Incap Oyj (ICP1V) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to Incap's Q4 results webcast. My name is Pauliina Tennila, and I will be hosting this webcast today. Incap's President and CEO, Otto Pukk; and CFO, Antti Pynnonen, will go through the Q4 and full year 2023 result presentation. And after that, there is time for questions and answers. You can post your questions in the chat room already during the presentation. You can also watch the recording of this webcast later on at Incap's website. Otto and Antti, please go ahead.

Thank you very much, Pauliina, and welcome, everybody, from my side as well. So let's kick off with a short presentation over the result, and then try to spend most of the time, of course, in the Q&A, as we normally do. So looking at Incap's results for the year. Of course, if you look at the market in general, that was overall a quite good market for EMS business in 2023. But we saw a common problem on the market after this component crisis. There was an overstocking. And there was a -- we could start seeing also a price pressure when it comes to -- in general. We also were affected by the overstocking. As you all remember, our largest customer, they had to reduce their inventory. And this is something that we have been working very closely with them during the whole year to fulfill. And now during Q4, we, of course, saw the full effect of that, but that we will talk a little bit more about later. Otherwise, if you look at the other business, I think we managed to keep our inventories on a very healthy level. Also, if we exclude our biggest customer, we managed to keep growing. So we grew over 35% in -- yes, if you exclude the biggest customer, and if you then look at purely organic and exclude the acquisition of Pennatronics, then the growth was 17%, which I think is, in the industry, very good result. So if you look at general milestones, of course, the successful acquisition of our U.S. unit is perhaps the top 1 in that. Also, I'm quite happy on how we manage to steer during these more difficult times. Our profitability, of course, was affected by the destocking exercise and our low utilization rate in our Indian factory. But still, we managed to keep our figures well in black, and in compared to perhaps many other EMS companies in very healthy levels, even if that a little bit Q4 and so was in -- our darkest hours in that sense during the year. We kept on investing also in the other units. So all of the units kept growing, except for our Indian unit. And that -- we also facilitated through investments. So in Estonia, for example, we increased the SMT capability and we expanded our Slovakian plant and also, of course, finished the third factory in India and started to work on it. Even if -- perhaps that investment, we had hoped to have bigger utilization, it's now working. And still I think it has been a very good investment for us looking at the future. Sustainability work is very close to our heart, of course. And as I have talked about before, it's very much driven by our employees and in our organizations. We continue to develop that. We have now started preparing for the CSRD reporting requirements. And then already now, you will see in our Annual Report, some effects of this as well, even if it becomes mandatory in this year's report. We have already taken steps in that direction. And in general, I would say that we think that this standardization of the sustainability reporting and the driver of that, we believe it's a very positive development. And I think here, our industry can take a bigger responsibility in the whole value chain on how we drive sustainability. And in Incap, we are looking forward to be one of the leaders in that work within the industry. Yes. So to summarize the whole year, even if this has been a challenging year with the destocking exercise, I think overall, we still have done a very good result. We had 220 -- over EUR 220 million in revenue, and we kept the margin over the year on the EBIT as well on 12.7%, which industry-wise, I think is excellent. And that is a little bit to summarize in numbers. Antti will, of course, go in more into detail in Q4. Of course, I never can emphasize enough that all this that we achieved is driven by our great team. We have fantastic people, entrepreneurial people in our different units. And it's always a pleasure to see them take responsibility and drive the business in Incap. And I'm also very happy that we have now also new family members in our U.S. team, and that they have come very quickly on board and sharing our values and driving Incap now also in the new continent. So that has been a great contribution as well to the Incap family as a whole. But Antti, perhaps you want to dig in a little bit more into the numbers before we go to the Q&A?

Yes, absolutely. Otto, maybe you can switch on the first slide, Q4 here. Thank you so much. EUR 42.4 million was the revenue, what we recorded here and EBIT profitability, 8.7% and then I just wanted to highlight also the adjusted operating profit was EUR 4.4 million, so 10.4%, and the difference between adjusted EBIT and the operating profit was basically due to the purchase price amortizations and a little bit of nonrecurring items. So as you remember, we bought a company from U.S.A. in July. And there is this purchase price amortization still running in monthly basis. So that impacted there. But in double digit in adjusted EBIT, that's always the target for us as such when it comes to profitability. Here, we updated, of course, the latest Q4 revenue bar as well as the operating profit here in terms of the absolute euros and in the graph format. And then I think we'll come back later on, on this trend, which is a little bit going downwards since the peak quarters during 2022. Key figures. Inventory reduction has continued. So we started the year with almost EUR 92 million. And then in end of '23, it was EUR 71 million. And it's good to remember that in this number, there is EUR 9 million inventory increase due to the Pennatronics. So the acquisition has played a role there as well, increasing that one. So basically, the comparable number would be EUR 63 million -- sorry, EUR 62 million versus the EUR 92 million, so EUR 30 million reduction. Obviously, this very much shows also in our cash position. So in the pie chart in the middle, we have a EUR 42.6 million in cash. So a very strong cash position here. Also the interest-bearing net debt elements are described here. Loan, interest-bearing, noncurrent and current loans are here. But yes, the financial position is very strong. And then -- yes, we have plenty of ideas of when it comes, for example, for expanding our geographical location in terms of the inorganic growth, but of course, the main focus always is the organic growth. But there is a combination of these 2 what we're all the time considering internally.

A little bit of a new starting point that we see. Our dependence on our largest customer have gone down quite significantly, and we are all seeing Q4 as perhaps the low point and expect us to start slowly growing from that. Incap now is seen more and more by customers and other stakeholders as a global company, thanks to the U.S. acquisition. And we see that, that have contributed to different kind of cross-selling opportunities and the possibilities for our existing customers and also for customers that come from Pennatronics side. We have financially a good position, and we have a very solid pipeline when it comes to M&A and are continuing to look at possible transactions here in the future. And overall, we expect all of our factories, except for India, where the largest customer's destocking exercise will continue during the first half of this year. But in the other units, we expect growth. And as a group as a whole, as well, we expect us to start growing slowly quarter-by-quarter in that sense, starting from already now. Our outlook, we have said that we estimate that our revenue and profit -- operating profit will be lower than 2023. I think everybody should remember that in 2023, the first half was still on very high volumes, and we have ramped down since that. But if we also start comparing on the second half of the year, then there will be growth moving forward from that. And that's why we also estimate that our revenue will grow quarter-by-quarter and start improving over the year in that sense. Of course, as always, we give our estimate, given that nothing unexpected is given. But I think that a little bit summarizes the quarter and also the year, and we're ready for your guys' questions.

So the first question is the -- in your 2024 outlook, you highlighted a projected decrease in both revenue and EBIT compared to the previous year. However, you also anticipate a sequence of revenue growth quarter-by-quarter. Can we expect a corresponding quarterly EBIT growth at a similar pace?

Yes. As I mentioned, we expect the quarter-to-quarter growth in that sense. We should remember that if you look at the full figures for 2023, we had a very strong, exceptionally strong first half. And of course, this contributed very much also to our biggest customer ending up with too much inventory. So those figures, we won't match during this year. Of course, that first half is exceptional. So -- but we expect, compared to Q4, which we see as possible, I would say, the bottom in that sense or the quarter that was hardest affected by the decreasing exercise. We expect steady growth starting from there. When it comes to EBIT, of course, the EBIT also is very much dependent on the product mix that we are running. And also as I mentioned, there will be -- we expect somewhat price pressure on the market. But to make a simple question, of course, EBIT will also grow when the revenue grow because there is -- once we get better utilization of our Indian factories and so on, then that has a positive effect. But it's -- EBIT is never black and white. There's always a question of product mix as you have seen before.

Yes. If we make an assumption that we will have a stable and normal product mix. So then, of course, when the volume grows, like Otto mentioned, so then the profitability will follow just due to the fact that the fixed cost overheads, percentage-wise, their proportion becomes smaller, and that drives also the profit in the bottom row. So yes, we are expecting that to grow as well.

And what makes you confident that the revenue will grow? And also do you expect that the growth will continue from your largest customer in the second half year as well?

Yes. No. Confident that as we have had -- we have a strong track record when it comes to inorganic growth. And also, we have been able to land a successful acquisition. So in that sense, we showed the numbers here as well at over 35% growth in other accounts than if we exclude our biggest one. So I'm quite confident that we are on a good formula for growing organically, and then that will continue over time. And of course, we also expect our biggest customer to bounce back, of course, not to the same level that they caused them to have too much inventory, but to something in between what we are seeing now at that level. And that, of course, also will have a positive effect of the numbers in total that once this will start hitting up. And yes, that I expect on the second half and also now the first half very slowly in that sense, but it's already started. And as we described as well in India for not now solely for our biggest account, but for the other accounts there as well, we have started to recruit people again and increasing the manpower slowly. So there is positives here for sure.

Has the destocking exercise of the largest customer damaged your business relationship with the customer in any shape or form? And also as a related question, could you please maybe elaborate a little bit on the process of inventory reductions going on with your largest customers? So how has this happened? And did it have an effect on your relationship?

No, I think we -- by working very closely with them, I think this is a very strong sign of our commitment in supporting them. And rather that I would expect the cooperation to strengthen. In that sense, we are going through -- we have gone in the past through very positive times. Now we had a little bit rougher patch with them, but that's life. And then partnerships or in that sense in good or bad like they say, when you marry. So I think that, that is here as well. What was the second part of the question?

It was about the process. How did you do the adjustments of the inventory levels?

Yes. No, the adjustment of the inventory levels, of course, we produced less. That's how we did it. So orders were pushed out, and we produced much less so they don't end up with inventory that they don't have a direct need for that. They kept in the warehouse only. So basically, we turned a big machine. We stopped it in -- partially, we, of course, kept and worked very closely with them that we did not lose any capabilities or knowledge. So we were producing in a much smaller scale, but still producing on almost all of the different product lines we're engaged with, but on a much, much smaller scale than we did previously.

Yes. And this already started when we first indicated to the market about this situation. I think it was during April. So these are also like processes that takes time. It doesn't happen over the night that you can just reduce your stock level, but constantly working day after day and week after week, et cetera, et cetera. So you can start seeing the impact there. And indeed, you see it in the figures. So there was a massive reduction in inventory levels indeed.

And this change has, of course, had an impact on the dependency on single customers in your portfolio. So the question is that will the -- in the future, Incap's biggest customer share of total sales be permanently lower in the -- because if you consider the increase in sales to other customers and new customers -- new customer acquisitions?

Yes. No, of course, it's always difficult to speculate exactly on the share of any single customer. And we expect that our largest account also will get back on higher volumes than we are producing currently. That said, we're all growing quite strongly in other accounts. And currently, the company's client portfolio is very well balanced. And I think in Q4, Antti, do you remember the numbers by heart, but we are talking about dependency from the largest customer is 20-something percent.

Yes, 23%. And year before, it was like 75%. So it's a huge, huge difference.

Yes. So if we look at our numbers that have perhaps fallen back to 2021 level or somewhere 2020 levels. At that point, we had a customer dependency that was huge. Now we are a well-balanced company. We are making profit. And then even as I mentioned before in my review, in our darkest hour, we are still outperforming many in the industry when it comes to EBIT. So this is in a period where we have laid off over 1,000 people. So I think our model is quite solid and moving forward, then I expect us to continue the growth. And then let's see what exactly the product mix or customer mix will be. We don't turn down business, if it's a good business and we can earn money on it. So -- but of course, we are in a much better balanced position now than we were in the past when it comes to a dependency of single accounts.

Yes. You can a little bit think this way as well that in the past, there was probably some potential risk because of this high dependency. Now there's like a potential opportunity to actually grow again with the biggest customer if this is -- this will be the case. So yes, dynamics of the company have definitely changed.

And you mentioned that this destocking was actually somewhat a common phenomenon in the markets last year. And so do you see any weakness in other parts of your customer portfolio? Any destocking impacts or slow end markets?

We haven't seen anything on scale in that sense. But of course, being very active in the industry and talking to different stakeholders and also to both our customers and our competition and so on, then there is a trend in the market. Clearly, that component availability situation rendered in people having too much inventory. And some analysts even saying that, that was perhaps part of the problem as well that was a component shortage that people were overstocking. So we have seen. But when it comes to Incap, we haven't seen any, I would say, bigger effects that we have not been able to handle or where our customers have not taken the liability for that inventory. So we don't have anything that have affected, in that sense, our business or numbers. But clearly, we see here on the market this trend.

And how about the segments? So where did you see the most or least of the growth in 2023? And what do you expect from different segments in 2024?

Yes. No. As I said, we are growing or we are expecting to grow -- continue to grow in all of our units and except for India, then where we have our biggest customer. And also other accounts in India are expecting to grow. So from our point, there is not a clear sector that is growing. We see this in multiple sectors. That said, we have talked about it before. We are very much into different kind of green electronics, and when it comes to smart home IT solutions, power electronics and smart grid and these kind of applications. So within those segments, we see growth. And that, of course, is clear megatrends that we see continue over time as well, light vehicles and so on, what we have been talking about here in the past.

And then a question about the personnel expenses. And they increased in the second half of '23 compared to the previous year. So previous year, it was 5.7% of revenue. And this year, it was 15.7% of revenue. Is this a new level of personnel expenses or just temporary level due to the low usage level of the Indian factory?

Yes. So there are a couple of reasons, of course, then one being that we acquired in July, Pennatronics. And then if you look at absolute personnel expenses, H2 '23 versus '22 similar period. So that explains most of the increase. But then also, as the question was so that there is definitely price salary -- price increase pressure as well in the units. So there has been -- basically in each unit, minimum wages have increased, let's say, 7% to 10% on the unit level. So that is something. And of course, then that's also true that in India, the weight of the Indian operations from the total group level. So there has been also different like wages and salary levels between Incap different units. So when the product mix and the utilization rate of that unit is changing, so that impacts on the -- overall, like salary levels as well. And eventually, of course, then the product mix is. So how much we do like a small, medium batch of production with a lot of tailor-made-like solutions and handmade -- handwork needed there in final assembly, et cetera, versus a business that is done mainly by machines. So it's a combination of those things. But hopefully, I could summarize the main elements of that topic here.

So talking about the salary increases. Overall, how is the -- you have mentioned that the pricing competition is increasing. Do you believe that you are able to maintain your high profitability during the next years?

Yes. I think, of course, profitability is very much driven by our product mix. And we should also remember that there is some price pressure on the market and so -- and for us, I would say, the EBIT percentage is not wholly in that sense. It's the EBIT in absolute numbers that we are looking as I have said before. That said, I strongly believe that if we can get -- and we will get the utilization up of our factories in India, then that will play in our favor. And our model is still so that we have a very lean company. We basically have a handful of resources on -- in the headquarters and very low overheads. And we're not eating up the profit that we are getting from our Asian factory or from our Eastern Europe factories. And so the setup we have gives a possibility to maintain relatively higher profitability than perhaps companies with -- in the industry with another setup. But of course, the bigger we get, the more we feel the factories, and especially now with our third factory in India, then the better chance we have to earn good money as well. That said, I still think that -- and I want to emphasize on that in our darkest hour, in quarter 4, we were still outperforming many in the industry.

All right. And moving from India to the U.S. and Pennatronics. There is a question about, if you have made some changes in the operations of Pennatronics after the acquisition? And also that what are the cross-selling opportunities? How are they playing out with Pennatronics?

Yes, of course, Pennatronics was owner-driven, of course, before the transaction. And we have now promoted new management, both financial management and site management. Yesterday, Board of Directors confirmed also, David Spehar already into the group management team, and we welcome that. Of course, it's -- great people we have in U.S. They're doing an excellent job. But yes, operationally, we have done some changes and by appointing a new management and so on. And now it's up -- a little bit up to them, where in Incap, our decentralized model is to empower people and give them opportunity to develop the business and so as they see it. And we're looking forward to work with the U.S. team to expand on the U.S. market and then keep on growing. They are doing an excellent job so far and have been a very welcome supplement to the Incap family.

How about the investments? Do you have a plan for 2024? And how much have you planned to invest this year?

Antti, do you want to comment on...

Yes. Well, we are constantly looking at investments in order to support the growth and keep up the competence level and then the service level. And in order to be able to cater with the latest technology and component sizes are getting smaller and smaller. So we have to keep investing in our operations as well. We have a couple of line investments in the planning phase internally. That is definitely something we are looking into more in detail. And then on the IT side, there are a couple of investments as well. We are considering some ERP-related investments here. And then M&A acquisition topic is always -- as a big chunk of investment planning that we are considering here. So definitely, that is something we are still looking at. And then we'll probably -- definitely we'll announce then publicly those in the form of a press release when the major investment take place.

But more or less on the same level. If we exclude now, of course, we have the major investment of building the third factory. But if you look at otherwise, we will continue on the same level. We strongly believe that if we want to cater our customers with making the latest electronics and latest technology, we need to have good technology in our factories and be on the edge there with -- when it comes to our capabilities. And this is something we see -- now a fundamental driving the businesses to keep investing in the production and keeping that top of the line. So we will, of course, continue with that. But investments is always -- it's what you invest, what you need in that sense. And of course, it's not just investing for the sake of the investment. So everything is driven by our customer needs and demands and how we see the future.

Yes. Very much like normalized investment needs based on the -- like we have had some machines 15, 20 years old, they are just breaking up. So we -- definitely, we have to have replacement investment down there. So this kind of normalized investments, we are -- we never like over invest either. So we -- I think we have had in the past just the right balance there.

Okay. And then there are a couple of questions that all relate to the customer portfolio and differences between customers, for instance, about the growth rates and the profitability. So can you give some kind of light on how your customers are compared to each other.

Yes, it's a tricky question as we don't keep like -- yes, do that kind of comparison with names and so. But as I said before, that with -- expect our largest account, we have been growing the full year. We expect that growth to continue in all the accounts. We expect also our largest account to start picking up and start growing now in -- slowly over the year. Even if the stock exercise will continue in the first half as we have announced. So I don't know how I could shed more light on that without revealing any names and so and getting into trouble.

All right. I think we have time for one more question here. So the last question would be about the M&A. And how do the valuations and pipeline look like? And should we expect any deals during 2024?

Yes. No, I think if you look at general valuations have come down during last year. And I think currently, there is good opportunities on it. I mentioned before, we have a good pipeline. We're working actively. And so afterwards, closing the deal, there's always 2 parties into that and then you need to agree upon valuation and final negotiations and so that is always hard to predict on it. But we, for sure, are still looking into our M&A track. We have good financials and possibilities to pursue this. And let's see. I wouldn't be surprised if we see some acquisition activities also here in this or next year.

Yes. And in terms of the -- how we work in M&A, we have an established team. We have worked already several years with the M&A team. What we have here in the headquarter level, we are driving the M&A., a lot of from the central level here. But of course, then we want to use knowledge and the local contacts, what our country organization and our local managing directors in there can offer knowing the potential [indiscernible] companies there in local, for example, now in expanding into U.S.A. So there -- now we have a very good established experienced team that can support us in terms of finding right M&A targets, et cetera. So as we commented, we have a robust M&A pipeline. And that is very high on the agenda for everyone here working in Incap.

And that's why the dividends -- there will be no dividends as the Board of Directors proposed. There was a question about if you...

Yes. To be point -- organic and inorganic growth. That's...

All right. There's also some positive feedback here. So maybe I'll read it aloud to everybody that very good webcast, good and clear answers to the questions. The future looks more promising and Incap's strategy seems solid. So maybe that's a good place to end. And maybe Otto, would you like to say some words before ending the webcast.

Yes. Thank you, Pauliina and Antti. Of course, thank you, guys for following us and the interest you have in Incap. It's always a pleasure of answering your questions. And so -- of course, you are also welcome to contact us otherwise and ask questions. We are always trying to play with open cards and give as good answers as we can in that sense and be as transparent as we can. So I'm looking forward for this year. And I think there is still a lot of positives out of this last release that we have had. And hopefully, this will develop even further during the year. So thank you very much from my side and until next time.

Thank you very much.

Thank you.