Earnings Call: Q1 2020

May 8, 2020

Good afternoon. This is the Chorus Call conference operator. Welcome, and thank you for joining the Karel Industries' First Quarter twenty twenty Results Conference Call. As a reminder, all participants are in listen only mode. After the presentation, there will be an opportunity to ask questions. At this time, I would like to turn the conference over to Mr. Francesco Nalini, CEO of Karele Industries. Please go ahead, sir. Thank you. Good afternoon and welcome to the presentation of Q1 twenty twenty results. I take this opportunity to welcome on board our new CFO, Mr. Nicola Biondo, who joined Karel on the May 4 and who is taking part in this conference. I'm starting from page two with the main highlights on the period. Obviously, this was a pretty challenging quarter, especially on the supply chain side due to the several disruptions that took place first in China and then in Europe. However, thanks to the resilience of our production footprint, we managed to mitigate the effect of these disruptions and reported revenues were substantially in line with the 2019 with a decline of 1.7%. We estimate the impact of the disruption to be approximately 6,000,000 to €7,000,000 This has generated a backlog and part of it will be recovered in the following month. So moving down, revenues were substantially in line with what was reported in Q1 twenty nineteen with a decline of 1.7%. And this was despite the temporary shutdown of the two main plants of Care Group that is China and Italy that account for more than 60% of the total production capacity. This confirms the validity of our long standing strategy of having production resiliency and redundancy since as you know we can manufacture 90% of our product platforms in at least two plants. EBITDA margin was 18.2%, 130 basis points less than the full year adjusted results and that's mainly due to the lack of operating leverage since revenues didn't grow as expected. Of course, we implemented a number of initiatives to mitigate the effect of the situation, especially containing OpEx. The effect on the first quarter is limited because we started applying this effect in March. However, the full effect will be deployed in the following month. Net financial position at 62,000,000 is in line with the full year in spite of an expected increase in net working capital related to a seasonal effect in receivables. Moving to Page three, we can focus on the supply chain. As you know, we have one production plant in Suzhou, China that accounts for approximately 30% of the total capacity of the group. The plant was shut down for one week at the February and then gradually returned to the full capacity in the following weeks. As of today, it's running at 115% of the plant capacity because in the past weeks we increased very rapidly its capacity by adding shifts and adding machines and the capacity is increasing even more in the coming weeks. In this respect, it was particularly important the footprint expansion roadmap that we completed last year since now we have three times as much shop floor space in China as the one we had before. So it's relatively easy to increase very rapidly the capacity and increase the resiliency. In Italy, we have one production hub in Padua and the recuperator plant near Milan and they account for approximately 30% to 40% of the capacity of the group. The production hub first slowed down and then stopped entirely for approximately ten days at the March due to the COVID related restrictions. Production restarted on the April 7 with limited capacity related basically to the so called essential supply chains, which in our case mean the provision of systems for healthcare, data centers and supermarket. Capacity then increased gradually over the following weeks as the restrictions were gradually loosened and then we went back to 100% capacity since May 4 when the lockdown was lifted. The recuperator plant never stopped. It continued working for the essential supply chains and went back to 100% capacity again on May 4. As we speak, the total capacity of the group is more than 100% of what was originally planned in order to be more resilient and better cope with potential disruptions. The temporary shutdown of the two Chinese and Italian plants has created the backlog, which will be partly recovered after March 31. Moving to Page four, we put in place a number of initiatives to mitigate the effect of the pandemic situation both on the top line side and on the cost side. So in terms of supply chain, during the shutdown of the Chinese plant, we moved very rapidly part of the production to Brazil and Europe. And during the shutdown of the Italian plant, we moved part of the production to Croatia and back to China. Of course, the shutdown of the Italian plant had a significantly higher impact than the shutdown of the Chinese plant just because it accounts for a higher capacity as a share of the group. In terms of costs, we started implementing a number of cost containment measures. We activated in Italy the government social scheme and similar tools in other countries and we applied a strong reduction in discretionary expenses and obviously business travel. The positive impact in Q1 of these actions was limited because we started in March, but the impact will be higher in the following period. Moving to Page five, we can see some economic figures. So looking at the top right with the revenue bridge, in Q1 twenty nineteen we had a turnover of €80,100,000 without the COVID related disruptions revenues in the quarter would have been approximately €85,000,000 As I mentioned, we lost 6,000,000 to €7,000,000 for the impact of the lockdown and will end at €78,700,000 in Q1 twenty twenty. For sure, if it weren't for the shutdown of the Italian plant, revenues would have been growing in this period. EBITDA decreased by 8.7% to €14,400,000 with a profitability of 18.2% down from 19.6% in the same period of last year. This is mainly related to the lack of operating leverage since sales didn't grow and in particular to the annualization effect of the new hires that we did during 2019. Of course, the incremental effect of the new hires is particularly visible in the first quarter because we see all of them. This effect will be lower in the following quarters as we go through to 2020. Net profit went down by 14.1% to $7,600,000 The decrease is related to the operating results as well as to higher G and A for the investment program we did in the last two years. And CapEx were $2,400,000 so more or less half what they were last year since the footprint expansion roadmap is now over. Moving to Page six with the revenue breakdown. To the left, we can see the breakdown by region. So EMEA grew by 2.9% net of foreign exchange and this is due to a very good performance of the refrigeration market that accelerated in 2020 as well as a very good performance in Eastern Europe where we have been investing recently as you know to increase our presence. Asia Pacific decreased by 17.3% net of foreign exchange and this is entirely due to the Chinese lockdown and to the decrease in demand in Asia, which was entirely expected. North America decreased by 10.8% net of foreign exchange. This is related to two elements. One is an expected normalization after a very positive 2019 where we had the 20% growth. And the second effect is a slowdown in demand in North America that materialized in March due to the COVID situation. Latin America grew by 4.7% net of foreign exchange due to a particularly good performance in Brazil. To the right, we can see the breakdown by sector. HVAC decreased by 4.9% net of foreign exchange. Refrigeration grew by 5.4% net of foreign exchange. So refrigeration as a good performance is accelerating and that is what we had expected after Q2 and Q3 last year when especially in Europe the growth decelerated. The decrease in HVAC is mainly due to a higher impact of the shutdown of Italy due to product mix reasons. So this does not reflect the actual demand of the market. It reflects the shutdown of the Italian plant that affected mainly HVAC for product mix reasons. The non core business declined by 8.8%. So the total decline 1.7% is neutral in terms of exchange rate. I'm moving to page seven and I leave it to Nicolas to comment the items below the EBITDA. Thank you, Francesco. The slide number seven details the group results from EBITDA to net profit. The first quarter twenty twenty was impacted by higher G and A cost mainly related to the relevant CapEx level of 2019. In the period under review, the financial charters were higher compared to last year due to an increased amount of loans available for the group. The ForEx impact in Q1 twenty twenty was positive for about €20,000 compared to losses for more than €400,000 realized in Q1 twenty nineteen. The tax rate in the period was 19.3%, pretty in line with the 2019. Since the Chinese authorities confirmed the reduction tax rate for high-tech enterprises, we expect to close the year with a tax rate on around 20%. The group net profit of the first quarter twenty twenty was equal to €7,600,000 compared to €8,800,000 of the same period of 2019. Slide number eight shows the net financial position evolution of the first quarter twenty twenty. The net financial position was pretty stable compared to December 2019 level. The fund from operations was equal to €12,200,000 higher than the CapEx and the increase of the net working capital of the period. The increase in net working capital was mainly driven by a seasonal effect. It should be noted that the DSO at the end of the quarter improved compared with the same period of last year. At the end of the quarter, the group has an amount of cash, cash equivalent and available credit lines of about €90,000,000 The financing activity performed during the period made even stronger the good financial situation of the group. At the April, the same amount is equal of around €100,000,000 I leave the floor to Francesco to go on with the presentation. Thank you, Nicolas. So I'm on Page nine. To summarize, in spite of the temporary shutdown of the two main plants of the group that represent more than 60% of the total capacity, our strategy proved again once again its resiliency since revenues were basically in line with the same period last year. It was particularly important the production footprint expansion plan that we completed last year since it allowed us to very rapidly increase the capacity in China, but also in Croatia to mitigate the effect of the shutdown in Italy and to increase our resiliency even further for the future. Looking at the demand side, revenues in Q1 were only slightly impacted by the global slowdown in demand. The impact was basically concentrated in Asia as we had expected and North America. We expect a further deterioration of demand however in Q2 with a very high level of uncertainty and volatility. To mitigate this, we put in place several initiatives to reduce OpEx and limit nonessential CapEx and to improve the liquidity level and the balance sheet position which was already very strong to begin with. So to conclude, the pandemic limits the visibility on the full year expectations. A further deterioration in demand is foreseeable in Q2, which combined with the prolonged effect in April of the shutdown of the Italian plant should lead to a single digit reduction in revenues in the first half. In the medium term all the underlying growth drivers of our business remain unchanged. On the other hand, we foresee several new opportunities coming for example from data centers whose development which development is increasing because of the acceleration in digitalization from air handling units because of the increased sensitivity in indoor air quality which could lead to ways of renovations in commercial and industrial spaces and that will benefit our control systems, but also very much our humidification systems and also the recuperator heat exchangers. We expect also a trend in refrigeration and other applications towards more remote monitoring and servicing, which is absolutely in line with our strategy of developing digital services. This positive effect could materialize already in the 2020. Thank you very much for your attention. We are now more than happy to answer to all of your questions. Excuse me. This is the Chorus Call conference operator. We will now begin the question and answer session. The The first question is from William Turner of Goldman Sachs. Please go ahead. Hi, everyone. Thanks for taking my questions. I hope you're all well. My first one is on your comments that you made on the demand from your end markets. Could you provide any more color on is there any vertical which is pushing back on orders or which you see as particularly challenged during the COVID-nineteen outbreak? For example, I know you do have some exposure to restaurants and food, retail rather than supermarkets and then also the commercial construction market? Okay. Thanks for the question William. So in terms of end markets, for sure some of them we believe will be particularly challenged in the coming periods. One for example is foodservice. For sure the foodservice segment will challenged. Likewise, the industrial applications for the part related to automotive, it's been slowing down for a month now and probably it will be in bad shape for a while. Fortunately, these two applications count for not much in our global turnover. In terms of food retail, we are pretty optimistic, especially for the small convenience store surfaces that probably we see a growth. Let's say, supermarkets in general have been working at full speed in during this crisis. So we expect that in the future they will start again quite intensely to invest in renovating the stores and increasing the efficiency in complying with the F Gas regulation. And so we in general are pretty optimistic about the food retail industry. Going to commercial air conditioning, for sure there could be a slowdown in new construction. We believe that on the other hand as I was mentioning there will be a number of projects of renovation to improve indoor air quality to increase, let's say, fresh air inside environment to humidify more environments because that's very important for avoiding the spread of viruses and bacteria. So we expect that that could have a positive effect even if construction slows down. Great. Thank you. And then on to working capital, I've got a couple of questions around this. So the first one is I noticed that inventories have increased quite a bit even though obviously with the flat sales. Has there been any particular reason for this? Are you seeing any shortages in electronics programs sorry, electronic components? That was a bit of an issue in 2018. Or do you foresee that happening in the future? And then my second question on the work capital is, obviously, you can see probably your 2019 numbers that there is a seasonality in trade receivables. But is it all entirely from that seasonality impact? Or are you finding an unusual amount of customers pushing back on payments given obviously these quite unprecedented circumstances? Thanks. Okay. Thanks, William. So starting from net working capital. Let's say the increase in inventory was basically wanted to let's say to increase our resiliency. As you we were expecting disruptions in Europe. So we increased a little bit our inventory levels to be more flexible towards the disruptions. But in any case working capital in the period was 15.8% of sales, so was very, very low compared to historical levels. So it's still very, very low. An increase in inventory was wanted to increase the resiliency and will probably increase a little bit more also in the following quarters because we wanted to be more resilient towards possible disruptions. In terms of the upstream supply chain, of course, there are some tensions. Not all suppliers both in Asia and Europe are now back to let's say completely normal operations. But let's say the situation is now much, much better than it was for example in March and everything is fully being taken care of. And so looking forward this basically is leading has led to some increase in lead times, but no more major disruptions after let's say May 4 when the plants in Italy fully reopen. So we don't expect major disruptions coming from the upstream supply chain. Talking about the receivables, the effect is absolutely seasonal. And let's say, as also Nicola was mentioning, the DSO in the period was '75, whereas the DSO in sorry, 71, sorry, 71, whereas the DSO in Q1 twenty nineteen was 78. So let's say, we had a significant improvement over the same quarter of 2019. This is a seasonal effect that we have every first quarter. We had the same effect also in the first quarter of last year. Great. Thank you. And then my final question is could you comment a little bit on your product development pipeline? Even though, obviously, you're cutting all nonessential CapEx, can you talk about what you're how you're thinking about R and D? Are there any new product verticals that you're thinking of launching in the immediate future? Or has the current weakness in the markets kind of possibly results in postponement of new product launches? Thanks. Okay. Of course, the R and D investment is the investment that we the R and D as well as operations investments basically are continuing. So we consider them to a very high extent essential CapEx. So in terms of R and D, basically we are concentrating on the applications where we see the highest opportunities in this rapidly changing environment. For example, we are now investing in indoor air quality. We believe that our humidification systems in particular can be very suitable for this and we are investing in this direction. We are investing in natural refrigerants very much not only in refrigeration, but also in air conditioning because we see a big trend in also in air conditioning now in Europe moving to natural refrigerants, for example, in terms of heat pumps. And this is another direction where we are focusing our investment. We also focused more and more on digital services and services in general because as I mentioned this is one other area where we see the new normal let's say to be we see this area as being very important in the new normal. So investment in R and D is going on. Investment in operation is going on and especially is going on to increase the resiliency of the supply chain. And we are focusing on the applications that we see more promising in this new changing environment. Great, thank you. The next question is from Alessandro Tortora of Mediobanca. Please go ahead. Yes. Thanks. I have three questions, if I may. Good afternoon to everybody. The first question is on the action that you're gonna put in place in order to keep all your cost items under control. If you can give us an idea of what's your target, internal target in terms of profitability if you believe that to be fully impacted of this measure, you will be able to keep probably, I don't know, in the low end of your range profitability range that we discussed in during the full year results? The second question is on cash management action. You mentioned before that you are clearly compressing CapEx, nonessential CapEx. So if you can give us also an idea for the full year of which level of CapEx you can, let's say, achieve. The third question is on your first half guidance. Clearly, we are now you are now assuming a single digit reduction compared to, for sure, two months ago. You were still expecting a year of growth for for for Carol. For all the initiatives that you mentioned before, all the project, you believe that is still, let's say, possible for current to achieve some growth or looking at all the other operators into the sector, maybe we should assume something, let's say, a sort of a transitional year also for current? Thanks. Okay. Thank you, Alessandro. So in terms of costs, basically we focused on all discretionary expenses. So we had we are enacting a significant reduction in consulting expenses, in marketing expenses. We are freezing all the exhibitions that are a major marketing expense for us. We just had one big exhibition, which was in the first quarter in February. So that was a big ticket item and which will not happen again in the following quarters because we are freezing all the coming exhibitions, of course. In terms of personnel, of course, when especially when the Italian plant was shut down, we used government social scheme for all blue collars and partly also for white collars. Individual countries are using similar tools according to the local, let's say, to the local demand. So we are basically enacting all the necessary reduction of discretionary expenses and we try to make salaries and labor costs as variable as possible. On the other hand, and then I come to your second question. On the other hand, we believe we have to invest for the long term, for the medium to long term. So we are not by any means reducing what we consider essential in terms of innovation. And so we are continuing to invest. So let's say our initial expectation for CapEx for 2020 was approximately €15,000,000 It will be probably something less, but not much less because we want to continue investing for growth in the medium long term because as I was mentioning, we believe there are many, many opportunities in addition to the ones that we already had for the medium long term. In terms of the visibility on sales, so and our profitability target. So it's really too early to provide an expectation for the full year unfortunately because uncertainty is extremely high and also the visibility is very low. So in the first half, we will have a single digit decrease in revenues. In the full year, we still don't know. I mean, the underlying growth drivers could kick in already in second half, but it's too soon to say. In terms of our profitability range, let's say the expectation that we always provided is a profitability range for the medium term. What is going to happen this year is something that it's pretty difficult to say. Of course, I mean, we are forecasting for the first half a single digit decline in revenues, so we do not expect any dramatic reductions in profitability. Okay. Let's say two follow ups. The first one is on the outlook by region. Clearly, this first part of the year have shown some, let's say, weakness, okay, in The U. S. Market compared to an initial idea of consolidation. I understood that COVID-nineteen impacted, but if we look at the timing in theory, we should see US mostly impacted now. What has changed basically in The US market? Because we know that compared to the, unfortunately, the domestic Italian lockdown measure in that country was, let's say, a bit more, how can I say, modest? So just an an update on The US market and second on China. Being the first country exiting from the COVID nineteen pandemic, can you give us an update of the underlying trends into the market? And the last is on the m and a. If m and a activity for the company is still still alive in the sense that you're still monitoring or maybe you see incremental opportunities for current? Thanks. Okay. So going back to the market, Let's first let's have a look again at the first quarter. So in China, basically the decrease was due to the shutdown of the plant, but also to a decrease in demand. If you remember the presentation of the full year result, we said that we were expecting a 3,000,000 to €4,000,000 reduction in Asia due to the pandemic situation, which is basically what happened. Of course, this has created a significant backlog in terms of demand. So part, let's say, there was a decrease in demand. Demand now in Asia and China in particular is picking up again pretty fast. And so we are pretty optimistic about the region. Of course, we had the decrease of the first quarter, but now the outlook is pretty, pretty, let's say, improving in definitely improving especially in China, while the rest of Asia is still in a pretty, pretty difficult situation because it's behind China in terms of the epidemic. In general, looking at the group, because you mentioned that we were expecting a growth this year, of course, were expecting a growth. But please consider that we lost like close to €4,000,000 just because of the shutdown of the Italian plant. So without the shutdown of the Italian plant and just for March we would have been growing despite the decrease of Asia. Now especially the shutdown of the Italian plant has created a backlog because that was demand that was just moved ahead. Now we are working at full speed with more than 100% capacity to recover the backlog. And so we are let's say we are working intensely to recover the backlog. What is going to happen on demand is still pretty uncertain. Of course, for the second quarter in terms of demand, we expect like everybody else, we expect a reduction. Going to North America, I have to say that already in March, we started seeing a decrease in demand, very cautious approach by the industry, probably because they were seeing the pandemic coming, But that was pretty industry wise that there was a very cautious approach. So that was what we have been seeing in March in North America. And as you correctly said, North America is behind us in terms of the evolution of the pandemic. So it's particularly uncertain what will happen there. So we are basically optimistic in China. We are also pretty optimistic about Europe. In Europe, we have we expect let's say, we expect to continue with a relative good performance in Eastern Europe. Western Europe is a more mixed situation according to the individual countries, but in general we remain relatively optimistic. On the other hand, North America is the most as well as Latin America by the way are the most uncertain let's say scenarios because they are lagging behind in terms of the pandemic evolution. Looking at M and A, as you have seen, we had €90,000,000 cash and cash equivalents on March 31. And then as Nicolas was mentioning, we also strengthened our balance sheet after March 31. We are now around €100,000,000 So we believe that we are in a good position to let's say take advantage of any opportunities that we would find. And yes, we are still looking absolutely. Honestly, during especially during March and April, we were focused very much on the resiliency of our supply chain. But in general, we remain very committed to our M and A strategy. Okay. Thanks. Star and one on your telephone. Mr. Nalini, there are no more questions registered at this time. Okay. Thanks everybody for attending. Thanks for the questions and talk to you at the presentation of the first half results. Thank you very much.