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

Hello, and welcome to the Enea Interim Report for January to September 2022. [Operator Instructions] Today, I'm pleased to present the CEO, Jan Haglund; and the CFO, Ola Burmark. Please begin.

Thank you very much, and thank you for listening to this conference about Enea's Q3 report. I'm Jan Haglund, CEO of Enea, and I'm joined in this conference by our CFO, Ola Burmark. We will in this conference summarize the quarter from a financial point of view as well as the key events that have affected the quarter. Ola will go through details in the financial results and we'll end with a way forward, a strategy direction and also a bit of how we see the model. On Page 3, we summarize Enea's financial results for the third quarter as well as the period January to September 2022. Our net sales for the quarter came in at SEK 229 million and our operating margin was 18%. Both of these are significantly stronger than the first quarter this year -- the 2 first quarters this year. Operating cash flow was also strong in the third quarter SEK 92 million contributing to a lower net debt. The net debt is now down to SEK 283 million of the company, which also gives a net debt to EBITDA lower than 1, 0.93. Earnings per share came in at SEK 2.42 in the quarter while part of this, SEK 0.73, came from the final part of the divestiture of our Services business, which was executed and decided earlier this year. And finally, we are an innovation company focusing on software products for telecom and cybersecurity and we continue to invest in R&D. 28% of our sales were reinvested in R&D either as expense R&D or as balanced capitalized R&D. As mentioned before, the first 2 quarters this year were weaker than the third quarter. For the period, we came in at SEK 657 million, an operating margin of 13% and earnings per share at SEK 8.61 where SEK 3.24 were the part of continuing business and operating cash flow for the period was SEK 169 million. Let me summarize a bit on the next page the key developments in this quarter. We're really happy to see that we continue to win business in our key areas in cybersecurity, in traffic management and in 5G. And in particular this quarter, we had 2 major contracts in North America that we're very pleased with. We saw an increase in net sales, operating profit and cash flow compared with previous quarters this year and we did see also a stable and in fact increasing base of recurring revenue from support and maintenance. We have a broad and strong customer base where customers rely on our services and software in order to maintain critical operations of telecom and cybersecurity. Network Solutions is by far the dominating product group of our company, 88% in fact of the turnover, and it grew 4% organically while the smaller product group, 12% of our turnover, Operating Systems declined 23%. That is an expected decline, has been going on for 7 years, but it's also a smaller part of the company now. So the total impact is smaller. As previously decided, we continue to invest in a stronger sales force in selected regions. We do that because we believe that through stronger presence, we have the opportunity to sell a broader portfolio and to expand already strong customer relations in regions like North America, Europe and partly in other places of the world also. Cybersecurity is our newest business area through the acquisition of AdaptiveMobile Security last year. We continue to see strong development -- solid development of that business area and of course a high attention on the market on cybersecurity enhanced by the geopolitical environment. Having said that, we also see challenges of the market; energy prices, inflation, higher interest rates do create pressure for customers and it does affect the investment climate. Let me say a bit more about some of our key deals in this quarter. On the next page we summarize the deal that was taken in September and August about messaging security where we closed a USD 5.9 million messaging security win with a North American communication platform-as-a- service provider. An existing customer that chose to expand their business and continue to rely on us for the secure delivery in particular of application-to-person traffic, which is growing; growing in terms of traffic, growing in terms of volume, but also growing in terms of impact on society. This deal was important from a strategic point of view because it expands the relation with an important customer. Also important financially where software licenses contributed with USD 1.8 million in the quarter and the overall agreement does increase our recurring revenue for the 3-year period. On the next page, we summarize the product launch we did. We launched a product already in July for traffic management. Traffic management, as some of you may know, is an important market and also an area where Enea has a leading position in several years. Now traffic management continues to be important in particular with 5G coming because traffic will increase with 5G and 5G will for several years coexist with 4G. That's why our new solution, the 5G Service Engine is designed for dual mode 4G and 5G traffic management and we're in fact first to the market with a cloud native commercial product with this kind of support. Traffic management is important because it does give the opportunity to improve subscribers' quality of experience, it does accelerate traffic delivery and it also alleviates the radio network congestion, something that is already important and will continue to be important with 5G due to growing traffic. Our product is also designed with open interfaces creating the possibility for a wider vendor ecosystem. For example for analytics or service management product, also an area where we differentiate a bit different from some of competition that have more of a closed environment. Now this product was launched in July. And on the next page, we summarize the fact that we won our first reference with this product already in September. The reference worth CAD 4.4 million. An existing customer choosing to continue to work with us and continue to work with our products and selected our products for 5G traffic management. This deal had an important financial impact on the quarter with CAD 3.3 million revenue recognized in the third quarter of 2022 and the total contract value was CAD 4.4 million. It's an important deal and also serves as an important reference going forward for other opportunities, in particular 5G opportunity. Now traffic management can be used for different things. I talked about the quality experience. On the next page, Page 8, we also based on recent research show how traffic management can be used for energy saving. Energy is an important part of operators' or customers' OpEx and also a growing part due to increasing energy prices. If you look into a network, in fact it's the radio access network that consumes the majority of the energy, 73% based on independent investigations and research. Looking into the traffic that generates and consumes all this energy, it's a lot of video traffic. In fact it's up to 70% typically in a mobile network that is video; video coming from applications like Facebook, YouTube, TikTok and others. Now traffic management can in fact be used to reduce the video consumption, the bandwidth without noticeable impact for the end users. And our research shows that without any impact on user perception, it's quite straightforward to get a 20% reduction in bandwidth, which corresponds to approximately 10% energy saving cost. If you translate that to dollars in a typical operator, it actually corresponds to very high numbers, about USD 10 million in energy savings based on an operator with 10 million subscribers. We believe that this can create business opportunities for us going forward as we see increased pressure on the operators' OpEx. Now this was 1 example of thought leadership and publications we've done during the month. On Page 8, we summarize a few other publications. A lot are centered around cybersecurity where we have done research and also published to the market how cybersecurity for mobile networks is impacting and playing out now in the ongoing war in Ukraine. In particular then how mobile networks are both affected, targeted, but also used as tools in the conflict for communication and actions on the battlefield. We've also published reports on more enterprise cybersecurity, an area called intrusion detection where we have important software tools in particular based on deep package inspection technology that we see are gaining [ presence ] and gaining market traction going forward. Finally IoT, the Internet of Things, is an area where we have product offerings and where we see a nascent market. We have recently won 2 important awards here, Product of the Year as well as Best IoT Platform. We're really happy about that and we see that as a confirmation about our investments in product development and also as a confirmation of the market opportunity in IoT. With that summary of the quarter, I'll leave the word over to our CFO, Ola Burmark, to summarize the financial results bit more in detail. Ola, over to you.

Thank you. So we move in to Slide 11. The third quarter came in at the same level as last year with net sales of SEK 229 million. Here adjusting for currency variations, that represent a decline by 8%. Total revenues though were significantly higher in the quarter and actually also during the year. But specifically during this quarter, we see big impacts of currencies in many parts of the P&L basically. The third quarter this year versus the third quarter last year, we actually have big deviations in currencies. So in other revenues, we have 2 parts. One is actually SEK 14 million in currency gains related to revaluation of current assets and we did also receive about SEK 10 million in a COVID related loan from the United States that was forgiven. That was the last outstanding loan for COVID related financing in U.S. so there are no further such applications that can be filed. If we look at the different parts of the organization. The Network Solutions reported an organic growth of 4% in floating currencies, but a negative growth in floating currencies of 4%. And Operating Systems continues to decline and have currency adjusted negative growth of 24% in the quarter compared to last year. We move into next slide and look little bit deeper into Network Solutions and look at the revenue development. We do see licenses has grown during this year quarter-by-quarter, but it's still significantly lower than it was a year-ago. So we report license revenues in Network Solutions of SEK 90 million in the quarter compared to SEK 107 million last year. It is a decline by 17%. But we should then bear in mind that in the third quarter last year, we did recognize revenue related to achieved milestones in one of the larger data management projects for 4G and 5G core networks and that amounted to SEK 28.5 million. What we do see that we have successfully prolonged support and maintenance contracts so the base of recurring revenue continues to grow. Support and maintenance has grown by 27% compared to last year and professional services a sales burn and that is a consequence of the experts and analysts we have available for cybersecurity in the AdaptiveMobile. Year-to-date it's basically very much the same trend. License revenues, as you see, year-over-year has grown but we're yet not on the level as we were last year. So year-to-date we have recognized revenues of SEK 257 million related to licenses. It's a decline by 7% versus last year. But we're also here highlighting that this year we have recognized SEK 29.5 million related to those milestones in data management projects and last year up to September we have recognized SEK 47 million. I go to the next slide, Operating Systems. Here we do see the trend and the trend continues. We report sales in Network Solutions of SEK 28 million in the quarter. It's compared to SEK 36 million same quarter last year, but it's a decline by 27%. If we look into this one more deeply, we see the currency adjusted decline of 24% and this business basically consists of 3 parts. It's 2 key accounts plus a number of other customers and where we see the sharpest decline is in these 2 key accounts where we have a decline by 33% in the quarter and those key accounts now represent 60% of the total sales in Operating Systems. Looking at the sort of January to September period, it is basically the same trend. The Operating Systems has generated a revenue of SEK 92 million. It's a decline of 20% versus same quarter last year and currency adjustment of 21%. And in terms of the key accounts, it's very much the same trend that has continued over the year. So Operating Systems is very predictable and basically develops as it has during the past 2 years. Moving into Slide 14 and by this one, we actually show how the transformation of the company has been developed since 2017. In third quarter 2017, 33% of our business was Network Solutions and basically 2/3 was Operating Systems. Operating Systems has, as we said, declined over the period while we have built the network. Now Network Solutions are 88% of our total revenues. I move to Slide 15. Profitability-wise we report an EBITDA of 37% in the quarter that means SEK 85 million compared to SEK 92 million same period last year. There were no nonrecurring items in the EBITDA. And we do also see that we have a better gross margin in the quarter and this gross margin is positively affected mainly even though we have slightly lower license and sales as I said initially, we do see that support and maintenance revenues and also professional services revenues has grown and margin on those ones has improved since same period last year. And as I mentioned also initially, the forgiveness of the COVID related loan has also a positive impact on the gross profit. If you look at the operational expenses, there is an increase of some SEK 10 million compared to last year. Just to be explicit on that, we are basically not increasing our operational spend, but this is a result of increased depreciations and amortizations of SEK 8 million and we do also have an unfavorable foreign exchange impact when it comes to the cost of almost SEK 8 million. So if we're adjusting from the above, the operational spendings are decreasing and they have decreased by SEK 4.5 million compared to the same quarter last year. I move to Slide 16 and EBIT. EBIT of 18% in third quarter and this is definitely a sequential improvement towards the first 2 quarters in this year. The EBIT amounted to SEK 41 million compared to SEK 54 million same quarter last year. We are at 18% compared to 24% last year yet we are still not back on the margins we had last year, but we do see an improvement quarter-over-quarter this year. Earnings per share for the total company was SEK 2.42 in the quarter versus SEK 2.33 last year. And for the continued operations, it's SEK 1.69 compared to SEK 2.11 last year. So in the quarter, we finally closed the transaction with the Service business and the final hold-back was settled, which also impacted sort of the total result for the group, but this is now accounted for as discontinued business. What stands out in the quarter is the positive cash flow. We have successfully collected cash in the quarter, which resulted in operating cash flow of SEK 92 million compared to SEK 28 million same period last year. And as I said, we also had a cash flow from the divestment of about SEK 15 million in the quarter. The interest bearing bank loans in total gross value amounts to about SEK 545 million so that is significantly lower than the same period last year. And we have also grown our cash, which are amounting to SEK 264 million in the quarter versus SEK 180 million last year. So net debt has therefore decreased and we're now looking at a net debt of SEK 283 million. So equity ratio going up, 68.5% and definitely then the net debt to EBITDA i.e. the leverage of the company has gone down further and we're now below 1. Thank you. I hand back to you, Jan.

Thank you so much, Ola. So we'll jump to Page #19 with a bit of market summary. We see that on the telecom market, the underlying factors remain strong. Traffic growth continues, we see new applications coming to life and all of this will require the higher network performance, which is a key area for us. We also see a strong movement driven by efficiency and agility towards what can be called the Digital telco where the first movers are really setting the scene now to reshaping the industry, basing operations for example on model cloud technology and cloud operations. Cybersecurity is by no doubt one of the hottest areas in our industry driven by increased geopolitical tension. We see evidence of attacks almost all the time and we know that mobile networks are strategic and therefore potential targets. The war in Ukraine is clear evidence of that. In particular, we see very high attention in the Americas. Now the macro environment is challenging and we continue to see a challenging macro environment with now the energy pricing in particular affecting the operating expenses of our customers. We see currently variations as outlined by Ola. And all of this together with inflation and higher increase in interest rates does create a cautious decision making and deferred investments. Now our strategy summarized on Page 20 remains and remains firm. Our strategy to be a software specialist to produce cloud-native products in a world where many of our competitors have proprietary platforms. And with trends then going towards openness, towards commercial cloud environments, we believe that we are very well positioned for the future for long-term growth in this area. We also believe that our leading positions, in particular in telecom software for mobile core and security for mobile networks, are key for the future with trends like 5G increasing cybersecurity threat. This is exactly the position to be in for the future. And we have a global presence, we can still strengthen it. But with strong direct and indirect market channels supported by a distributed R&D organization, we have the possibility to serve customers in global and advanced markets. And on Page 21, we've chosen to summarize some of the evidence and proof points of this strategy just in this quarter, in the third quarter of 2022. The divestment of our software development services was in fact driven by our strategy to become a pure software product company and we're really happy to do that because not only does it increase our focus, it also did contribute positively to our financials both during the year and going forward thanks to a positive impact on the gross margin. In terms of the leading positions, I've already talked about some of the product launches where our R&D investments, in particular in 5G and cybersecurity have borne fruit. The 5G Service Engine is a clear example of that launched in July and the wins that we have both in traffic management and messaging with leading Tier 1 service providers also confirms our leading position. We can beat anyone in this space. We're also happy to see the continued momentum of our most recent acquisition, AdaptiveMobile Security, well positioned and leading in the area of security for mobile networks. Our global presence is important. We have customers all over the world, in particular in North America and Europe. And strengthening go-to-market through investment in sales is something we initiated earlier this year and it will continue during this year. We see the opportunity to expand our business in our key accounts not only through stronger relations, but also through cross-selling where we already have established relations or in fact stream contracts. Those can be used in order to close new business for a wider portfolio. So we're wrapping up on Page 22. We repeat our outlook for the year. We did have weaker first and second quarters and that's the reason why we see that our long-term target for sales growth and an operating profit above 20% it remains, but an uncertain macro environment and a weak start of the year means that we judge it challenging to reach the profitability for the full year 2022. With that, I hand it back to the moderator to check if there are any questions on the presentation. Thank you very much.

[Operator Instructions] Our first question comes from the line of Jesper Von Koch of Redeye. I stand corrected. We seem to have lost the line of Jesper from the queue. [Operator Instructions] And we will go to our question from the line of Jesper Von Koch.

So let's start with the capital allocation. I mean your balance sheet has definitely improved over the last year and no acquisitions has been made so there is room for some actions, I guess. So could you just elaborate on how you think about M&A versus potential buybacks considering that NIIs is currently trading well below the valuation multiples that you have paid for recent acquisitions? Is this an interesting option that you're evaluating?

I can start and Ola can chime in. I mean we're happy to see that we have strengthened the balance sheet during the year thanks to both our own organic cash generation and on top of that the divestment of software development services which was driven, as I mentioned before, from a strategic direction to purify as a software product company, but it did have a very positive impact on our balance sheet also. We continue at the company to seek the complementary acquisitions. We've done about 1 acquisition a year during the last 5 years and the company you see today is very different from the one in 2017 with expansions into telecom, into 5G, into cybersecurity. So we continue to seek acquisitions that can complement us, but we're not in a hurry I should say. It needs to be the right value, it needs to be the right area, it needs to fit not only with our product strategy, but also with our go-to-market strategy. So we're happy to see the strengthening of the balance sheet and we will carefully make sure that we use that going forward to create shareholder value.

And also about how you and perhaps also the Board are thinking about potential buybacks. Is that something that you are thinking of?

We have not communicated anything around potential buybacks and when and if that is a topic, we will of course communicate to the market about that.

Okay. And so also regarding M&A opportunities, are you seeing that multiples are coming down also on potential acquisition objects or how is your experience?