Kitron ASA

OSE:KIT

Earnings Call Transcript 2021-Q3

[Lars Peter Nilsson, CEO & President]

Good morning, and welcome to a review of Kitron's Third Quarter 2021 I'm Peter Nilsson, CEO of Kitron. And with me today, as usual, is CFO, Cathrin Nylander. I'd like to remind you that we will conclude with a Q&A session, and I strongly encourage you to post questions during the presentation. Now let's look at an overview of the quarter. Next slide, please, Slide 2. Kitron's revenue in the third quarter was NOK 831 million versus last year's NOK 1,054 million. A decrease was expected within the medical devices market sector as the exceptional corona-related demand wanes. Customer demand has been very strong. However, revenue growth was limited by ongoing component shortages. The order backlog ended at a record NOK 256 million, an increase of 38% compared to last year. This is a record and reflects a strong total demand situation. The order backlog increased within all market sectors. In absolute numbers, the order backlog grew the most within electrification and Defence/Aerospace, while the percentage growth was particularly strong within connectivity. Adjusted for currency rates, the order backlog increase was close to 40% compared to last year. Next slide, please, Slide 3. Some highlights and important events. As demand continues to be very strong for both 2021 and 2022 with significant growth opportunities in most market sectors. The general material supply situation has rapidly become more challenging in the third quarter and continues to be difficult on lead times and deliveries. We currently believe that we're at the worst of these constraints, and we expect the situation to start showing some improvements as we progress into 2022. After last year's high deliveries of medical devices and corona-driven -- and medical devices driven by the corona pandemic. 2021 has now returned to normal levels with normal seasonality in the third quarter. Given this year's increase of inventory and working capital, we now turn our focus on executing demand into deliveries, improving our cash flow and protecting competitiveness and profitability. Next slide, please, Slide 4. So what are some of the activities and actions we're taking to execute the order backlog. While we've strongly suggested that our customers should secure demand and components for longer horizon as supply on some parts is severely constrained and lead times have significantly increased. Customer behavior is changing and the future demand is being secured on a longer horizon. Last year, in October 2020, less than half of the expected output for 2021 was actively being ordered or forecasted by customers. This year, in October 2021, more than 90% of expected output for 2022 is already on order with suppliers. In addition, several customers have secured critical parts for the full year of 2022 and 2023. Many customers are also redesigning or approving alternate parts where possible. From a new sales perspective, Kitron targets growth in market sectors less affected by supply chain constraints, such as high-level assemblies and others. Next slide, please, Slide 5. So let's talk a little bit about the strategic outlook. Well, demand continues to be very strong. And although supply chain constraints are projected to continue into next year, many constraints should taper off, and we'll see a normalization supply chain. We will continue to monitor the situation, and we will continue taking proactive measures. We see long-term strong customer demand and well-identified strategic program acquisitions to support our strategic path. And we maintain our long-term growth targets. Next slide, please. Now here is CFO, Cathrin Nylander, to walk us through the financials. Cathrin?[Audio Gap]

[Cathrin Nylander, Chief Financial Officer]

Compared to the development we've had in the last quarters. Slide 9, please. EBIT affected by material supply constraints and seasonality. The third quarter profit was NOK 50 million compared to NOK 90 million last year. This corresponds to 6% EBIT margin. which is, as expected, down from 8.6% last year due to the economies of scale and exceptional utilization of overhead we had last year. In addition, the revenue delays of around NOK 200 million in the quarter creates lower contribution margin and lower EBIT consequently. Year-to-date profit margin is 6.8% and in line with the lower end of the current year outlook. That said, apart from in 2020, Q3 had normally had a weaker profitability than the other quarters due to seasonality and lower activity in the vacation months. We talked about the currency effect on revenue and depending on the current side of the business and there are some local effects due to revaluation of net working capital. And this has a loss affected Q3 of 0.4% and whereas it was 0.8% last year. And below EBIT, we have a noncash net negative volume of NOK 40.4 million in the finance net compared to a negative volume of NOK 4 million in last year. And this is mainly group internal loans specifically euro loans in Poland. Year-to-date, we have a negative value of 12.6% compared to 0 last year.

[Lars Peter Nilsson, CEO & President]

[indiscernible] verified that the sound is working for you, Cathrin, That is because there are so many comments all the time. Sorry, go ahead.

[Cathrin Nylander, Chief Financial Officer]

Tax rate is higher than last year's 24%. This is due to a noncash correction of temporary differences on write-down of assets and consequential effects of those. It's a non-time noncash adjustment, and it will not have an effect on the general tax rate going forward. Slide 10, please. Every by country mixed margin trends. Norway and Sweden continue staying at the margin levels of 6.5% or 7%. Norway 6.5%, same as last year and Sweden at 6.4%, up from 6.2%. Good margins in spite of lower revenue. Year-to-date, both Norway and Sweden is at 7% EBIT margin. Central and Eastern Europe, consisting of Lithuania and Poland, which reduced EBIT margins from 5.5% to last year compared to 5.0% this year. Even though Poland has substantially improved margins compared to last year. both Poland and Lithuania are affected by the volume delays. So year-to-date, CEE is at 7.9% EBIT margin. The others, consisting of U.S. and China, show 6% profitability in Q3. China is performing well, but obviously not at the same level as last year, and the U.S. still needs improvement. EBIT margin in others of 6% is up from 5.7% in Q2 and actually 1.7% in the first quarter. Year-to-date other is at 4.6%. Slide 11, please. Capital buildup due to material supply delays. Working capital ended at NOK 157 million, an increase from NOK 134 million last year. Adjusting for foreign exchange effects and consolidation, it is around 6% increase on last year's level. Last year, working capital was driven by the exceptional demand for ventilators. As this graph shows, after the Q3 2020, working capital was reduced with around NOK 100 million down to NOK 1035 million, mainly a reduction of trade receivables. The change in the last quarter this year going from NOK 1034 million to NOK 1157 million, an increase of NOK 123 million. And the main driver is mainly inventory, partly compensated by increase in trade payables. A late pushout of NOK 200 million in revenue, will have consequences for the inventory, hence the increase. Our main focus is to bring in inventory in line with what is deliverable going forward and to secure allocated components into consign. Currently, in addition to the inventory we're carrying in our books out of our books, we're carrying a couple of hundred million of inventory for our customers. Trade payables are increasing as a result of the high buying activity and off-balance sheet activity. Trade receivables increased in percent of revenue as we invoice in consigned material and prepayments to a higher degree than before. Overdues are slightly below last year's level. In total, our net working capital percentage of sales is at staggering 31.8% and slightly higher, you might say, than last year's NOK 25.1 million. Cash conversion cycle is up to 124 days from 96 last year, main driver is, of course, the IO. ROOC at 12.8%, down from 22.4% last year. And so thus, there is a negative cash flow of NOK 70 million in the quarter compared to a negative NOK 3 million last year. The negative cash flow is driven by the increase in net working capital and partly compensated by profitability. So what do we expect for the next quarter, we expect stabilized net working capital, a slight reduction in inventory and a reduction in payables and an increase in trade receivables due to higher sales, which now should give a positive cash flow in Q4. We should also give an improvement in the ratio together with the higher volumes. So net working capital to be in the high 20s in percent of sales and ROOC to be between 15% to 20%. And finally, net interest-bearing debt over EBITDA increased from NOK 1.9 million to NOK 2.2 million this year and adjusted for IFRS, it's about 2.0. Net debt is at NOK 791 million. So now back to you, Peter. Slide 12, please.

[Lars Peter Nilsson, CEO & President]

Market development. Thank you, Cathrin. Let's start with the order backlog. Next slide, please, Slide 13. The order backlog, as previously stated, ended at NOK 2568 million, which is an increase of 38% compared to last year. It's a strong -- reflects a strong total demand situation, but it also includes delays in revenue due to extended lead times. The order backlog has increased within all market sectors. And as we've said, in absolute numbers, we see the strongest growth in electrification and Defence/Aerospace. Adjusted for the currency rates, the order backlog shows actually a growth of 43% compared to last year. Next slide, please. Slide 14. Let's move on to our guidance. So next slide, please, Slide 15. Well, as we've stated many times, total demand is very strong, and the order backlog is at a record level. However, in the very short term, supply shortages have somewhat limited Kitron's ability to turn demand into revenues. And the outlook for 2021 is adjusted to reflect this. For 2021, Kitron has previously indicated the revenue outlook between NOK 3.9 billion and NOK 4.2 billion and an EBIT margin between 6.8% and 7.4%. Due to the constraints in the supply chain and resulting delays of revenue, the revenue for 2021 is now expected to be between NOK 3.7 billion and NOK 3.9 billion, and EBIT margin is expected to land between 6.9% and 7.1%. Growth is expected within connectivity, electrification and industry sectors, whereas there's a decline this year within medical devices and Defence/Aerospace sectors. Next slide, please. What are the key takeaways, Slide 16. Well, we believe it's a solid quarter despite the challenges in the supply chain and the normalization of last year's exceptional demand and deliveries of medical devices. Order backlog and 2022 demand outlook supports continued growth, and we see a long-term customer demand and well-identified strategic program acquisitions to follow our strategic trajectory. This concludes the presentation portion, and we're ready to move on to Q&A. Are you ready Cathrin?

[Cathrin Nylander, Chief Financial Officer]

I am..

[Lars Peter Nilsson, CEO & President]

Okay. Well, this time around, actually, we have questions from the start.

[Cathrin Nylander, Chief Financial Officer]

Very good.

[Lars Peter Nilsson, CEO & President]

Of no delay here. First question, can you explain and elaborate on the well-identified strategic program acquisitions to support your strategic trajectory, right? And yes, I can let's just say from -- without going into things we haven't announced yet that we're working on several programs within the areas we have identified as growth areas. So most targeted is the market sector electrification and all of the subsectors that are connected to electrification. So a lot of infrastructure projects infrastructure products, power storage solutions, things like that. Those are types of programs that we're working on. And then, of course, there's a continued increase within Defence/Aerospace programs that are coming online over the next 2 to 3 years. So as we're prepared to announce those, we'll obviously do that. But currently, we're not in a position to do that. The next question is, again, from [indiscernible], we'll just take it from [indiscernible] in order. Kitron seems to be somewhat harder affected by shortages than its peers. Is this correct? And is it driven by sector/product exposures or other measures? I would say your first conclusion is a little bit correct here. It's driven by sector and product exposure. We see -- for example, if we look at where do we have less effect even if we -- there is effect we see less effect within our Swedish and Norwegian operations where we have a higher level assembly of products. We do more of a complete build. We have -- also from a market point of view, we have -- the Nordic customers tend to be standing more on their toes when it comes to forecasting, proactively redesigning product and securing material in the past 12 months. whilst other international customers maybe have not sort of really been on that same level. But more likely, it's what kind of products are you building, the highest effect we see is within our Central Eastern European operations where there's a lot of the PCBA build, so pure electronics built. Those sites are most affected, and they also have the more shortages that they work on. Moving on to [indiscernible] says, how is the development in the order backlog adjusted for the changed customer behavior by placing more long-term orders to secure components. Well, we have no adjustment, right? We're reporting or the backlog as is. In order backlog for us is all fixed-firm orders and the first 4 months of forecast. If we look at the order backlog and look at as a percentage of the order backlog or fixed infirmed orders more or less than last year. I mean you would probably maybe expect them to be -- to have a higher degree of fixed infirm orders. And it's very similar to last year. It's a little bit higher. I haven't calculated the exact percentage, but it's a little bit higher than last year. But still, it's the first 4 months of forecast. So it's not like the order backlog now looks at all of next year just because we have forecast in place to secure material. [indiscernible] says, do you think the ongoing component should sustainably change the industry structure and in your perspective, lead to higher amount of fixed orders. In the short term, right, it's necessary. It's necessary to have a close regional but preferably, sustainable supply chain. And if that's what the corona pandemic and the supply shortage situation has shown us. with everything from difficulties in transportation globally to the ongoing I hate to say, energy crisis in China, but let's say, constraints in power and electricity in China has shown us. So it's obviously if you have a closer supply chain, if you're in your region or in your home market with your supply chain, it is easier for you to deal with some of these issues. That said, components and electronics, that's a global supply chain. You can't find all of it in Europe even if you wanted to. Let's move on a bit. Could you give us some -- from Vincent asks, could you give us some details about capacity and load for your plans, Q4 versus Q3. We'll make you confident that the supply chain issues will improve in Q4. Do you feel like talking Cathrin?

[Cathrin Nylander, Chief Financial Officer]

No. No. I think why we feel more secure for Q4 is that we've spent, I think, some weeks now looking into Q4 and moving out volumes that we're not able to deliver. And looked at all the orders we have and if we are to secure the components that we need, and we have the in-house whether or not, et cetera, et cetera. So it's been a quality work to bring the expectations in Q4 down to what we actually can deliver. When we started looking at Q4, obviously, the demand was much higher again for Q4 than what we are indicating now in our adjusted guidance.

[Lars Peter Nilsson, CEO & President]

I mean, as we showed in some of our slides here, I think we talked about it and you spoke about it also, but back on Slide 3, we're looking at the revenue waterfall if you sum all of those things up, that's what we were looking at as we entered Q3. We thought Q3 is going to be a record quarter. And we thought it was going to be a record quarter up until mid-August. And beyond -- even beyond that, there seems to be a possibility of at least being close to NOK 1 billion. However, a lot of decommitments on confirmed orders from customers in mid-August to late September, really pushed -- delayed our sales to a lot of customers.

[Cathrin Nylander, Chief Financial Officer]

So [indiscernible] has been contacting suppliers and asking for commitment on the deliveries, which are -- for the components that are on a...

[Lars Peter Nilsson, CEO & President]

And also cutting back down what we actually have on hand. So that gives us a -- But still, the outlook, as you know, there's still a spread, right? We can't be more detailed than we are right now. Could you give us some -- burn asks, can you give us some input -- some information on input costs and selling prices? How are they affected through the shortages? Thank you very much. Well, thank you, Bjorn. Most of the time, we work with a cost-plus model with our customers. So we pass along any extra cost that's -- and that's the usual business model within our industry. We've seen some of our competitors actually announced that some of the top line increase this year has been driven by increase in material cost and prices. I think for us, it has had a marginal effect. It's not -- it's maybe in the tens of millions and not in hundreds of millions. But we are securing ourselves to a very large extent on extra cost or spot market buys where component prices could be up to 100x the normal price. And obviously, we work with our customers to come to a resolution on those things and works out pretty well. Vincent has come back here and the order intake, excluding Defence/Aerospace, the order thing including the decline quarter-on-quarter?

[Cathrin Nylander, Chief Financial Officer]

Yes. That's medical [indiscernible]

[Lars Peter Nilsson, CEO & President]

Defence and Medical declined strongly quarter-on-quarter, NOK 608 million versus NOK 858 million. Do you see a change in customer behavior and the wait-and-see mode. I'm not entirely following here what's...

[Cathrin Nylander, Chief Financial Officer]

No. So we have to look into when we -- order backlog is just part of what we know as we talk about because it's a fixed and from orders and 4 months forecast. Obviously, we're not looking at that. We're looking at the whole demand situation that we have, and that's increasing strongly quarter-on-quarter. And we're talking numbers that are well above these numbers.

[Lars Peter Nilsson, CEO & President]

Okay. It's a question is, if you exclude Defence and Medical -- The order intake in the order backlog has decreased on electrification and the others.

[Cathrin Nylander, Chief Financial Officer]

Yes. However, the demand has increased. So in total, we have more, but that's over the 4 months forecast.

[Lars Peter Nilsson, CEO & President]

As a follow-up question on the order backlog. Can you help quantify how much of the order of the growth in order backlog is due to long-term orders. I think I've addressed this already. but we use the same time horizon. And as a percentage, the fixed and firm orders are not so much greater than last year.

[Cathrin Nylander, Chief Financial Officer]

No, they're not higher than last year.

[Lars Peter Nilsson, CEO & President]

I was just looking at the chart. Still firm and then to [indiscernible] still firm on the long-term strategic financial targets.

[Cathrin Nylander, Chief Financial Officer]

Yes.

[Lars Peter Nilsson, CEO & President]

Yes. We are. And it looks like that is it. So we'll give the...

[Cathrin Nylander, Chief Financial Officer]

Few more minutes.

[Lars Peter Nilsson, CEO & President]

Yes, another seconds to see if there's any follow-up. Okay. I'm not seeing any further questions. So here, here's a final one, right from [indiscernible], how will you address your capacity in the medium term, given what seems to be a strong demand growth? We will address the acute capacity the way we do all along. I think when you look at the financial results in Sweden and Norway, they've continuously -- they're working on adjusting. And hence, the year-to-date financial results in Sweden and Norway are strong. They are also in Lithuania and Poland. However, and then the third quarter, there was an expectation thereof being able to deliver more. And hence, they had more production capacity than they needed. That's been adjusted even though we see a growth in Q4, again coming back strong and coming back even stronger into the first quarter of next year. But we are more careful, and we are more analyzing and looking at actually having a stronger confirmation of being able to have supply before we commit the capacity increases. From a footprint point of view, we have a lot of capacity. We've talked about this before. And that's that. Very good. 59 viewers remain. I'll thank you for sticking with us and hope to talk to you in February for our fourth quarter update, and looking forward to presenting stronger numbers then. Thank you all. Thanks Bye.

[Cathrin Nylander, Chief Financial Officer]

Thank you.