hGears AG (HGEA) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Q3 Results 2024 Conference Call. [Operator Instructions] The conference is being recorded. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Christian Weiz, Head of Investor.

Good morning, everybody, and welcome to the hGears 9 Months 2024 Results Conference Call. Thank you for joining us this morning. I am Christian Weiz, Head of Investor Relations. With me on the call today are Sven Arend, our CEO; and Daniel Basok, our CFO. They will present our first 9 months results and be available for the Q&A session after the presentation. If you have not yet received our relevant earnings documents, you can find them on the Investor Relations section of our website. Before we begin the presentation, I would like to draw your attention to the disclaimer on Slide 2, which sets out the legal framework under which this presentation must be considered and which I will assume you have read. And now let me hand over the call to our CEO, Sven Arend.

Thank you, Christian, and good morning to everyone joining us today for this 9 Months 2024 earnings call. Unfortunately, the market conditions have deteriorated since our last numbers release and the expected stabilization did not materialize. It was rather the contrary. We experienced a further slowdown during the third quarter 2024. The overall economic outlook has not really brightened. Furthermore, the geopolitical imponderabilities have not eased with the ongoing wars and the result of the elections in the U.S. And as if that were not enough, last night, the growing disagreements finally led to the breakup of the coalition government in Germany. On January 15, Chancellor Scholz intends to call a vote of confidence in the Bundestag with new elections to be held by the end of March. These political uncertainties add to the insecurity, and this does not, of course, help consumer confidence. The destocking in the bicycle industry continues and even big players in this market struggle with the tough market conditions. We have no doubt that e-Bike production will recover, but for the time being, nobody knows exactly when. As the ACEA statistics show, car sales continue to slide in Europe, while in China, local competition has become tough for European carmakers. Meanwhile, it is fair to say that the European car industry is in crisis. The newspapers are full of articles with that regard, and this has, of course, also an effect on our [e]-Mobility business area. Meanwhile, e-Tools declined year-over-year in the first 9 months 2024, but the business area witnessed another sequential improvement in the third quarter, actually the third in a row, and we read this as a further sign of stabilization. We have continued adapting our organization and our structures. Until recently, we maintained our agility in case of quick recovery following the 2 years of destocking and declining demand. In the first step, we used short-time work and introduced the 35-hour week to save costs. However, given the lack of any significant signs of demand recovery and the automotive crisis, we will need to adopt our workforce further. The numbers Daniel will present for the 9 months of the year demonstrate the success of already implemented measures. Nevertheless, we cannot fully offset the lack of volumes, leading to negative operational leverage and inefficiencies related to stock costs that continue to burn our results. Cash preservation remains our main focus and the name of the game. Our balance sheet remains solid and reflects our disciplined approach. The current cash position provides us with the necessary financial maneuverability in the current economic conditions. Against the background of the current slump in global industries, we have updated our guidance recently. And due to the mentioned uncertainties and limited visibility, we also decided to review our midterm guidance. This concludes the review of the 9-month highlights, and I would like now to spend some time on the next slide to provide a more detailed overview on the sales development of all the business areas. The chart on Slide 5 shows a sequential increase of e-Tools in the third quarter. Again, we would not call it a recovery yet, however, see signs of stabilization. As highlighted earlier, the e-Mobility is under the spell of the evolving crisis in the automotive industry. In relative terms, the business area performed pretty well due to our focus on premium sports and luxury segments of the automotive industry. The destocking process across all levels of the bicycle industry supply chain continues to take its toll on the e-Bike business area. I know I'm repeating myself, but this destocking process is taking longer and proving harsher than any industry expert insider or expert had anticipated. Now let me hand over to Daniel, who will give you a bit more beef on the bone with regards to the 9 Months 2024 financials.

Thanks, Arend, and good morning to all of you also from my side. So, flipping to Slide #6, let me start the review of the financials, and let's start with the sales performance before we have a closer look at the profitability. As Sven said earlier, on a group level, we experienced a further deceleration in third quarter 2024, and the results were below our expectations. Apparently, our customers in the e-Bike industry still have excess inventories, and therefore, we experienced more volume reductions. This caused further sales declines in the period under review. The e-Bike business area declined by 28% compared to the 9-month period in the previous year and reached sales of EUR 14.3 million. The e-Mobility business could not relate the overall decline we are currently observing in the European automotive industry. The business area saw a 9.4% decline to EUR 33.8 million compared to the 9 months period in the previous year. However, compared to the car manufacturers, we are provide quite resilient, which is, as Sven highlighted before, due to our focus on the luxury premium and hypercar segment. EPS declined in the first 9 months by 8.8% to EUR 24 million, but the good news is that the business area experienced another sequential and year-over-year improvement and therefore, supports our assumption of stabilization. Now let's talk a bit about the gross profit and the gross profit margins, as shown in the middle chart on Slide 6. hGears achieved an adjusted gross profit of EUR 33.7 million in the first 9 months of 2024. Of course, the further reduction in production volumes in the third quarter has a further negative effect on operational leverage. Furthermore, start-stop related inefficiencies continue to cause costs to burden our gross profit margins. Meanwhile, the sales recovery of the lower margin equals business area and at the same time, the decline in sales of the e-Bike and the e-Mobility business areas meant that the sales mix deteriorated. The other reason is the fact that we have had more lower gross profit margin assembly activity in the e-Mobility business lately. The adjusted gross profit margin in the first 9 months, therefore, reached 46.5%. However, this means that we were able to keep the adjusted gross profit margin at the level of the first half of this year, which we consider a good achievement given current conditions. In absolute terms, the adjusted gross profit declined by EUR 9 million year-over-year in the first 9 months. We continue to streamline our organization, enhance the operational efficiency and save costs. Nevertheless, the adjusted EBITDA on the right side of the slide shows that our adjusted EBITDA declined year-over-year in the period. However, we were able to cushion the drop in gross profit with the countermeasures. Compared to the 9 months in the previous year, we were able to reduce personnel expenses by EUR 2.5 million, 9% compared to the previous year. Given we do not expect a short-term recovery, we continue to work towards further reduction of the personnel expenses. At the same time, we achieved a EUR 2.8 million reduction in the net operating expenses, which is more than 27% versus previous year, of which EUR 735,000 come from savings and advisory fees and around EUR 180,000 in recruiting costs. Nevertheless, due to lower volumes and related inefficiencies, these savings were insufficient to fully offset the gross profit loss, resulting in an adjusted EBITDA decline from $4 million in the previous year to EUR 0.4 million in the first 9 months of 2024. Please turn to Slide 7, which provides an overview of the balance sheet and liquidity metrics. Our balance sheet remains robust with an equity ratio standing at a strong 52.5%. This high equity ratio should help us weathering the current tough conditions and future unforeseen challenges. Our net debt amounts to EUR 7.7 million, which includes EUR 8.1 million in leasing liabilities under IFRS 16. The net debt is EUR 2 million lower than it was 12 months ago. In absolute terms, our debt remains at low levels, but the net debt to LTM adjusted EBITDA multiple increased, of course, as a result of the very low adjusted EBITDA in the last 12 months. And before I hand back to Sven, let me repeat what we always say in the last calls. Cash is king, and our major focus is and remains on cash preservation. And as such, we have a strong EUR 19.2 million cash position as of the end of September 2024. Our disciplined cash management is also reflected in the low LTM working capital, which improved from 13.8% of revenues in the previous year-end of September to 8.9% in September 2024 and thereby also declined compared to 9.2% that we achieved at the end of June. In summary, I still think we have a very strong balance sheet and a solid cash position, which provides us security towards the upcoming periods. So, Sven, I'm handing over back to you for your outlook and closing remarks.

Thank you, Daniel. To sum it up, let me say the current challenging environment represents a bit of a rough ride and has impacted our results. Customers have further reduced orders and volumes, which, of course, had an impact on our performance. However, our structural measures and cost-saving efforts pay off, and you can see that in the numbers. We have a solid balance sheet, and this is very reassuring in the current environment. We need to be patient and we'll stick to our stringent, diligent and disciplined path. We continue to see significant growth potential once our business areas recover and are therefore confident about the business model. Having said that, and even the third sequential quarterly top line increase of the e-Tools business is a bright spot, we unfortunately do not see yet a recovery in our e-Bike and e-Mobility business area in the short term. Our medium-term outlook is therefore under review for the time being. Meanwhile, we provide guidance for 2024 as follows: group revenues of EUR 90 million to EUR 95 million and adjusted EBITDA of minus EUR 1 million to plus EUR 1 million and negative free cash flow of between minus EUR 5 million and minus EUR 2 million. Ladies and gentlemen, let me thank you for attending our 9 months '24 results release. And I would now like to hand back to the operator to open the Q&A session.

[Operator Instructions] The first question is from Fabio Holscher with Warburg Research.

I have one question for each actually. I'll start with e-Bikes. It's about the recovery or the speed of the recovery from here. What are you currently seeing or hearing from manufacturers and dealers on demand and inventory? Is it basically safe to say that we have to wait for the order season at the end of 2025 for a visible recovery? Or could it be that seasonality changes a bit going forward when customer demand were to suddenly pick up come spring?

I think in the end, the issue we have is the transparency of that industry is extremely limited. What we do, hear and see is that Number one, of course, there has been significant destocking [Technical difficulty] inventory is really good or required to support this industry throughout the year. But at the same time, we now hear that there's a lot of hesitation to make commitments also for the coming up season, which may mean that people right now basically order at very, very low levels because they also know that the flexibility of the industry right now to respond even during the season is there. And therefore, that probably it may even have an overkill effect. I would say that we expect '25 based on current predictions, again, not to see any significant changes. The only thing we do see is that we have manufacturers that in the last 2 years, tried to get into the business and had no volumes and they seem to at least have some very small volumes, which would suggest that some customers are now through the downturn and are maybe starting. But again, that's just a hint of a change. Right now, if we look at the numbers, no significant change.

And then on e-Tools, do you think the Q3 improvement now is a sign of stabilization that will continue from here? And if yes, there a specific region that sticks out positively or negatively?

Stabilization, yes, in the sense, I think that they have cleaned their inventories. I mean, of course, it remains to be seen now all the geopolitical and political changes worldwide will impact the behavior. I mean we have seen, if you look at Germany, housing drop significantly this year with interest rate increases, the same in many countries in Europe. So, I think, again, it's difficult to say, will this continue at the rate of increase we've seen in the last few quarters or will it flatten out? I would basically say let's be cautiously optimistic, but at least we don't see any further decline in that area.

And then maybe you can help us understand the decline in automotive. Is there a specific subsegment, which has now been weaker in e-Mobility? I mean, obviously, everyone is becoming more cautious. Car volumes are down, but that mainly concerns like the volume brands, premium cars and not necessarily luxury as far as I can tell.

Well, I think in the end, honestly, if you look at maybe with Germany being one of the largest markets, if you look at the statistics there, since incentives have been taken away on e-cars, the number of e-cars produced has dropped significantly. And I think that is something that is impacting. On the project landscape, what that led to is that a lot of companies are basically consolidating right now, reassessing their programs, and that is leading to delays, lower projected numbers as we move ahead. Again, in the long run, the potential is clearly there, but I think the changes in incentives plus the hesitation of customers, plus again, the environment we're in right now have led to lower sales.

So, you're saying it's mostly BEV at the moment?

I mean, let's say, if you take companies, many companies right now are going through adjustments and that's when you look at the luxury end or higher end, which is typically a lot of it, is company's cars, the purchase of new company cars is being delayed. So also there, we will see an impact because people will just -- even for political reasons, not go out while you're going through some adjustments in the company and put a brand-new vehicle outside the door.

The next question is from Tom Herben with ABN AMRO.

Tom Herben from ABN AMRO. 5 questions from my side. Let's start with the first one. What can you do to reduce costs further? Can you put more stuff on [indiscernible]? And if so, what is the impact roughly?

I mean we are going -- in the end, let's face it, with what we've done until now, we basically kept people in availability when markets recovered at short term. What we will now do is basically take that, let's call it, excess that's still in the organization and cut the workforce correspondingly. In terms of the effect, I think we're still doing the calculations of where we will end up and what that will lead to because we're finalizing numbers for next year.

Second question, where do you stand on finding new market segments and customers?

Honestly, we're open, but let's also be honest there. I mean, I think we had that discussion previously that the current industries that we're in should provide in future enough potential to grow. Of course, if you look especially at things like the automotive industry, typically when you get an order, it's going to take 1, 2, 3 years before that materializes in your bottom line. We are doing some activities in industrial. But in the end, let's face it, with the current downturn in all industries, you would have to drive existing suppliers out of their turf. And I think that's a challenge when everybody is struggling with a smaller cake that's available.

Third question concerning automotive. How are your discussions with key clients in automotive evolving when talking about 2025? And do you see light at the end of the tunnel in H1 2025?

I think it's too early to comment on that. Again, we're trenching the numbers right now. I think what we can say in general, like I said before, the market is currently reassessing programs and topics. So, I think it's too early to say basically what that will mean for the bottom line right now.

Fourth question concerning prices. How should we think about energy prices and raw material prices in terms of 2025 tailwinds?

Tom, it's Daniel here from our side. I appreciate very much your effort to dig a little bit into 2025. But as you probably know, we are not in the position to provide any guidance now to 2025. That being said, we do see in raw materials and in energy that basically the markets are very stable. We haven't seen any peaks highs or lows there in 2024. And our base assumption is that also towards 2025, we will not see big either reduction or increases in both energy or raw material.

And can you give any view on the destocking in e-Bike you have any view on that when this will end this trend?

I think like we said before, honestly, let's face it, everybody continues to be surprised that it's still ongoing. I think it's a multiple sequence of effects. I mean it started, of course, with people building up inventories over the last few years. And when I joined early last year, there were still announcements of wholesalers adding another 100,000 bicycles in capacity to stock and to then distribute. I think what you will have seen with also the hesitation of the financial market towards this industry that obviously that level has had to be reduced significantly. What we also see again is a hesitation throughout the whole pipeline, starting from the family shop that sells bicycles to all the others that you said, am I going to be daring and bold going into '25? Or do I stay hesitant? And in the end, the answer is everybody is staying hesitant. And then the third factor that I mentioned before just now is we now hear from the market that whereas in the past, this industry made a full commitment to the following calendar year by October, November, they're basically now saying, look, why would I, which, to be honest, I even find healthy for the industry. But in the end, they're basically saying, why would I? I know that if I come back early quarter 1, quarter 2 and say, okay, I've sold unexpectedly what I plan to have, they will find some way to refill it, which in the past wasn't there. So, I think that's adding to all these things add to the fact that right now, there's a very conservative plan out there, which again, should provide the potential to a turnaround. And then if it does, it should be quite significant. But I think everybody stopped having the courage to say when is that point going to be reached.

The next question is from Martijn den Drijver, HAV.

I have a couple of questions regarding the cash flow development into the fourth quarter. And the first one is, I mean, you're guiding minus 5% free cash flow at the bottom end. What other payments can we expect below that? And generally speaking, what level of cash at year-end would start maybe to get you a bit more worried?

The spend that we provided now for the first quarter is very much going to be dependent on the order book and the deliveries that we are going to deliver in the last 2 months, if we talk about November and December now. And that is going to have an impact on also on the cash, of course, Moreover, as the situation is not very stable, there can be some postponement of receivables, collections and so on. And therefore, we provided a broader spend in a range for the free cash flow. Plus, on top, we still have some investments, which as maybe took a chance, we initiated at the beginning of 2022 -- and we postponed now for almost 3 years, where our supplier is basically forcing us to pick up the manufacturing equipment that was ordered back then. And that is something that we also expect to see as a negative impact on the cash flow in Q4. The question about the cash position and where I feel confident and comfortable with. I think, again, at the end, that's what we have also guided during the year with the free cash flow guidance that we are guiding, I feel comfortable. I think it's not a big secret that we are in a burning cash situation also in 2024. But as long as the pace is not accelerating, we should be fine also for '24 and of course, for '25 and going forward. But that requires to continue very string discipline on cash management, and that's what we are doing basically on our side.

Maybe one follow-up. So, the credit facility that you have now in place is 3 years. I think the overall volume is roughly EUR 20 million, if I'm not mistaken. I mean, are there any covenants or KPIs that the banks are actively looking at in terms of the terms of this credit facility?

No, just to put it maybe to provide a little bit more details, we currently have around EUR 15 million of asset-based financing in our balance sheet plus EUR 5 million from the bank, which is basically on a revolving base that we are using occasionally when we need. And the asset-based financing has no covenants. Because the assets are, of course, used as a collateral to secure the loan. And that was also one of the reasons why we decided to opt for this type of financing at the beginning of the year to make sure that we will not have covenants and we will have a little bit more freedom to act within these constraints.

That's an important clarification. And then one more thing, the work sort of the inventory, I mean should we expect whatever into Q4 discounting, impairments? Is this something that is a topic?

No, I think it's a very fair question. But to be very honest, we are evaluating our inventories at the end of every month. And as a manufacturing company, that is a huge factor in cash management, in net working capital management and so on. Therefore, we do not expect to have a huge, or we do not expect to have any extraordinary write-downs of inventory towards the year-end. And we expect to keep the net working capital to be below 10% of our last 12 months of sales.

[Operator Instructions] There are no more questions at this time. I would now like to turn the conference back over to Sven Arend, CEO, for any closing remarks.

Right. Thank you. And again, thanks, everyone, for attending the call and looking forward to speaking to you soon. Goodbye.

Ladies and gentlemen, the conference is now over. Thank you for your participation. You may now disconnect your lines. Goodbye.