LEM Holding SA (LEHN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the 9-Month Results 2020/'21 Conference Call and Live Webcast. I am Sandra, the Chorus Call operator. [Operator Instructions] And the conference is being recorded. The presentation will be followed by a Q&A session. [Operator Instructions] The conference Must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Frank Rehfeld, CEO. Please go ahead, sir.

Thank you very much. Good morning, ladies and gentlemen. Thank you for joining us on this webcast where we would like to review LEM's 9 months results of our financial year 2021. My name is Frank Rehfeld. I'm the CEO of LEM, and I'm here together with Andrea Borla, our CFO. For those who are not yet familiar with LEM, LEM is providing sensors for measuring electrical parameters, namely current, voltage and energy, and with those help our customers and society to transition to a sustainable future. Now the today's agenda, after my opening remarks, I will give you more detail on the business performance of our 2 segments. Andrea Borla, our CFO, will then introduce our financial results and I'm going to outline how we see the future at the end. We would have loved to meeting many of you in person after this was neither possible in May for the '19/'20 results nor end of October for our half year results, but the second wave with worrisome levels and infection rates in most European countries does still force us to run this as a virtual event. Sorry for that. You surely all got used to increasingly work remotely with your teams and in your companies. And also at LEM, we reacted to the increased infection rates in October and the resulting changes in governmental guidelines from November on. And we are still in a home office mode in the majority -- with the majority of our indirect employees in Europe, the U.S. and Japan. For us, safety of our employees is of utmost importance. But every one of us, we she or he in home office or at his desk in LEM is going live every day as challenging as it is short term in order to assure business continuity for our customers. LEM has proven to be rather resilient in the economic environment. We continue to be a reliable partner for the industry and automotive sectors. Our customers can depend on LEM, no matter what economic and technological challenges they face. We are pleased to report that we finished the first 9 months with sales down only 3% at constant currencies as well as stable profitability. We continue to have a strong balance sheet even in this tough economic environment. The main reason for that can be found in our large customer base as well as the balanced geographical distribution of our customers. In particular, the restarting growth in China has helped in the first 9 months, specifically in the area of renewable energy and also new energy vehicles. We saw further improvements in the order books in Q3, which we take as a good sign. However, we also still see uncertainties in the next 6 to 9 months in logistics, the availability of semiconductor and electronic components as well as further COVID impact. Looking to the long term, we are convinced that the acceleration of the megatrends of electrification and renewable energy production that are the base for LEM's future are going to continue. The rebound in both our automotive as well as our industry business was mainly driven by the strong recovery of the Chinese economy that will be the only sizable economy that has seen in 2020 growth by about 2.3%. To illustrate this year, you can see this graph that depicts the Chinese annual growth since 2011. And you see, on the one hand, a gradually slower growth rate of the Chinese economy, the bigger it becomes. But at the same time, also a fast V-shape recovery in 2020 with predictions to get 7% growth for 2021. You've certainly all heard and read about the challenges that the recovering world economy is facing. Also, we are confronted with the shortages of electronic components and particular semiconductors as well as the limitations in transportation capacity. The LEM team is intensively working with our suppliers on minimizing these impacts. The Q3 orders went strongly up by 7% in comparison to last year. Still, the orders compared to full 9 months period are down by 8%. Certainly, we see here some stock fill effects of our customers who over order in times of component shortages. Our Chinese as well as our Bulgarian operations were running at full capacity throughout the reporting period, whereas we reduced our capacity in Switzerland to 70% from August to October. Since November, we are back at 100% also in Switzerland. It goes without saying that in all sides, sanitary measures for all our employees are implemented. Our strategic investments were the footprint extension in Malaysia as well as the Geneva headquarter have been impacted time-wise by the pandemic, however, not been put in question. With that, let's move now to the business performance. LEM is delivering sensors into the motors and drives business, the area of power storage, renewable power generation and energy conversion as well as provides energy meters for traction application and fast charging stations for electrical vehicles. We are organized in 2 business segments: Automotive and Industry that have about 20-80 share in the total LEM turnover. Both the Industry and the Automotive segment saw reduced sales in comparison to last year in Swiss francs, auto with a small 1.5%. Industry was impacted by more than 9%. On constant currencies, the gap for Industry reduced to 5%, whereas auto even grew by more than 4% year-on-year. Looking at the geographic spread of our business, you will notice that our Chinese sales were growing in comparison to the same period of the financial -- of the last financial year and even strongly growing in the last quarter, whereas all other regions were shrinking. This explains that the Chinese share of our business relative to the other regions has been further increased to now 39%. The proportions of the other regions with Europe at 29%, North America with 10%, and rest of the world with 22% remained largely unchanged in comparison to the H1 numbers. Let us now look deeper into our 2 business segments, starting with the bigger one, the Industry segment. Now almost all business -- businesses in Industry have lost in comparison to the same period last year, except the renewable energy business. The Industry segment, our drives business is the biggest. This business has been suffering 5% -- minus 5% in comparison to the same period last year, with Asia and the U.S. recovering, and we see a positive trend for drives upcoming. Even in the current pandemic situation, our renewable energy business was slightly growing, mainly driven by solar in China, whereas Europe kept flat; however, also a year with a stronger outlook. The traction business is minus 27% against last year looks weak. However, please bear in mind that we compare against very strong sales last year. Still, the decline reflects lockdown impact from China and India with delayed orders. Projecting this picture now from a regional perspective, you see that the real driver for the Industry growth was China with more than 6% on 9 months and even stronger Q3 effects with more than 10% on Q3. We see improved orders also from the other regions. But with reference to the Chinese GDP development, I've been introducing before, sales growth was only realized in China, whereas all other regions were suffering from reduced economic activities. Please bear in mind that almost 50% of the 9 months decline of 9% are coming from currency effects. We had, in particular, rather and weak Chinese renminbi during the beginning of Q2 and a rather strong Swiss franc against the euro in comparison to the last year. Now we continue to strongly invest into research and development and launch several new product families as well as new product generation. We've been launching an outdoor Rogowski coil as well as an integrator that some Rogowski applications are using. Both products, the Rogowski coil as well as the integrator are products that we are selling into smart grid application. They are used in medium voltage applications in order to stabilize the grids that are getting destabilized by all renewable applications. Now let us look deeper into our second business segment, the Automotive segment. We are surely aware that the automotive sector has been under enormous pressure since COVID-19 has sparked a collapse of car sales. Car manufacturers stopped their production and step-by-step restarted their plants during Q1 of our financial year. On top of that, now the semiconductor crisis has again forced the automotive industry to reduce their production capacity since the end of last year. You probably know that automotive only makes about 10% of the worldwide semiconductor demand. Still, the situation has been substantially improving for LEM since our H1 review, and this is true for all application areas. In the battery segment, you see still a mix of development of combustion engine vehicles and new energy vehicles. Therefore, this segment is impacted by the general automotive market and our decision to focus on investments towards new energy vehicles. Motor control and charging systems profit from the increasing demand for electric vehicles. Looking to the global distribution of our automotive sales, you see similarities to the Industry business. First, due to the strong rebound in China in Q3, we saw on 9 months a growth by more than 4% in China. Therefore, the share of China for the Automotive business now accounts for 43%. Also, the European market saw a very positive development, also driven by incentives for electrical vehicles across all Europe. We've already been talking about the collapse of the U.S. market and the impact on our sales in the previous slide, still in comparison to our H1 figures. We see less of a decline, in particular in Q3, improving the 9 months' performance from minus 42% in H1 by more than 10 percentage points. We are not happy with our rest of the world performance, where the still good performance in Korea was offset by Japan. We've been sharing with you as the investor and analyst community that we are working on our automotive strategy. And I would like to invite you to follow me here on a small endeavor into automotive electronics. Don't be afraid it looks less complicated or it is less complicated than it looks. But it probably illustrates the challenges that component manufacturers like LEM are facing. You see in the graph on the y-axis an increasing level of functional integration from a simple sensor up to the functionality like state of charge or state of health. And along this axis, LEM's automotive customers require different functionalities in a high-voltage battery sensor that looks from the outside mainly like a simple standard sensor. On the x-axis, you see different physical integration levels of a sensing function that is relevant for the sensor functionality for motor control. And you see here, this axis ranging from a sensing element, that means an integrated circuit up to a complex sensor that integrates multiple phases in bus bars. This is in particular relevant for motor control functionality since the inverters here are shrinking generation by generation, and so the sensors need to follow up. This probably also gives you, again, background on our strategic rationale, while LEM has been deciding to move into the fabless semiconductor business. And we are playing in all functional as well as physical integration levels. As you can see here, on the one hand, with our own offers for integrated circuits up to the more complex sensors for motor control and, on the other hand, on all functional integration levels for battery management. The core for all our sensing functionalities is always the measuring capability that is defined by the ASICs. And at the same time, we try to further grow our module business to limit the impact of commoditization and easy replacement. Therefore, you see these 2 areas highlighted as areas for our strategic thrust to also be -- and this is the target here and a one-stop shop for current sensing for our automotive customers. With this, I would like to hand over to Andrea Borla, our CFO, who will go deeper in the financial results.

Ladies and gentlemen, good morning also from my side. As the group CFO, I'm pleased to report solid financial results during the first 9 months, which have continued to improve during the Q3. As already mentioned by Frank, we have been faced with a challenging environment mainly impacted by worldwide sanitary crisis and the ongoing U.S.-China trade war. Considering this difficult market environment, the sales held up not so badly and decreased by 8% at a constant exchange rate by 3% only. Those lower sales impacted logically as well the EBIT and the net profit, which, in absolute value, are both slightly lower than last year's performance. Let's now have a closer look on the various P&L elements. The gross margin in absolute value, as you can see, dropped by CHF 9 million from CHF 110.9 million to CHF 100.6 million. In respect of the gross margin in percentage, we have lost 0.9% points from 47% to 46.1%. What are the main causes both for this decrease? As a consequence of the COVID-19 crisis, the air freight costs out of China have substantially increased and hit our gross margin. This was very true, especially during Q1 but the supply chain bottlenecks remain still valid today. Those negative impacts could be partially be compensated, thanks to efficiency programs and continuous purchase price reductions. Also important to keep in mind is our 2 low-cost location, which are situated in China and in Bulgaria. They cover now 84% of all sensors produced by LEM. Percentage of our low-cost locations will further increase in the future. On SG&As, in view of the soft top line, we have been experiencing -- in the first 9 months, we have been also very vigilant on all SG&A expenses and headcounts. We as well could take advantage from the sanitary crisis effects such as less travels, government subsidies in China and no sales exhibitions. As a result, we lowered the SG&As by over CHF 4 million from CHF 42.7 million to CHF 38.3 million. The R&D expenses were reduced as well by around CHF 2 million from CHF 21.9 million to CHF 19.8 million. Whereas we have continued to increase the number of R&D engineers by 20 since beginning of our FY 2020/'21, we have reduced the spending on third-party subcontracting. We focus not only on renewing our current product portfolio, but as well on developing new product families addressing new markets and applications in the future. We have now launched some very exciting new products, such as the DC meter and the first integrated current sensors HMSR as our first fruits. Going forward, R&D expenses are expected to remain in the 8% to 10% range. In contrast to last year, LEM did not suffer from any exchange effects as gains on U.S. dollar hedges and losses on our transactions compensated each other. LEM's policy to fully hedge the net exposure of the cash flow nominated in U.S. dollar, euro and Japanese yen will remain. As LEM has only limited third-party debts during the first 9 months, the interest expenses remained rather modest. The main element of the financial expenses related to expenses on our lease liabilities. The effective tax rate of 17.1% is, of course, a mix of the Geneva tax rate at 13%, the China tax rate at 15% and the mix of all other countries at 25%. If we exclude last year's nonrecurring tax gain, which we booked in December last year and we compare the same, the tax rate remained stable at 17.1%. On top of that, we also have 5% withholding taxes to be paid for the dividends mainly out of China. And here, you find now the full P&L for both the first 9 months and for the Q3. In spite of having lower Q3 sales compared to previous year, the EBIT is now higher than last year's EBIT. This is noteworthy, as this is the first time since 2 years that we could exceed the previous year's operational performance. As a summary, we have been faced with a challenging market environment, but we managed to protect our overall profitability, reflected in an EBIT margin of 20% and a net profit margin of 16.5%. In these uncertain times, you may now wonder what the future will bring for that. I'm happy to hand back to Frank.

Thank you very much, Andrea. Yes. So how do we see the outlook? And in order to calibrate where we are, I would like to share with you a picture from the IMF indicating the global uncertainty since the mid-90s. And you will probably easily get the idea here. We have, in the past 25 years, never been living in times of greater uncertainty than today. There are good reasons to believe that the future looks a bit brighter. However, I'm convinced that uncertainty will remain an important part of our daily life. And that is the reason why we want to prepare the LEM organization even better for those future uncertainties. What do we expect for the remaining quarter of the financial year 2021? In comparison to other industry peers, we're showing a good level of resilience in those pandemic times. COVID-19 gives us little visibility for the next 6 months until we see stronger vaccination impact. However, our strong order book allows us to improve our outlook for the top line to CHF 290 million, which represents a decline of 6% against last year and an EBIT margin close to 20%. With this, I would like to thank you for your time and attention, and already today, I'd like to invite you to our full year review on May 19 in, so to say, whatever constellation. Herewith, I'd like to open the Q&A.

[Operator Instructions] The first question comes from Michal Lichvar from Vontobel.

Basically, 2 questions from my side. The first one, you mentioned the higher logistics costs relating to air freight. And I was wondering if you can quantify somehow that effect so that we can get a feel for how the situation would look like once the total logistics costs normalize. And also in terms of your -- also referring to the margin in terms of your SG&A reduction, I was wondering how much of that is permanent and how much of that sort of will come back post crisis, possibly if travel expenses increase again. So that's regarding the margin. And then I have a follow-up on the order book.

Okay. Thank you, Michal. I take the 2 questions in respect of the margin. So effectively, higher logistic costs we had, especially in the first quarter, air freight cost. Now in the meantime, we have also transferred some transportation onto the train. But we see here, again, an uptick in quarter 3. So overall, after 9 months, what you can assume is that our hit was close to 1% point on the gross margin coming from higher logistic costs. On the question on SG&As, of course, we had also here some important savings out of traveling that we are not able to travel and sales exhibition, et cetera. And I think even if we go back to normal times, I think, let's say, the travel tendencies will be reduced also in the future. And overall, I think here, you can also assume probably that overall 1% point could be a fair assessment of the hit or the savings we had out of this less traveling, less exhibitions realized in the first 9 months.

Okay. Perfect. That's very helpful. And then the follow-up on the order book. You showed your geographic sort of developments, in particular, in Industry, with positive China, but Europe is still rather negative in terms of the sales trends. If you look at the order book, how is that picture comparing? Do you see a bit clearer signs of recovery here in Europe?

Yes. We -- as you know, we do not provide these details about the detailed order books by regions. But what we can say overall is what you see here is effectively that we see some momentum coming up. The order received quarter-by-quarter have increased over the last time. And this is through a bit -- throughout most regions, but we do not provide you now the detailed data on orders by regions.

And maybe just to add on here. You probably remember what I just said about component shortage in the worldwide electronics component market. We see here clearly also some over ordering out of an, let's say, stock fill mode that we see with our customers. So I would also be cautious to over-interpret the order book as now 1:1 transferring easily into sales. So we are there also cautious here internally.

[Operator Instructions] The next question comes from Serge Rotzer from Crédit Suisse.

I would have 1 or 2 follow-up questions to Michal's questions. Also in gross profit margin, you explained us the impact of the air freight costs. But I'm wondering also the impact of the sales mix. From a rough calculation, if I take out the air freights, gross profit margin was down by 50 bps. Is this now due to the sales mix of Automotive to Industrial? Or can you help me to better understand this, what impact Automotive has on the gross profit margin? And then secondly, as a follow-up, in EV, can you give us a feeling about the profitability mix of the 3 sub-businesses, battery management, motor control and charging systems? How -- what we can expect here?

So, I take this -- also these 2 questions. On the gross profit margin, overall, the sale mix is not so determined. It's really the main, main driver of the drop. If you look at last year, we were at 47%; we dropped now at 46.1%. Really, the main driver is really focused there on the freight cost. It's not so much to do about the sales mix. Even though we do not provide information about the margins of the different segments, we can say that there are no huge, huge differences between the margin and profitability of those different segments. And in respect of EVA, exactly the same, we will not provide you now about this level of details about gross margins. But you can expect at least in the first 9 months, this was not a reason of having a better or lower margins. So no major impact on that.

Okay. Then probably a follow-up question on customers. Were you able to gain new customers and in which field, in which business? And -- or on the other side, what is the behavior of the existing customers? Are there big differences?

Right. Maybe I'd take this one. So for sure, we continued even in a virtual way to acquire business. And I think with respect to design in both in Industry and Auto, we make very good progress. I can share with you that, in particular, also in the new products, in the area of the integrated current sensing. So basically the fabless LEM part and also the metering, the DC metering business, we see a very, very good resonance of customers to our products. So I think we are really spot-on to the market. And in some areas, we even have limits in capacity to really follow the demand. So there are really strong surges that we are seeing. And the same also applies for Automotive. We are working strongly here with the Chinese customers, but see also more and more progress with the European customers, in particular, and we are making there very good progress. So we don't see really a change in behaviors in the sense of that there are now completely new developments. What we clearly see is that the trends looking, in particular to Automotive, are continuing that increased compactness in sensing and is going to move forward. And that I think the probably a little bit reluctant developments in the European electrical vehicle market is now changing into a stronger embracing of this development.

But with all the new models we have seen now in Europe, especially also from EW, BMW, Mercedes-Benz, you said you make progress with Europeans, does this mean firm orders or only that you're in contact? How can I understand that?

I mean making -- a very good question, yes. So for sure, making progress for us is having design ins. So this is for us the criteria because you're probably aware we will see in the next foreseeable time frame, '22, '23, about 500 different models in electrical vehicles coming to the market. And to exactly now predict how well each model is selling, this is not in our hand. What we can do is to realize design ins, hopefully, at a lower complexity level than 500 different models. And then basically, hope that these market -- these cars also have then according market success.

[Operator Instructions] Gentlemen, so far there are no more questions.

Okay. We will take the questions now from -- that came in by writing. We have 1 question from Carlos Moreno from Premier Miton. His question is, you spent more than you did. But do you think you spend enough money on R&D? Many of your near peers spend towards 20% of sales.

Okay. I think it's a very good question. Thank you very much. Now let us quickly reflect on where LEM is and where LEM comes from. You probably look -- when you look back in the history of LEM, we come from an order of magnitude of R&D on sales of about 5% to 6%. And we've been doubling this to now 9% in this year. When you compare LEM, and this is for sure, the mix between Auto and Industry. When you compare LEM now with industry peers, it really depends on in which segment you are. I think there are a substantial amount of companies who are spending by far less than these about 9% to 10% that LEM is spending. And there are in the semiconductor areas, quite some companies who spend above 15% going even up to 20%. What you see in the LEM spending is probably a mix between exactly this, let's say, rather traditional products and, on the other hand, rather very innovative technologies and where you basically have to spend substantially more. So do we think we underinvest? No, I don't think, we don't underinvest because we don't basically restrain ourselves with respect to R&D costs. But for sure, we also would like to invest on where we have an according returns and, for sure, that is one of the challenging management tasks today to really set on the right horses and to invest where eventually also a return can be generated. But again, I think I'm looking into the substantial investments that we did into the fabless area and also going up the value chain into the area of adding software, producing a DC meter. We've been really, really substantially increasing already our investments. Hopefully, Carlos, this answers the question.

Looks like there is one more question from UBP.

The next question comes from [ Regina ] Power from UBP.

Just wondering, probably a bit of a provocative question, but looking at the development of sales in the North American markets, both in the Industry segment and in the Automotive segment, combined with your production footprint, which you said is now -- well, more than 84% coming from China and Bulgaria. Does it still make sense to keep exposure to those North American markets? Or is that something that you would eventually think of selling or not catering to anymore?

So thank you very much, [ Regina ], for this question. Maybe I'll take that. And no, I think it's not a provocative question. It's a valid question, and it's a question that necessarily comes up when you look at exactly the distribution of where we manufacture and how we are reporting ourselves. Now I think what needs to be understood, the way we are reporting our sales is we report where we ship to. We don't report where eventually those products are ending up in the different geographies. So when you have in mind that in the world power electronic market, only 5% of the power electronics is really manufactured in the U.S. whereas a lot of power electronics manufactured in Asia is ending up in the U.S., and I think the U.S. share of the power electronics market is about 25% in using but not in producing, you probably better understand the picture. That basically also a lot of electronics we are shipping to Asia is then further assembled into equipment that ends up in the U.S. Do we see more potential in the U.S.? Looking mid to long term, I would clearly say, yes, because we are convinced with the U.S. rejoining the Paris treaty, we will see stronger developments in renewals and also further strong developments in the new energy vehicle area and there is further growth to be expected. Whether this justifies a plant and it's, for sure, something that needs to be revisited. At the moment, we would not see that yet, but this is something that is, for sure, to be decided as soon as we see an according size.

The next question comes from Marc Possa from VAG.

I have a very simple question in terms of the Lyon R&D plants that you did build up. Is it right to assume that there were no additional costs stemming from that new opening and ramping up of that facility? And maybe in that context as well, could you maybe describe how the market is evolving? Is it fair to assume that due to your focus and the stringence that you live that you're potentially having more of a USP, i.e., gaining market shares because many other competitors will not be able to kind of be as innovative and as successful as you are and have been in the past? So are you gaining market shares basically organically?

Right. Maybe I'll start with the second part of your question. I have not been 100% getting the first part. If you could then quickly repeat that, Marc, that would be very nice. And second part. So I think, yes, we do have a solid performance. I think we have also been foreseeing the one or the other component shortage so that allows us to now react. I think we are in a situation where I would say, yes, we can gain market share and we see weaknesses in the one or the other competitor as well. I think it's -- we are far away from being here in a celebration mode and say we've made it because this market remains complex, agile and I would not go so far that, yes, we are here the easy winner out of a difficult situation. But for sure, I think the fact that LEM is in basically all important applications in the power electronics market gives us here an advantage. Okay? So hopefully, this answered the second part of your question. Marc, if you could just repeat the first part with utility investment, I was not sure but I got.

Yes, the first part was more to find out whether there were still some costs of the movement to Lyon to the new R&D center in that result or not, whether that was already expensed basically in previous quarters. Is there any kind of one-off in those 19 point -- what is it CHF 9 million?

So I think what you can see here is that this location is fully established. There are no one-off costs. You rather see, let's say, at the same output, some improvements because you can imagine that we had in order to get up certain competencies, in particular, for software. We had to refer to consultants, and we could then convert those consulting capacities in in-house hires at more advantageous rates. So we had rather there an improvement potential in terms of cost rather than, let's say, one-off write-offs.

Okay. There may be another additional question to you. My second question before concerning the market shares and the developments within those markets in the industries. Looking at the business mix change more into EVs, electronic vehicles, with more complexity on the current side and the measurements and so on, is it fair to assume that your historic market share of about 50% should, since you're an early mover into that new EV domain, rather increase organically: a, because you're an early mover; b because you're still more innovative than many others; and c, because the complexity of such is rising into an area where there is a very few that can master those developments correctly? Is that fair to assume?

To be very open and also transparent, I think what we see in terms of presence in the market, I think, we are an early mover with respect to our standard sensors. But looking into the mid- to long-term trend, in particular, in automotive, where we will see a lot of compactness, a lot of basically, yes -- increased compactness in order to get the cost down because you are clearly aware that cost parity with combustion engine vehicles is the target of the automotive industry. So we will see a lot of sensing functions moving into current sensors. I would say, we are here acquiring new competencies, in particular, in how to run a fabless business. So probably there, we are an early mover in terms of understanding the applications, but to -- we also have to establish here a couple of competencies.

[Operator Instructions] Gentlemen, so far there are no more questions.

Good. Thank you very much. But there are also no more questions from the web. Again, thank you very much for your attention. Thanks a lot for trusting LEM for spending your time here on this call. And again, I'd like to repeat my invitation to join us on the reporting of the full year results in May. Thank you very much, and have a great day.

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