we placed a very efficient financing structure with a low financing cost with a net debt-to-EBITDA of 0.55, having headroom for potential acquisitions. The strong balance sheet is also reflected in the equity-to-asset ratio, which increased to 68% from 50% previous year. To conclude, we have a very solid financial position, making it possible to invest in both nonorganic opportunities and our organic growth projects. Back to Jan.

Thank you, Bjorn. So I'll take it forward into summarizing this call and also looking into the outlook for the year. On Page 16, just summarizing our strategy. Our strategy stands firm. Our strategy is based on building a market position in areas where we can be #1 or working with Tier 1. Our strategy is built on business models for software with high gross margin and also recurring revenue. We have a go-to-market model based on a combination of direct sales, working directly with advanced big customers, and also indirect sales through strong partnerships with larger systems vendors. Our growth strategy is built on the combination of organic growth as a basis and where inorganic growth has in the past complemented our organic growth in a good way. And we continue to seek acquisition targets that complement our position and add value to the company. Our track record remains firm, with leading positions in several areas. Our financial position also stands firm, as Björn summarized. And we have a management team and a competent structure in the company that allows us to work in highly advanced technology leadership areas and also in global business, where we touch advanced customers across the world. The news in this quarter, our wins and finalist positions for a couple of our new investment products, our new contracts in 5G in North America and Germany, our new customers in traffic management as well as the numbers presented by Björn for financial results, all prove that we are on track with our strategy execution. So finally, on the last slide, market outlook. There is no doubt that the ongoing pandemic has created increased uncertainty in the short and medium term for the market as well as for us, for our company. Having said that, we continue to have a positive outlook for our markets that we address, which is software in telecom and enterprise networks. We maintain the target of an operating margin over 20%, but we do believe that the consequence of the pandemic will have a negative impact on our sales for 2020. This was our analysis already in the first quarter, and we maintain this outlook now also in the second quarter. So with that, I'll thank you for listening and open up for questions and answers.

[Operator Instructions] And our first question comes from the line of Simon Granath from ABG.

Jan and Björn, congrats on the solid quarters. I know that you've touched upon this subject on several occasions, but in Q1, you mentioned that you're sorry for the pandemic resulting in project delays. However, it does not look like the effect was that big in the Q2 numbers. Would you say that there is a time lag until such delays actually hurt your financials? And also, do you think that the risk has increased, decreased, or does it remain the same now compared with the publication of your Q1 results in April?

Thank you, Simon, for the question. Now I think we started to see these indications already during Q1, and we had effects during Q1. We have continued to see effects in Q2, but they are limited to some projects and some customers. And I mean since the pandemic continues across the world, we expect to see continued effects. And that's why we also reiterate our outlook of a negative impact on our sales due to these effects.

And just a follow-up question. On that, would you say that, that affects all your revenue streams, meaning all the -- meaning both Network Solutions, operating system solutions and Global Services, of course?

Well I think the effect of the corona pandemic are a bit different. For project-based business, where we have the larger amount in Network Solutions, it's mainly then project delays as well as potential delayed investments that can have an impact. On the operating systems side, the impact is more if there are disturbances in production, where we are dependent on royalty revenues. And we -- it is very difficult to judge that impact since that lies with our customers, but we have probably seen some of that also during the quarter. When it comes to our Software Development Service, as Björn mentioned, we have some customers that are more hit than others by the corona pandemic effects due to the industries they operate. For example, aerospace industry, and there, we have seen a lower demand, in particular in the U.S.

All clear. And another question is regarding SD WAN, which is a relatively new business area for you. Can you speak a little bit around your strategy here? Is it to grow organically? Or should M&A be added? How are you thinking around partners? When do you expect it to constitute a significant share of sales, where I presume it is fairly low as of today?

Yes. Thank you. Well we actually contribute to SD WAN solutions in 2 ways. We have 1 way that we -- where we, through our DPI solutions, contribute to traffic classification to larger system providers based on contracts and deals that were published. Some were published last year, if you recall. So that's 1 important contribution where we see that the security demands for SD WAN require advanced traffic classification and where our DPI technology is used and becoming popular with several customers. And the other area where we contribute to SD WAN solution is done through virtualization platforms, which I think you primarily refer to. That's an area which is more of a future potential area for us. It's an area where we have released a product called NFV Access, where we continue to win customers. But our revenue models are also entirely based on subscriptions and recurring revenue. So they start from low levels, and then they grow as customers deploy and become successful themselves. When it comes to our strategy, we -- our basis for growth is always organic investments and organic development. And then like all areas, we continuously seek if we can find acquisitions that complement our offering in a good way.

Our next question comes from Viktor Westman from Redeye.

I just wanted to clarify with you, when you say that the coronavirus will have a negative impact on your sales, do you mean that there will be no growth? Or are you saying that you will not grow this year due to the coronavirus? Or do you mean that you will grow less?

Viktor, so I mean we're just saying that the corona pandemic will have a negative impact. So meaning that hadn't the corona pandemic happened, which we, of course, would all have liked, we think that we -- in some of our accounts, with some of our projects, et cetera, would have come out stronger, meaning that we see a negative impact. Exactly how to quantify that is very difficult based on the uncertainty on the market.

Okay. Yes. And just another question also. You mentioned that you cannot have any physical meetings with customers in the current situation, but you do a lot of online work with the online support. Is -- I mean of course, it's easier when you're a software business, I can imagine, but is there something you cannot do here? Are there some problems for you with this situation going on?