Vaisala Oyj

Good afternoon and welcome to Vaisala's third quarter analyst presentation. My name is Kai Yystöme. I am the president and CEO of Vaisala. I've been in the job now for three weeks, so pretty much brand new. Very excited to have you all here. And with me we have our chairman of the board, Raimo Voipio. And our CFO, Karina Muurinen.

Good afternoon.

And our head of IR, Paula Liimatta. Good afternoon, everyone. The economic downturn triggered by the COVID-19 has obviously been the backdrop for our business and business environment. When we look at what that has meant to Vaisala, I would highlight two parts. Obviously, the emerging economies have suffered through this kind of economic turmoil, like any economic turmoil more than developed markets. as well as then for us as kind of close to our business is the airport segment, where the air travel obviously has been significantly down because of all the restrictions and the behavioral change. And those have obviously impacted our business and especially our order intake, as you soon will see. That being said, our operational performance in terms of profitability has remained strong, and much like what we said in the second quarter, we have been operating very well in this relatively difficult environment. When we look at our key numbers for third quarter, The order, starting from orders received, they were down by 19%, driven by weather and environment, business unit and Middle East and Africa, the emerging markets, and then the airport segment. The impact of the value, then there was a specific case which I'm going to highlight here and a couple times later is we renegotiated a big deal to Argentina which we announced earlier in the year we renegotiate the scope and the value of the Argentinian deal and that caused a negative correction in the order book and in the order intake by 5.6 million euros in Industrial measurement, the order intake actually increased by 2%, very much following a strong order intake in Asia-Pacific. Order book declined by 13%, very much driven by weather and environment, weak order intake, especially in the big projects in weather and environment, and Again, the Argentinian renegotiating of that contract had a very significant impact on the order book. Actually, the one-fourth of the decline was caused by that. Net sales decreased by 11%. where, again, a bigger contributor was weather and environment, and that was driven by the weak order intake earlier in the year, again, in bigger projects and in the airport segment especially. In industrial measurements, the net sales increased in APAC following a week. Sorry. I'll go in the net. So in industrial measurement, net sales increased in APAC following strong orders in second quarter. Then gross margin improved by 2.5 percentage points, and there are three reasons for the increased gross margin. First of all, it's a different mix, i.e. lower percentage in the project part of a business. Then the second contributor was a significant improvement on the digital business side in the weather and environment business area. following the restructuring of the business earlier in the year. And then the third portion is the higher share of industrial measurement in the total Vaisala mix. And then when we look at the operating result, very strong operating result for Vaisala in third quarter. And apart from the higher gross margin, the operating expenses were down significantly. Mainly due to the restrictions on the COVID-19 example would be travel expenses were significantly down. Then if we go into the orders received and take a look at that on a Vaisala level, the orders received decreased by 19%. And if we take the comparable exchange rates, the decline was 16%. The decline was most significant in, as I said, in Middle East Africa and in Latin America in weather and environment business area. And obviously, again, the Argentinian renegotiating had a significant impact. Orders received actually increased in APAC in both of the business areas, both in weather and environment as well as in industrial measurements. When we look at the industrial measurement business area alone, the order intake actually increased by 2%. And if we take on comparable rates, that actually was 6% of the increase. And when we look at – and where that came from, that came especially from APAC, where actually the orders came up by 19% during the quarter for industrial measurements. Then when we look at the order book, again, same kind of a trend. Order book decreased by 13% year on year. When we look at where that came from, again, whether an environment business area was driving that minus 15%, whereas in industrial measurement, we actually were up by 7% year on year. And the Argentinian renegotiation, again, had just a reminder, a big impact on that. Then moving on to net sales. The net sales followed the trend, decreased by 11%. Again, if we look at the comparable rates, 9%. Net sales decreased in all regions, and when we look at the regional split on net sales now, it's almost equal split between Americas, Europe, Middle East, and Africa, and APAC. The net sales was really driven by the significant drop on the project business in weather and environment. Actually, it was down by 48% year on year. Again, we have to remember that the third quarter in 2019 was a strong quarter. there was a strong project business quarter. So the comparable is just as a reminder. The other kind of important maybe part of the net sales, which Karina will come back soon, is the fact that now the industrial measurement share of the entire business actually increased due to the Relative underperformance on the project business on the weather and environment side. Now, I'd like actually now ask Karina to walk through the profitability and the cash flow on the quarter. Karina.

Yeah. Yeah. So the operating profit for the third quarter was strong. Operating profit totaled 19.5 million euros and was 21% of net sales. And one driver, important driver for the operating profit was the increase in gross margin by 2.5% points. It's coming from both business areas. In weather and environment, the cross-margin development is strongly coming from digital business, which has been during 2019 and continued in 2020. restructuring and reorganizing and refocusing its operations and the results are now seen and the digital business is now performing on expected level. Product business has continued bringing expected gross margin levels despite the declining volumes. and also the project business has been continuing on the same level of gross margins as previously, even if there is material decline in the net sales. Also the mix, so the higher share of product business is of course impacting the gross margin levels positively. One element that is helping the operating profit is of course the decrease in operating expenses, which is largely coming from the impacts of COVID-19 and related restrictions in operations like lower travel expenses. There are two exceptional cases impacting the operating profit during the third quarter. The other one is the remaining half of the credit loss allowance that was reversed, and originally the credit loss allowance was booked in the third quarter and totaled 1.1 million euros. So now the total credit allowance has been reversed. And the other one is the valuation of contingent considerations. Due to the decreased outlook, we have now revalued these contingent considerations related to acquisitions. R&D expenses continue about on the same level as previous year. They are 12% of net sales and totaled 11.5 million euros during the third quarter. Then going to the cash flow for the three quarters period. So operating cash flow for the three quarters was 16.7 million euros, which is one million euros less than previous year. The operating cash flow is following the strong operating result, but it was offset by the networking capital, changes as the accrued liabilities have been increasing this year by 19 million euros. Capital expenditure has been 8 million euros higher than previous year and majority of this increase is coming from those two building projects that we have had. The other one in USA, Louisville, that was completed during the third quarter and the other one in Vantaa, the R&D building that will be finalized in the end of this year. Additionally, our cash flow includes a dividend payment that was 22 million euros. And during the third quarter, we also repaid 25 million euros of the revolving credit facility that we have had since last year. Then Maisala's financial position continues strong, and the cash in the end of September was 39 million euros, even if we have been paying dividends and repaid part of the revolving credit facility. Also, the capital expenditure has been on a higher level than in previous years. Then I hand over back to Kai.

Thank you, Karina. And now let's take a look at first weather and environment a little bit deeper. So as said, orders received declined significantly and driven by Middle East and Africa and Latin America. The order book itself decreased by 15%. and net sales decreased by 14% if we take constant currencies, 13%. The operating result itself improved very much along the lines what Karina just talked about. The gross margin improved almost immediately. Three percentage points driven by the two things that Karina mentioned, the improvement on the digital business side, which was a significant contributor of this, as well as then the lower share of the project business contributed to the increased gross margin percentage points. In the operating expenses side, the restrictions related to the virus situation impacted so that the operating expenses declined. R&D expenses were 12.3 million euros, 12.3 percentage points of the net sales. And I want to remind here that both on the weather and environment side as well as on the industrial measurement side, we continue to invest and increase the investments in R&D and other development projects. Through this time, we believe in our strategy, and we have continued also to increase the headcount during this time based on the strategy. Speaking of industrial measurement side, then when we look at that side of the business, the orders received increased by 2%. And if we take constant currencies, that means 6% increase in orders received. If we look at the order book, it increased by 7%. driven by strong orders received in APAC, which were in the period up by 19%. Net sales decreased by 3% if we take constant currencies, that translates into 1%. And then on operating results side, it was roughly on the previous year's level. Again, the restrictions on the travel and other things based on the virus situation decreased the operating expenses. But like on the weather and environment side, we continue to invest on on R&D and other development projects. The other thing worthwhile saying on both sides of the business is that we have managed the business well through the restrictions. We have found new ways of both on the project deliveries on weather and environment side delivering project which previously required travel now being able to do those approvals and some of even the installations remotely with the local partners as well as then in marketing side turning from analog marketing tools to kind of completely on the digital marketing including some of the fairs now being not kind of as fairs used to be but actually online fairs and quite successfully so now Carino will walk us through on the numbers on year-to-date level.

So, similarly as in the third quarter, the orders received for the first three quarters has declined by 14%. And the decline is coming from weather and environment business area, where we have been missing large project orders for the whole year. And the decline in orders received in weather and environment business area is 44 million euros. In weather and environment, only orders increased in North America. Otherwise, the decline has been quite global. Order book is reflecting the decline in orders received and has decreased by 13%. But then net sales for the whole year has declined 4%. to 273 million euros. And due to the resilience in industrial measurements business, the decline is only 2 million euros and it is coming from the net sales during the second and third quarter. But the decline is global, has been affected all geographical regions. In weather and environment, the decline for the three quarters is coming evenly from product business and from project business. And it's coming mainly from Americas and APEC regions, whereas EMEA has been growing by 6%. Still, we have been able to improve our operating result, which totaled 32.6 million euros and is now 12% of net sales. And also for the whole year, the gross margin has been improving in industrial measurements. It's been improving both in the products and services sector. and in whether an environment it has been improving, especially in digital business. Operating expenses also for the whole year have been decreasing following the restrictions related to COVID-19 pandemic, so the operating expenses have been declining in almost all cost categories. But Earnings per share is now down from 52 cents to 68 cents.

Okay, and looking at the market outlook and business outlook, our market outlook remains unchanged. We reiterated the outlook and The global economic downturn is affecting especially the emerging markets and especially the airport segment in the weather and environment side. The industrial measurement business has suffered from COVID-19 mainly through the customers postponing their own investments in the economic uncertainty. Then if we look at the business outlook for the rest of the year, we estimate that our full year 2020 net sales will be in the range of 370 to 390 million euros. So we narrowed the range and then And the operating result will be in the range of 40 to 48 million euros, as now said in our pre-release in October 21st. The economic downturn has affected, as described, some of our businesses significantly. The weather and environment has missed, especially the big projects in order intake side, as well as on the net sales side following the weak order intake already earlier in the year. On the industrial measurement side, we have not met our growth targets due to the economic uncertainty and the environment causing some of our customers delaying some of their investments. And at the same time, the operating performance has been strong. So the cross margin has increased through the facts and the items that we went through, i.e. the mix between the businesses was different. A bigger part of the business was from industrial measurement. The mix in terms of the project business was lower than earlier, as well as then the structural improvements on the digital business increased the gross margins. decrease in operating costs and expenses due to the prolonged COVID-19 situation has improved the EBIT more than previously we estimated. Now this is the end of the prepared remarks and I would open now the floor for questions.

Thank you Kai and Karina. Now it's ready to take your questions. Let's start with the live audience here in Helsinki. Please state your name and company to benefit those on the phone lines.

Thank you. First, I have two maybe big picture questions to Kai and then one to Karina. Kai, it's maybe not the easiest market environment to jump on board in this case, so I won't go to specific items, but maybe a bit on your plans and if you maybe done some homework, so maybe what are your plans for the first six months if you could a bit explain what you what you're going to do and and also if you have already now some focus areas where you see you can or why so I can improve so first thing I have to mention that I as I said in in my opening I have been in the job for three weeks so so it is a bit premature to kind of state strong strong opinions on the business

Since, as you said yourself, this is a very complicated business. And actually, if you look at the revenue streams and the businesses, they come from many different elements. And there's a whole host of learning for me to be done. So what I have done so far and continue to do is get to know our customers as much as we can or I can in this situation and getting their feedback on this, talking to the organization very thoroughly and building, maybe testing my hypothesis with what I hear from the organization and the customers. And then very much want to engage you as investors and analysts as well in terms of your opinions on how you see the business as such. I believe the fundamentals in the company are good. I don't think there's big changes of the direction to be done. I think it's much more of smaller tweaks here and there, emphasis on slightly different things. I would not like to kind of go into those here and now, maybe a little bit, kind of give me another month or two and we can talk about it much much more specifically

Okay, thank you. Fair enough. To Karina, maybe when we look at the market environment and orders received and sales decline, if we think it continues, you've done a good effort in adjusting your cost base. Can you maybe talk a little bit how you see, is there still room to adjust and how much and where?

So far we have done adjustments in the operations that require presence with the customers and we have been trying to find new ways to do for example installations and customer acceptance testings together with the customers So developing remote ways of working together with the customers.

Successfully, I have to say.

Yeah. So I can't say that we haven't been limiting our resources. We have saved through more cost-efficient ways of working. And another way to do the operations perhaps more efficiently is that we have delayed recruitments that were planned for this year, so the recruitments that were planned to enable the growth. But still, we have continued recruitments because the headcount during this year has been increasing by 84 people net, And it means that we have strengthened the areas that we see important long term.

Thank you. Matt, I'm going to kind of give a couple of questions. First of all, you touched already on the cost side. I was wondering how big a percentage do you think that your costs is kind of temporary and how much is coming back when the corona impact is over? You mentioned the remote working possibilities that you haven't done before. Could that be a source that you would get a permanent improvement in the processes that you are doing also when we kind of exit the corona phase?

I'm sure we don't 100% return to the ways of working we had before corona. Certainly, the new ways of working, utilizing digitalization, utilizing remote cooperation with the customers, those will continue. But we also know that there are some delays in the project implementations because they require presence at the customer side. So everything cannot be done remotely, but part of the tasks can be done remotely together with the customers. Then what comes to the admin working remotely, I think that will be something that will continue also after COVID-19, not to the extent we have done it so far, but partially certainly.

So would it be fair to assume that perhaps half of the cost savings that you have achieved now in the particular circumstances are going to be permanent and half coming back? Or what would you say is the kind of ratio that we should expect?

That's hard to predict and it's something that we certainly will investigate more thoroughly during the target setting for next year.

Okay. Then regarding the missed orders in weather and in industrial, to what extent do you think that they will come back? I mean, so that they would, after COVID, get back perhaps in the industrial business where they are kind of expendables. If the production is not running, then they are not needed. So you basically... will lose them. But in the weather business, I would imagine that many of the projects that the customers are thinking, they are not something that would suddenly disappear. They will be postponed and then they come back. What's your kind of view on a division basis? How this should kind of continue then when we start to exit the COVID time?

I would answer that this way, that if we start from weather and environment side, if we look at the business pipeline, sales pipeline, actually the number of sales cases has not materially diminished from the sales pipeline. It's actually the velocity through the pipeline that has slowed down. In some cases in the bigger projects, significantly for the time being, But the cases remain. And in our business, as you well know, sometimes we have even a signed deal where we don't know when that materializes into the business. Example would be the Ethiopia case. And if you go back to the earlier, the Vietnam case was a bit similar. Even when you have signed, from our perspective, the deal, then getting the financing and when the financing is actually done, by the other side, as is the case in the Ethiopia side. It remains a little bit hazy for us.

Well, now that you mentioned Ethiopia, that was my third question. So we've been wondering that what on earth is postponing the thing. So is it that the Ethiopian politicians, they want bribes or they want a better financial package or what?

So what is the delay? So it's more getting the financing right for the Ethiopian government and getting it through the Ethiopian governance when the financing is clear. And then a second part of your question was on industrial measurement side. You characterized many of the instrumentation that we do I would say it this way, that many of the investments have been postponed, as I said earlier, postponed by the unpredictability of the business. I completely sympathize with that. the people who are building factories or warehouses or environments that, you know, when you are in a big uncertain situation, it's easy to postpone until the clarity on the business kind of comes back. So I would definitely not call them as lost, and we have definitely not lost market share on industrial measurement side. then there are some parts of the industrial measurement which have actually gone pretty well in this environment. A good example would be the continuous monitoring systems where the life science customers have been investing very much for the fully understandable reasons like creating vaccines at the moment and we have been very successful in securing those deals and the order book and the business has actually developed quite positively. Similarly, we've talked before about the opportunity in the power side on industrial measurement and that has actually, we had a record quarter in third quarter on the power side.

All right, good. Then finally on the weather business, you said that you have actually not lost any contracts, but the velocity is kind of lower at the moment. To what extent do you think that the pipeline consists of, let's say, developing country projects which are dependent on Western financing? And to what extent they are kind of Western projects which can be financed when the decision then comes? So what kind of risk do you see that if there's prolonged weakness in the Western economies who are basically aiding the developing countries, So if Western countries are struggling, they won't be spending money outside. So what kind of risk do you think that that poses to your business and to the pipeline execution, let's say, in 2021 and perhaps beyond?

I'll let Karin complete, but I'll say this, that if I look at weather and environment, the sales pipeline, it consists both emerging markets and developed markets, as we have had in the past. And even in developed markets, one will see how each one of the societies or countries will develop. will come out of this turmoil and how will they recover, for example, in the aviation side and what will be the local governments or the federal governments approach in terms of also the stimulus money and how will that be directed, completely unknown at the moment. And we will kind of see much more when we do the execution plan for next year and have maybe more visibility into that than into the potential financing in the emerging markets. I think if you look at the little bit longer term, I don't think the need is going anywhere. The climate change is going to continue, and the need for measuring the extreme weather instances as well as improving the economy through safer travel routes and so on, the big trend lines continue to be in our favor.

All right. Good. Thank you.

Thank you. Now it's time to take the questions from the listeners on the phone lines. Operator, please. Operator, please, can you hear us?

Apologies, there seems to be a technical difficulty. If you wish to ask an audio question, you may do so by pressing 01 on your telephone keypad. If you wish to withdraw your question, you may do so by pressing 02 to cancel. Once again, it's 01 on your telephone keypad if you wish to ask an audio question. There'll be a brief pause whilst we wait for questions to be registered. Okay, there appears to be no questions registered. So I'll hand back to the speakers for any other remarks.

Okay, thank you. Do we have any further questions from the live audience in Helsinki?

Yes, thank you. Jonas Forslund from Evli Bank. I have a question regarding weather and environment and the gross margin improvement that you mentioned, where it came from, but could you somehow say that did less project contribute more to the improvement in gross margin or the digital services, or was it... evenly distributed between them two, or which had bigger impact in the improvement of gross margin in weather environment?

Services improvement has more impact than the mix of project and product sales. So digital business, when they relocated the R&D to Finland in 2019 and now discontinued the assessment services, that has a bigger impact than the mix.

Thank you. Now, looking forward then... Aviation is struggling now and could suffer or struggle many years to come, or it could be quite some time before we reach pre-corona levels, if we ever reach them again. So looking at this quarter, less orders received, smaller order book, less net sales, still a better operating profit. What's the lesson here? I mean, do we need so much projects in euros, or is there another way for you to provide more of the sort of value-added growth margin, high growth margin business to your clients, especially in the weather and environment? How should we look at this? Maybe it's not that bad then, the whole situation, or is it?

So I think one thing in any business, optimizing for the cross-margin percentage is always a dangerous thing. It's the absolute number that you are trying to optimize and think very carefully through that. So that would be just a general statement on any business. And then I would say this, that the big projects are also driving the product business. So while we do, for example, a big project for an airfield or airport operator, then there may be a product business kind of following that up in the coming years. And so it's not so black and white that we don't see... that it will be a possibility to drop out completely from the project business and continue just on the product business. There will be a clear impact on the product business side as well.

Projects always include a big share of products. So additionally, we are selling then services like installation or training services and then those site works that are typically the low margin part of the projects. But without the project business, we wouldn't be selling some of the products or we would be selling much less of the products if we didn't have the project capability.

Thank you.

Well, it looks like we have had all the questions for today. Thank you very much, Karina and Kai, for answering those good questions. And I would like to wish everyone a good following for the day. Thank you.