Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the hGears Q3 Results 2023 conference call. Throughout today's recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. If you would like to ask a question, you may press Star followed by one on your touchtone telephone. Please press the star key followed by zero for operator assistance. I would now like to turn the conference over to Christian Weiz, Head of Investor Relations. Please go ahead.
Good morning, everybody, and a warm welcome to all of you participating in today's nine months 2023 earnings 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 results for the first nine months of this year and will also 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 two, which sets out the legal framework under which this presentation must be considered and which we assume you have read.
With that, I would like now to turn over the call to Sven Arend, our CEO.
Thank you, Christian. Good morning to all of you joining today. In reviewing our nine-month results, there are two key observations that I would like to share. Firstly, as expected, the business trends observed in the first half of 2023 continued into Q3 of 2023. The operating environment continued to be influenced by prolonged industry-wide destocking across the entire value chain in both e-bikes and e-tools, with end-market dynamics and e-tools further influenced by the interest rate environment. Secondly, as mentioned on previous calls, we are not passive observers. Our focus remains on optimizing operational excellence while streamlining operating structures and refining resource management. We continue to proactively review all elements within our control to drive efficiencies and future-proof the business.
Specifically, with measures such as setting up cross-functional value streams that will accompany projects from the RFQ through to the industrialization phase, ensuring cost-efficient development processes and flawless industrialization. Our top-line and profitability, but also our balance sheet profile, illustrates these economic trends. Let me provide a bit more background. In terms of top-line drivers, we see how the temporary slowdown in the e-bike and e-tools market has affected revenue realization during the first nine months of this year. Even if we see two sequential quarters of revenue improvement in e-bikes, which helps the revenue mix in Q3. In e-bike, we continue to see supply and demand imbalances across the industry. As you well know, in the last few years, we've had significant increase in the number of acquired customers. Still, with these ongoing lower consumer demand backdrop, even those customers have revised their forecast for next year.
In e-Tools, destocking continues to be slow and end consumer demand remains subdued amid the current interest backdrop. Although we've seen inflationary pressures decrease and the ECB's key interest rate remains unchanged as it opened to pause in October after 10 consecutive hikes. For the conventional business, we saw satisfying year-to-date growth, but also a quarter-on-quarter deceleration. From a profitability standpoint, we see different supportive and limiting factors influencing our results at the gross profit and Adjusted EBITDA levels, including product mix, lower volumes, stop and start effects, and lack of operating leverage, although I will let Daniel cover these later. Also, as mentioned earlier, we are seeing the first visible gains from the initiatives launched earlier this year, which is reflected in the year-to-date reduction in personnel expenses and FTEs.
I will give further examples on the next slide, but as you will see, all of this is linked to a very stringent approach to managing our cost and cash base, which brings me to the last element on this slide, our cash flow. We do not usually provide details on our cash flow and balance sheet in our Q3 results, but amid the current economic conditions, we feel it is important to give you an update after our half-year results. Our Free Cash Flow generation remains entirely in line with the trends we outlined in the first half of the year, and we continue to expect neutral Free Cash Flow in the second half. In fact, we've done better than that because we generated close to EUR 1 million of Free Cash Flow in quarter three and expect quarter four to be neutral.
As you will see, with our free cash flow in the first nine months amounting to close to negative EUR 10 million, we will comfortably be within our guided range. It is also important to highlight that our full year 2023 guidance and midterm targets also remain unchanged. More generally, we continue to display a solid balance sheet profile, both from a liquidity, net debt, and leverage perspective. This concludes the review of the nine-month highlights, and I would like to spend some time on the next slide to provide a few examples of the measures we are undertaking internally. As we have alluded to before, hGears is going through a transitional phase as the environment for some of the markets we play in experiences significant temporary changes.
You will remember this slide from our first half year results, where I mentioned the importance of using this year to appraise and recalibrate, focusing on the operational aspects within our control to preserve our cost base and balance sheet strength, while ensuring scalability for when the market conditions will improve. In essence, it is about the efficient cost management, process improvement, and improved capacity utilization. While I went through the details of this slide last quarter, I think it is important to provide you with a brief update on our progress so far. As an example, CapEx preservation. As you remember, we aim to lower CapEx spending, including replacement investments and maintenance, while ensuring full efficiency and availability of existing assets. This is also possible given that we have finished the rollout to support the future growth, which was necessary at the time of the IPO.
We are now actively monitoring every CapEx spend at the board level, regardless of size. This means that any CapEx release must be approved by Daniel or myself, and while we still have more to do on the capacity utilization side of things, we are nonetheless saving CapEx, utilizing existing machines better, and reducing the need to spend money on new ones. To date, our internal forecast on CapEx spend has been reduced, and we will probably land slightly above the lower end of the range, between EUR 10 million and EUR 13 million that Daniel indicated in the H1 call. I mentioned personnel expenses and resource management, and this is another example that supports our cost control efforts. In H1, our personnel expenses fell by EUR 1.8 million versus the same period last year, and for the nine months, the decrease is EUR 3 million.
This is mainly achieved through the reduction of our temporary operations workforce, but additionally, we are exploring further optimization opportunities across the organization, extending beyond our plants and production lines to encompass middle and upper management as well. This does not mean that we are compromising our competitive position or ability to scale in the future. And finally, regarding our development industrial process, the so-called NPI, new product introduction, we are progressing well with the teams and expect to see the first results by year-end. Our efforts here are geared towards having an enhanced structure that is aligned to our end markets, which will help drive efficiencies and further support our pipeline going forward.
So all in all, we're making steady progress in executing on our operational initiatives as we transition towards a leaner operating model, with the ultimate aim of ensuring greater productivity, higher levels of efficiency, enhanced business resilience, and, in time, greater profitability. I hope this provides an overview of where we stand, and I now hand over to Daniel for the financials.
Many thanks, Sven, and good morning to all of you from my side. Let's start the review of the financials on slide eight by looking at revenue and profitability. First, we start with the revenue and e-Mobility. As mentioned several times in the past, the ongoing supply and demand imbalances in e-bike persisted into Q3, and this is reflected in the 26.5% year-on-year revenue decline in e-Mobility for the first nine months of the year to EUR 28.3 million. For Q3, revenues were close to EUR 11 million and up 10.3% sequentially versus Q2 2023. This is a blended rate that reflects the mix between EHV and e-bikes, but all in all, both sub-business areas progressed positively versus last quarter.
Regarding e-bikes, the trends outlined during our last call remain, and we continue to see the knock-on effect from this, with the ongoing destocking continuing to progress slowly throughout the entire value chain, including dealerships. In e-tools, the revenues of EUR 30.7 million for the nine months of 2023 compared to EUR 31 million in the prior year, in the prior year. This results from two factors: the ongoing slow industry-wide destocking cycle to normalize inventory levels, and as observed in previous quarters, subdued end consumer demand. As you may have seen in results of other reporting names, the high interest rate environment that we now find ourselves in continues to affect the building and construction sector, albeit we see some regional variations.
The Fed and ECB's recent announcements to keep rates unchanged may provide some hope, although at this stage, we do not rule out further upward adjustments. Finally, the conventional business area continues to remain resilient. While the pace of expansion was lower versus previous quarters, we nonetheless delivered a 7.1% year-on-year revenue increase to EUR 34.5 million for the first nine months of the year. Moving on to profitability in the middle of the slide, looking at gross profit and gross profit margins. So our gross profit margin in the nine months of 2023 amounted to 50.7%, slightly less than 1% lower than 51.6% we posted for the nine months of 2022. Here, you will see several factors at play.
On the positive side, we benefited from a slightly favorable mix, which partially mitigates the implied margin contraction linked to the year-on-year volume decrease. However, on the negative side, the significantly lower volumes impact the production processes, referred to in our industry as stop-and-start or stop-and-go costs and inefficiencies. This means that we are running our production lines suboptimal in smaller batch runs, which requires us to stop more frequently than we would with larger volumes, generating additional warm-up costs. This falls back through to our adjusted EBITDA, as you can see in the last section of this slide on the right-hand side....
However, it is important to note, as mentioned by Sven before, that we are now starting to realize the benefits of some of the operational changes and adjustments implemented earlier this year, which is particularly evident in our personnel expenses, with 106 fewer FTEs versus the prior year period, and personnel expenses down by almost 10%, or to be precise, 9.5% year-on-year. In terms of recruiting, both new hires and replacements, we apply the same strict approach as we do for CapEx. That means that all hiring must be approved by Sven or myself. So there are some mitigating effects here, and we expect to see more, as some measures are only implemented from Q2 this year, and we will see a full impact towards the end and into 2024. Now, let's spend some time on our cash flow and balance sheet profile.
Please turn the presentation over to slide number nine. Here you will see that we have updated the slide that we presented to you during our previous call in the H1 results, and as you can see on the left-hand side, our net debt has reduced slightly compared to June, which now stands at EUR 9.7 million as of September 13, versus 10.3, end of June this year. This trend aligns with what we outlined in June, specifically because of our free cash flow generation during Q3. You might remember that I indicated an expectation for neutral free cash flow for the second half of 2023, and we generated close to EUR 1 million in Q3 positive and expect to be in a neutral position in Q4.
This is linked to phasing of our working capital and our strict oversight of CapEx spendings. So from a free cash flow and net debt position, we do not expect significant swings towards the year end. On the same chart, you will notice that the leverage increased slightly compared to June, where we stood at one, and now we are at 1.3. However, this is linked to the denominator in the calculation, namely a decrease in LTM adjusted EBITDA. Additionally, and to complete the picture, we also have a total RCF commitment of EUR 40 million, which remained undrawn at the end of September 2023.
Adding back the cash and the cash equivalents of EUR 21.2 million at the end of the period, leaves us with a totally available position and liquidity headroom of EUR 61.2 million, which are essential business attributes in the current climate. One crucial aspect to consider is that we are also able to maintain our solid cash and cash equivalent level above EUR 20 million while having finalized the purchase of our building and land in Schramberg in the third quarter. This was essentially the exercise of the end of the leasing period. This supports a decrease in our financial liabilities of EUR 2.3 million in the balance sheet.
I hope this provides you with additional insight into the strengths of our balance sheet, and as outlined in our press release, preserving our strong financial position remains of utmost priority, with strict oversight of cost and CapEx release, key to maintaining our low debt profile and balancing strengths. I will hand over to Sven now for the following slides.
Thank you, Daniel. So looking to the rest of the year and based on the current customer indication, we are maintaining our guidance. After rebasing our guidance for the fiscal year 2023 in June, we expect revenues from around EUR 115 million to EUR 123 million. The Adjusted EBITDA will be between EUR 5 million and EUR 9 million, with the lower or upper side of the range to be determined mainly by the product mix and phasing of growth in the different areas. We continue to be focused on cost and CapEx control and driving efficiencies where possible. And from this perspective, we are firmly committed as well to our free cash flow guidance. Our midterm targets also remain unchanged.
Ultimately, it's about delivering on a lean strategy to optimally position us to operate in the current market environment, while continuing to work on our pipeline of business and R&D in an efficient way and without compromising our competitive position and ability to rapidly scale up when the markets recover. This concludes our nine-month 2023 results call, and I'm now handing back to the operator for the Q&A session.
Ladies and gentlemen, at this time, we will begin the question and answer session. Anyone who wishes to ask a question may press star followed by one on their touchtone telephone. If you wish to remove yourself from the question queue, you may press star followed by two. If you're using a speaker equipment today, please leave the handset before making your selection. Anyone who has a question may press star followed by one at this time. One moment for the first question, please. The first question is from the line of Martijn den Drijver with ABN AMRO- Oddo BHF. Please go ahead.
Yes, good morning, gentlemen. Thank you, operator. I have five questions, if I may.
Sure.
The first one revolves around e-bike. Both looking at 2024, but also the midterm outlook. Looking at your largest customer in that segment and knowing what that company has done in terms of double and triple sourcing, what gives you the confidence that those volumes will continue or actually can come back and grow materially? Previously you were the sole supplier. That is no longer the case. So what gives you the confidence that e-bike volumes will go back to previous volumes and may even grow beyond that? That would be my first question, and I'll do them one by one.
... First of all, if you relate to the biggest customer that we have in that segment, we have in the last few months, of course, in view of, you know, the lower than expected demand, basically reshuffled the supply portions of the different businesses, and as a result, basically, hGears has ended up going forward with the bigger portion of the external suppliers. So we've actually gained market share with that customer, and the customer's also basically extended the commitment by another two years up to 2029. So I think there, we're very confident that we will play a significant role and the biggest role as an external supplier to that manufacturer.
We hope, of course, that the launch of the new products that they're currently doing will help to drive volumes going forward. I think for the market in general, and to be fair, that's something that I maybe personally struggle with a little bit sometimes, is the indications we have is that the market overall is around 20, maybe even 25% down. Our supplies into the pipeline due to the destocking are significantly higher. Now, you know, purely from a mathematical point of view, that means that we should see a recovery as soon as the destocking has really been finished, because the gap between supplies into the pipeline and final sales need to be closed. That is unavoidable, and therefore, there has to be a recovery.
When that happens, I think that's the surprising part for everybody, that that has taken longer than expected. And overall, to conclude, maybe we obviously touch base not only with our customers, but we also had an industrial expert of one of the largest banks here in Europe here the other day, and they still maintain that from the current volume of today of maybe 4 million-4.5 million e-bikes, they expect midterm for that market still to reach 8 million-10 million, which would still be a doubling of the retail sales volume in the years to come. And I think we see a lot of activities, obviously, with the existing, but also new customers. Current projections of them are very conservative, but we believe that the market overall still is very attractive going forward with growth.
Thank you. And just to follow up on that, that last element that you mentioned, the new clients, the start of production of your new contracts. Will that be a material factor, you think, in 2024?
Honestly, not as material as we had hoped, because, again, what we're seeing at the moment is that the hesitation in the market is massive. I mean, if we touch on those points, let's say I think we've had a multitude of, I would call it, macroeconomic and environmental factors hitting that market, starting from-
Mm-hmm
... bad weather at the beginning of the year, the destocking cycle. Then we see that, you know, customers basically, this year have chosen to do long-distance travel rather than do spend on consumer goods. All that has impacted the market. Now, we all know that this market makes decisions on the following year around this time of the year. And with everything that has happened, and now a sort of, you know, financing topic on higher interest rates, I think we will see conservative planning. Obviously, we're currently assessing those numbers, but that's why I think in the end, the 2024 will still be a conservative year, and then we'll see where we go from there.
That's great.
For us, what's important is that the market overall still represents a significant growth potential going forward.
No, that's great color. Then onwards to EHV, Daniel already mentioned that it was up sequentially. Can you give us a little bit more color as what you expect going into 2024 relative to 2023 for EHV?
We'd rather not. Honestly, again, there, we're crunching the numbers. I think, to be fair, my personal opinion, that market has, again, potential going forward. We are involved in all kinds of projects with also new components. I think we mentioned that in the call. It's not just, you know, the engine and the transmission side, it's also the electrification of components like steering and braking, that will provide potential going forward, but, but, you know, in terms of numbers, allow us to finish-
No, no, no.
Then we will-
I wasn't even talking about numbers. I was just thinking even something like: Well, there will be growth, there will be significant growth, there will be modest growth. No numbers needed, but I guess you've answered that already, yeah.
Yeah.
So I'll move on to my third question, which is regarding energy and raw materials. I think you already mentioned that you had a bit of tailwind, which you could not offset, which did not offset the negative volume aspect. But can you run us through your thinking of how raw materials, energy will work into your in your gross margin or your gross margin assumptions going into 2024? So a similar question. No numbers needed, just a bit of a general sense.
Hi, Martin. Good morning. It's Daniel here. With regards to the raw material and energy, I mean, we discussed it already in the past several times. We have, of course, this pass-through clause. We will push back as much as we can when the raw material and energy will start to decrease. However, you know, what we see currently is we all expected the energy to be slightly cheaper in this time of the year, but with currently what is happening in the Middle East and the oil prices, it is still somehow affecting the energy, and it is more or less on the levels of what we've seen in the previous years.
Mm-hmm.
In terms of trends, sorry, going forward, considering these pass-through clauses, I think the main effect on our gross profit currently is the inefficiencies that we have in the production.
Okay.
It's the low batches, low volumes that we have, the Stop-and-Go Costs that we are generating. So once we will be able to go up to higher volumes, we will see positive effects also on our gross profit, and of course, accordingly, on our Adjusted EBITDA.
I mean, just to give you maybe an example, because I think it's relatively unique for this industry. The tolerances required for these kind of products are so tight that in the end-
Mm-hmm
When production, you need a sort of certain period where the machines run, even without components, to reach a very stable temperature environment. So that means that every time you do a start-stop, you have several hours of running a machine on empty. Obviously, of course, when we're burdened, that doesn't happen. Now, with the significant reductions in some areas, we basically had a lot of these interruptions, and of course, that immediately affects your margins.
Got it. Got it. Then another question for Daniel. You mentioned that cost savings up to the in the first nine months of 2023 full effect in 2024. But what do you think will be the delta in between those, you know, in the cost savings from 2024- 2023? Is that, you know, EUR 500,000, EUR 1 million? Maybe a bit of color. No real hard numbers again, but just a bit more color as to the amount of savings we could expect in 2024 relative to 2023.
Sure. I mean, again, in terms of efficiencies that we have that Sven mentioned during the call, the NPI process, we do have expectation that it will generate efficiencies going forward. These efficiencies will basically make deliver the fact that we will have quicker ramp-up of new projects. We will need to have less, or we will-- with the numbers of engineers that we have today, we will be able to ramp up projects that will that will be faster. And on the other side, of course, also these measures that we are currently taking will impact maintenance. So when we are talking about turnover of machines, revamping of machines, and so on. So we do expect to see the positive outcome of this current project that we have in 2024.
It will be basically to reduce the linearity of the business, right? So in the moment when we will start to ramp up our top line, we expect the maintenance not to grow linearly, and we expect the personnel expenses not to grow linearly again. I think in terms of what we have done already this year, reducing the number of FTE, but even more important, to reduce the management levels in some cases, a positive, very positive impact in the full year 2020, 2024 and going forward.
All right. Just to follow up on that one, are you done now with the, those FTE reductions and the adjustments of the middle and higher management?
Well, honestly, we are, like, like we mentioned in the call, we're revising every time there's an open position, every time, you know, there's a turnover in areas on whether we need to replace or not, can we gain further efficiencies? You know, we're avoiding a hard, you know, one time. I think it's a continuous process. But I think, yeah, the majority of these topics is done, but that doesn't mean that we will stop. Let's say the efficiency drives should never stop. We will continue to assess it every time.
Okay, clear. My final question, any guidance you're willing to give already on CapEx 2024?
Not explicitly, but at the end of the day, we will strive to stay cash neutral for 2024. It's not going to be an easy task, but we finished now a very long investment cycle that we started immediately after the IPO in 2021, that continued towards mid of 2022, when we provided the last commitment. I'm happy to see that we have now, at the end of this cycle, and we made the last payments in now in the third quarter, and as we see, we were also cash positive in this quarter. But the target for the next year will be to be on the free cash flow neutral.
And again, considering that, what we currently see for our top line going forward and considering still some concerns with regard to the destocking cycle, it's not going to be an easy task, but it is definitely something that we are setting to ourselves, in terms of target for 2024 and something that I can already disclose now. And it will very much be in line with what we have done also in the past, i.e., means if I refer to maintenance CapEx, it will be between 3%-4% from the top line. We don't need, in a very bold statement, we don't need any growth CapEx anymore.
Of course, when we will win new projects that we currently have in the pipeline, there will be some minor adjustments of tooling and maybe one machine here and there, but it will be very limited, going forward. So it means we are going to be in the region of 3%-5% from the top line in terms of CapEx.
Got it. Thank you very much, gentlemen.
Thank you.
Thank you.
The next question is from the line of Fabio Hölscher with Warburg Research. Please go ahead.
Good morning, everyone. I have three questions. Good morning. I have three questions, please. I'll try to ask them all in one go. My first is on your full year guidance. The low point now suggests sales of EUR 31 million for Q4, which would be your best result this year. Can you please provide some indication which segment specifically is set to drive this? And secondly, for Sven, you've been with the company since February. The organizational structure has been adjusted quite a bit since your arrival. Daniel just mentioned it, especially with respect to your management team. Maybe you can just talk a bit about what the most important changes were and why? And of course, what that means for the financials.
And then finally, any news on your plans for adjacent industries, please? Thank you.
Sure. Let me start maybe with the order book and basically the guidance for the full year in terms of revenues. As you mentioned, EUR 31 million, that is to reach the lower end of the revenue. Currently, what we see is in our order book and what we see from the three plants is an order book that supports the guidance. And already we are at the eighth of November. I saw the preliminary numbers for October, and that is also supporting this outcome. So as for the time being, I have no reason to think that we will not reach our guidance.
The order book that we see for Q4 and the capacities that we have for Q4 supports revenues of what you mentioned before, EUR 31 million and even slightly more, and therefore I have no reason to think that we will not reach it.
And I think if we look at the organizational structure, I mean, in the end, probably over the last few years, the company was getting ready for a fast growth, also integrating other, other factories and businesses. I think for the time being, basically what we decided is that in order to have a fast, informal, you know, impact also on the different operations, we of course went ahead without a COO.
We basically strengthened the position of the plant managers, to be responsible for their plant and, you know, in an internal competition on trying to compete and externally and internally. As a result, we also removed the operations manager here in the German plant and basically left the plant manager fully responsible. So we consolidated that by one position. And I think, again, what we will continue to do is to really take a look at, are there any further steps in order to enhance fast, good communication between the factories, to change that, but I think we're pretty much done. I think from purely organizational point of view, we mentioned several times this, NPI process, which is a development process.
I think there's room for us to improve on how we handle these different types of activities, because we have anything from a build to print. So basically, we get a drawing and then just come up with what the machining process, kind of product, to people coming in with a sketch and an idea where they need significant support on the development side. Now, it's important that an organization sets itself up, A, to be able to help customers with the right amount of resources, but also to make sure that these resources are then actually being paid for by the project as we move along. And I think that's what we're looking at right now, to professionalize that. And we are on the sales side, we've basically moved ahead without a CSO, because, again, I think we are moving in relatively different environments.
So we basically will pursue the different kinds of businesses in a more concentrated way, and again, with a more direct access for Dan and myself to discuss with those divisions on what's the strategy and the vision going forward. And I think that, again, will help efficiency and speed. Last point, adjacent, honestly, yes, the reason we mentioned that is we are constantly looking at these markets. This is not something that is gonna have an impact in the next 12-18 months, but I think what's important for us is to basically continuously monitor opportunities. And we are having concrete discussions on some of these topics, but we'll bring them back on the table when they become really more concrete in the sense of, you know, they will contribute to the bottom line of the company.
Great. Thanks.
As a reminder, if you would like to ask a question, please press star and one on your touchtone telephone. Once again, to register for a question, please press star and one on your touchtone telephone. Ladies and gentlemen, there are no further questions at this time. I hand back to Sven Arend for closing comments.
Yeah. Thanks, everybody, for joining the call today. Again, looking forward to staying in touch and keeping you updated, as we move along the next few months. Then if there are any questions, of course, please feel free to reach out to us at any point in time.
Ladies and gentlemen, the conference-
Goodbye
... is now concluded, and you may disconnect your telephone. Thank you for joining. Have a pleasant day. Goodbye.