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Interview with André Harari, Chairman of the Board of Directors and Daniel Harari, Chief Executive Officer (February 23, 2012).
Record earnings for the second consecutive year. All the more remarkable given the worse-than-expected macroeconomic environment, Lectra’s 2011 performance once again confirms the relevance of its business model and the effectiveness of its long-term strategy. With even further reinforced operating ratios and balance sheet, Lectra is accelerating its roadmap in 2012 to fully achieve its growth potential, as soon as the crisis is definitively over.
The rebound in activity in 2010 enabled you to enter 2011 under good conditions. How did the year work out?
André Harari: The previous year’s record earnings set a high basis of comparison for 2011. Yet we improved on that performance, setting new records once again. After the 20% rise in 2010, following steep falls in 2008 and 2009, our revenues again rose 10% to reach €205.9 million. Income from operations before non-recurring items was up 35%, at €28.9 million. Our operating margin passed a new milestone with a rise of 2.7 percentage points to 14%. And our net income reached €19.2 million. For the first time, it represented 9.3% of revenues.
Consistent with our central scenario announced on February 10, 2011, this performance is all the more remarkable given the worse-than-expected macroeconomic environment. Our balance sheet continued its transformation. It is now particularly strong: the net financial debt of €56.4 million at the end of 2008 has been replaced by a net cash of €8.6 million, and shareholders’ equity has increased to €58.7 million, eliminating any liquidity risk for the coming years. Compared to 2007, the last year before the crisis, income from operations before non-recurring items has been multiplied by 2.5, despite a 6% fall in revenues, and our operating margin has gone from 5% to 14%. This performance is a direct result of the strategic roadmap formulated at the end of 2009 and fully demonstrates its relevance.
“COMPARED TO 2007, THE LAST YEAR BEFORE THE CRISIS, INCOME FROM OPERATIONS BEFORE NON-RECURRING ITEMS HAS BEEN MULTIPLIED BY 2.5, DESPITE A 6% FALL IN REVENUES, AND OUR OPERATING MARGIN HAS GONE FROM 5% TO 14%.”
Daniel Harari: In 2010, our orders for new software licenses and CAD/CAM equipment rebounded 51%. In 2011, the two half-years were very different from each other: the first followed the trend of the previous months, with a very steadfast growth in orders. This trend stopped in the third quarter, and in the fourth, orders fell sharply, as the concerns of our customers in light of the worsening global economic environment drastically slowed their investments. For the full year, orders remained stable.
Are there still tangible disparities among the world’s regions?
Daniel Harari: They are even greater, actually. Before the crisis, emerging countries accounted for 41% of our orders. Now that share has increased to 53%. Scrutinizing the geographic evolution more closely, we find that our orders in the Americas, which represented 22% of the total, have increased 17%, driven by the United States, Mexico, and Brazil. In the Asia-Pacific region, they have increased 10% to reach 36% of the total. In Europe, meanwhile, they are down 5%, despite the strong growth in Eastern European countries which maintained Europe’s overall share at 37%.
“NOW ACCOUNTING FOR A MAJORITY SHARE OF BUSINESS ACTIVITY, EMERGING COUNTRIES—LED BY CHINA, BRAZIL, AND MEXICO—HAVE SURPASSED THEIR PRE-CRISIS LEVELS.”
Compared to 2007, we are still lagging behind by 27%. But some countries have largely surpassed their pre-crisis levels. As such, orders have risen 17% in China, 28% in Brazil, and 77% in Mexico. These numbers reveal a widening split between the new and old economies.
Have you also seen differences in rhythm among your market sectors?
Daniel Harari: 2011 was also a record year for the automotive market. For the first time, its share approached that of fashion: the former accounted for 41% of orders and the latter for 45%. In 2010, the automotive sector accounted for 26%, and fashion 58%. Their respective changes in 2011 were +64% and –22%.
For the past several years, your business model has enabled you to successfully weather crises, grow during times of difficulty, and generate a high level of free cash flow. How do you account for that success?
André Harari: The company has profoundly changed. Our teams have battled on every front. Our investments have been significant. Our margins have increased on every product line, despite intensified competition as result of the crisis. Between 2007 and 2011, we reduced our fixed overheads nearly 20%. And we erased our financial debt thanks to the free cash flow generated. Our recurring revenues fully played their cushioning role during the crisis. And since 2010, revenues from new systems sales have once again become our growth driver, with a rise of 18% in 2011.
Given that the emerging countries are now your main markets and that your competitors have shifted their production to China, why have you maintained your production and R&D in France?
André Harari: This decision came after deep consideration. In 2005, we carried out a study on the benefits of a possible relocation. This exercise led us to maintain these activities in France, despite higher wage costs and the disadvantages of manufacturing in the euro zone when selling to the dollar or yuan zones, unlike our competitors. Despite this decision which contradicted that of our competitors and numerous industrial companies and which was met with pressure from certain investors, time has now fully vindicated our decision. While protecting our industrial property, we have successfully met three challenges.
First, we have faced competition with the low-cost products of our international competitors that had relocated to China and those of our Asian competitors: increasing wages and social charges, as well as inflation and the appreciation of the Chinese yuan, are now significantly impacting their production costs. Second, we have increased our competitiveness despite a persistently weak dollar/euro parity. Finally, we have continuously boosted our margins, bringing their global figure to their highest historic level.
Daniel Harari: As soon as this decision was made, we instigated a comprehensive reengineering of our line of automated cutters. Our efforts yielded major gains in manufacturing costs. Today, our price costs in France are roughly equivalent to what they would have been in China. Maintaining R&D in immediate proximity to production contributes significantly to our capacity to innovate. While our competitors are fighting on price, we have a radically different policy: we are winning on our value proposition, with a greatly superior return on investment and a lower total cost of ownership. Our offer enables our customers to achieve very substantial savings at different stages of their design and production processes.
“WHILE OUR COMPETITORS ARE FIGHTING ON PRICE, WE HAVE A RADICALLY DIFFERENT POLICY: WE ARE WINNING ON OUR VALUE PROPOSITION, WITH A GREATLY SUPERIOR RETURN ON INVESTMENT.”
Don’t you run the risk that Lectra will not be able to respond to a strong growth in sales of CAD/CAM equipment?
Daniel Harari: No. The Bordeaux-Cestas (France) manufacturing site has sufficient capacity to increase its output by 50% with no major new investment and around 50 additional staff members. In order to double the plant’s output, only a further 40% of floor space would be required.
In a general context of spending cuts, how are your R&D investments evolving?
Daniel Harari: R&D is a priority for Lectra. In 2011, our expenses in this area represented €18.2 million, or 9% of our revenues. Altogether, 220 engineers—16% of our workforce—are dedicated to research. That gives an idea of the central role innovation plays in our strategy. I might add that, while we have spent €165 million over the past ten years, this technological heritage is valued at zero in our balance sheet, as our R&D spending is fully expensed each year.
At no time during the crisis have we cut these investments. They have enabled us to reinforce our technological leadership every year. Take Versalis, for example, our new range of automated leather cutters for the automotive, furniture, and leather goods industries, unparalleled on the market. Or Version 7 of Modaris, our pattern-making software for fashion—the industry standard, used in particular by all the major French and Italian luxury fashion brands—which now integrates 3D and 2D and enables users to switch back and forth between the two to optimize the proper fit of clothing: a major advance.
At a time when the risks of companies relating to the economic context are at the center of investor concern, what is your exposure?
André Harari: Since the onset of the crisis in 2008, the worsening macroeconomic environment has constituted the main risk for the Group. Outside periods of severe crisis, the risks associated with our activity are hedged naturally, with sales and services throughout the world and their spread across major market sectors with different business cycles and growth rates, enabling the risks to offset each other. Our geographic exposure is balanced. Nearly 85% of our 2011 revenues came from 10 countries or groups of countries— Brazil, China, France, Germany and Eastern European countries, Italy, Japan, Portugal, South Korea, Spain, the United States and Mexico—but none represented more than 15%. The vast changes accompanying globalization translate into a drop in revenues in one country and a rise in another. Because of our strong presence in emerging countries, which are forecast to generate half of global growth in the coming decade, we are armed to make this a vector of dynamic growth. The other half of global growth is expected to come from developed countries, where our market share has long been significant.
Daniel Harari: Although we have developed long-term partnerships with major international groups, we are still not exposed to a risk of strong concentration. Our top 10 customers combined account for less than 20% of our revenues. Our installed base spans 23,000 customers in 100 countries. Every year, sales of new systems—50% of total revenues—are achieved with around 2,000 customers, and recurring contracts—30% of total revenues—with close to two-thirds of our customers. And the sales of spare parts and consumables—20% of revenues—are carried out for the great majority of Lectra CAD/CAM equipment installed throughout the world.
The year 2011 ended with the return to a situation of economic, financial, and monetary crisis. 2012 appears as though it, too, will be not only difficult but also unpredictable: isn’t it risky to give precedence to your long-term strategy?
André Harari: Launching initiatives aimed at building for the future and taking controlled risks are part of our DNA as entrepreneurs. Daniel and I have decided to give precedence to our long-term strategy, with the same major objectives as before, rather than to profitability in 2012, which will remain nonetheless above its pre-crisis level. This decision, both responsible and necessary, confirms our determination and our ambition.
“WE HAVE DECIDED TO GIVE PRECEDENCE TO OUR LONG-TERM STRATEGY RATHER THAN TO PROFITABILITY IN 2012, AND TO ACCELERATE OUR COMPANY’S TRANSFORMATION, SO AS TO FULLY ACHIEVE ITS GROWTH POTENTIAL IN ITS MOST PROMISING MARKETS.”
Our priority is to bolster the strategic roadmap we formulated at the end of 2009 in order to accelerate Lectra’s growth and its capacity to create value for its customers, and hence also for its teams and its shareholders. Innovation, human capital, and proximity to our customers are now more than ever the driving forces of the company’s leadership. That is why strengthening its sales and marketing teams and pursuing its steadfast investment in R&D constitute the keys to accelerating the company’s transformation over the next 24 months. This will enable it to fully achieve, once the crisis is over, its growth potential in its most promising geographic markets and market sectors. These investments for building the future correspond to a reinvestment of just two percentage points of our operating margin in 2012 and will produce their full effects in 2013 and 2014.
What are your hypotheses for business activity and earnings for 2012?
Daniel Harari: Although the scale and duration of the crisis are uncertain, I notice every day that, even more than deteriorating macroeconomic conditions, it is the alternation of good news and bad news which weighs heavily on our customers’ investment decisions. Even so, I am confident. Our financial and operating fundamentals have been transformed relative to 2008-2009. They give us the means to enter 2012 under the best conditions and in complete security, which is invaluable in the current environment. The sharp drop in sales activity in the closing months of 2011 penalized our order backlog at the beginning of the year, and the main uncertainty concerns the level of revenues from new systems sales. Even so, 2012 will be a year of solid performance. Assuming economic conditions in the first half of the year remain as deteriorated as they were at the end of 2011 and then return to their level of the first half of 2011, revenues at actual exchange rates would remain stable. Income from operations before non-recurring items would come to around €21 million; operating margin would be around 10%; and net income would be around €14 million. Our ambition is, of course, to achieve higher growth, and the leverage effect remains significant.
“EVEN MORE THAN DETERIORATING MACROECONOMIC CONDITIONS, IT IS THE ALTERNATION OF GOOD NEWS AND BAD NEWS WHICH WEIGHS HEAVILY ON OUR CUSTOMERS’ INVESTMENT DECISIONS. EVEN SO, 2012 WILL BE A YEAR OF SOLID PERFORMANCE.”
Our operating margin will remain superior to its pre-crisis level, even if the economy should remain as weak throughout the year as it was at the end of 2011. In that case, with estimated revenues of €190 million, our net income would come to around €10 million, still reflecting a high level of profitability.
André Harari: To conclude, if we remain properly cautious and vigilant, Lectra is well armed to continue to weather the crisis while gaining in strength and to confront the new global challenges that will follow. The major technological, commercial, and human assets that we have just described will enable it to respond to the needs and exigencies of our customers, who must make good the investments they have postponed over several years, to acquire the technologies necessary to boost their competitiveness. As a result, we will go on financing our organic growth in the medium term out of our own cash, continue our dividend payment policy, and preserve our cash in order to finance targeted acquisitions in the future, should such opportunities arise.
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