Smartoptics Group AS

OSE:SMOP

Earnings Call Transcript 2023-Q1

[Magnus Grenfeldt, executive]

So good morning to everyone in the room, and good morning to Hotel Continental in Oslo. Spring is definitely here, a bit of cloudy sky and Karl Johans painted in Italian colors today due to presidential visit. So a good day to talk about the Q1 results for Smartoptics. This is what we're here to do.

So as many of you probably have seen from the press announcement this morning, yet another very good quarter that I'm super pleased with. So we're now celebrating 8 complete quarters on the Norwegian Stock Exchange. And for those of you who have been following us over a longer time period, it is basically the sixth year with very similar trends in terms, particularly on revenue growth, which, of course, has gone up and down between the quarters, but the long-term trend is quite stable.

So the strategy is definitely working, and the business model is very good. So super pleased with that. Also pleased with the earnings of the company, and of course, the operating cash flow. As we have indicated earlier in our Q4 report, we would see a very positive cash flow in the first half of this year.

Gross margin stands out very, very positive. This is part of a longer-term trend that we believe is sustainable to gradually slowly increase the gross margins in the company, is 50.7%, a sustainable number. Well, that remains to be seen. But the long-term trend that we have been on for the past couple of years is definitely something that we believe can continue going forward.

So this is a result of several things. It is actions that we have taken, such as price management initiatives, yes, product mix -- or rather project mix. Q1 is a quarter where we have a lot of run rate business, not a lot of contribution from larger deals.

It's also procurement savings. It's a higher degree of software and service revenues. So a bunch of things contributing to a very, very positive gross margin, which stands out in this particular quarter.

So coming to highlights of the quarter, and we are starting a new year. New year, new opportunities, right? So I guess the big question that everyone is asking, given the amount of press and news around financial turmoil and economic downturn and so on and so forth, are we in a headwind or tailwind market with Smartoptics? And we see other people talking about problems in the market.

And I would say that we are still -- my answer is still definitely a tailwind. So our market right now is driven by introduction of 400-gig technology, new low-cost 400-gig transmission technology that is not changing individual customers' behavior in how you build networks, but it's rather something that everyone on the planet who is building networks, similar to what we do, is currently considering this technology, how to use it, how to get it into their networks and so on and so forth, to decrease the cost of transporting bandwidth in the networks. So very, very strong and important trends.

We also see another trend, which is strong at the moment, and that's kind of more like a general rollout of broadband networks across new geographies. Having spent -- those of you who spend a lot of time here in Scandinavia, you know that this is something that we have clearly behind us with fiber to the home and such. The modernization of the network has already happened.

But in the rest of the world, that is not the case. And right now, it's particularly strong in U.K., Ireland and Americas, specifically rural America, where there is a lot of government funding coming into modernizing the access networks, allowing people to get access to higher bandwidth services.

This has a very positive spillover effect on us because when you build that part of the network, you also need to build the transport network, which is our part of that. So a lot of new projects in those two geographies, U.K., Ireland and the U.S., in that segment. But also other places, South America, Germany, and this is happening in many places around the planet.

Enterprise is another area where the trend is strong right now. So what's happening in enterprise, well, they are also introducing 400-gig technology, but also 100 gig. So that's when servers are upgraded from 10-gig to 25-gig feeding switches that are then sending 100-gig signals. And then consequently, you need to transport 100 gig and 400 gig between your data centers as an enterprise in that case.

Also on the storage side, we're in a big upgrade cycle now on the storage area networks, from 16-gig up to 32-gig fiber channel technology, and this is all very positive for us. So very, very strong trends, allowing me to say that we still have a tailwind in our market.

Clearly, 5G is not a strong tailwind at the moment like it was about 18 months ago when we received fairly large orders for 5G backhaul. That has not happened recently. I'm expecting that market to come back 2024, 2025 and onwards because the 5G networks are far from complete. There is a lot of 5G to be built, and we're hearing from other sources too that the market is kind of on a pause, but it will come back. But 5G is only one thing that's driving bandwidth. The other three things that I named as examples are, in fact, stronger at the moment.

So new in the quarter. We're announcing one more big government network. This time, it's in Ireland. So it's the Office of the Government, CIO, that's building a network across all of Ireland to service things like schools, hospitals, municipalities, government organizations, blue light functions, et cetera, et cetera.

Those of you who have been with us now for a couple of quarters, you probably have seen, in Q3 last year, we announced a very, very, very similar project in a different geography, with a different Tier 1 service provider being the system integrator.

And if you follow us closely on, for instance, LinkedIn, you probably noticed that last week, there was an announcement from British Telecom in Wales talking about rolling out our DCP-R system and 400-gig technology. So thereby, it is official that it's British Telecom, the one we talked about in quarter 3. And as these networks will be built, we will come out with more detailed case studies, et cetera, to show what's really happening.

So what is good with these projects? Well, they are effectively government communication service providers. So it's networks that are built very, very similar to a communication service provider. So they are big. They are more complex than an enterprise network. They are nearly exclusively relying on our most advanced and modern technologies, such as the DCP-R ROADM platform and 400-gig technology.

And last but not least, they are using the SoSmart software suite to do things like network planning, bandwidth provisioning, day-to-day monitoring, et cetera. So they are very, very good proof points that we, Smartoptics can build these more advanced networks that we have set out to do in a very effective way. And of course, there's a soft factor here, too, that we can do business with these type of organizations like British Telecom. And in the Irish case, there is also a Tier 1 service provider that we are unfortunately not in a position to announce who it is, but there is a similar case there. And it's not a BT in that case.

So very good. And we're continuing our dialogues with large accounts. The situation is pretty much unchanged. We have said for a long time that we're constantly working with 5 to 10 of these -- well, let's call them whales for a lack of a better term.

Some of them are fairly well progressed. We're in labs, trialing out our equipment, et cetera, and we can start to see more regular revenue flows coming from those. Within the not-too-distant future, some of them are very early phases.

And as we progress, and I'm not necessarily talking about the $100 million target that we have been talking about for a long time, but surprise, surprise, after $100 million, there is another number and it's higher than $100 million. And what we are doing now is we're building for that higher number.

We're doing that in these dialogues with customers in terms of what they are requiring and asking us to do where we see the opportunities. We're investing very, very heavily into our R&D, and recruitments have been super positive here over the past couple of quarters. So we're seeing kind of a new force in our development teams now to be able to do what we need to do to hit that higher number that we eventually we'll start talking about with this community, of course, right?

So yes, when we do that, when we build our capabilities as an R&D organization, of course, we need to scale our sales. So we have recently regionalized the company into three major regions with the head of each region. We're investing into those teams. We are investing in the company, in general, things like new ERP systems, CSR, ESG type of initiatives, to make us a stronger partner for bigger companies.

So very positive start of 2023. Also from that perspective, investments, and we'll continue to invest. Because as I have said, many, many times in these scenarios, the big opportunity is ahead of us, and that's what we're going after. So this company is not ready to become a cash cow here, and now we are in it for the long term and for growth.

So very good. So moving forward, so if we roll back the clock a little bit to Q4 and the presentation I gave in Q4, I remember saying that we have untapped potential in the device side of the business. And this quarter, devices is growing by 19%. So apparently, someone has listened to me. That's very positive.

This is, of course, not -- it's a tad coincidental. I have to admit we have not made any major strategic initiatives on the device side, but it's very good that we're showing that we can accelerate also that side of the business. Previously, there's been an awful lot of focus on solutions, software and services, and the focus is mainly there still.

But the device is a very solid business. It gives us a very good run rate, and it gives us new customers that we can later upsell and cross-sell into with more advanced products. So very, very positive, and I'm super happy for that.

Software and Services, why is that growing at this pace? Well, there are a number of reasons. First, I would say that more and more customers are buying our advanced software and service bundles. So that's clearly a trend #1.

Also a couple of years ago, we started to charge a little bit differently for our products going away from a model where we sold the product, into a model where we sell a hardware product and the software license.

Now we've come far enough to say that we have full effect of that business model. So we are not selling products without a software license anymore so that has contributed positively all the way through 2022 and also into Q1.

And then, of course, we see early phases now, early days of SoSmart software revenue in these numbers, too. We are very, very far from the maximum potential on SoSmart, of course, but it's starting to contribute to the overall picture.

Right. So slightly lower growth on solutions. I'm not super worried about that at all. In fact, a part of it is, of course, that some of the revenue Well, I should put it like this. The green and the black is very, very closely associated with each other. We don't sell the black piece without the green and vice versa. So they belong together very much.

But it's also quarter 1, and quarter 1 is not a quarter where major projects are concluded. Major projects are generally concluded in Q2 and even more so in Q4. As you saw earlier, we had a huge Q4, as you know, behind us.

Good. So good growth everywhere. Geography. Again, those of you who have been following us, this is clearly an EMEA quarter. And it's been kind of every second quarter, EMEA. Every second quarter, the U.S. As you have seen over, I think it's actually a little bit more than a year now that this behavior has continued.

Q4 was clearly an Americas quarter. In fact, all of 2022 was clearly an Americas year. And going forward, the biggest opportunities that we work with, the best customer dialogues we have is Americas. So I want to reiterate that a large part of the future of this company is success in Americas with large customers.

So very good. But of course, bottom line, as I've said many times before, we have 2 very good markets. It's the U.S. and it's EMEA, and I'm very pleased with that. And we will continue to keep focus on these two.

APAC, also positive signs, of course, in the quarter. It is still a very low revenue, as you can see. So one project will have a very big impact on the overall number for the quarter and the growth. So it's early days to draw any conclusions, but we're seeing more and more traction in the APAC region, specifically in the geographies that we have been talking about before. It is Australia and New Zealand, it is Japan and it is Singapore and a few other markets where we are active -- more active.

I'd like to hand over to Mikael to talk a little bit about the balance sheet now.

[Mikael Haag, executive]

Thank you. Thank you. So on the balance sheet, very strong financial position, high equity ratio, low debt around USD 1 million, high -- strong cash position. So all in all, a very strong financial position, which sort of led us with confidence to the dividend that Magnus will talk about in a few slides.

On the working capital side, we see positive development. The working capital is going down to 15.8. And it's a result of lower receivables. Inventory is a bit flat. And the other two major parts, trade payables, the other part is also flattish. So receivables are down. Cash flow is up and working capital is down, very positive trend.

Going forward, we'll probably see a slight decline in inventories or flattish or slight decline, and the rest will sort of develop according with the revenue. So positive development. We're becoming more efficient.

A summary of the financials then. So revenue growth, again, 18.8% to USD 14.1 million, very strong. Gross profit is up by more than 40%, of course, driven by the increase in gross margin. And you can see the trend of gross margin is increasing. And if you look back further, it is a general trend, and it's driven by all those things that Magnus talked about.

It is the product mix. It is the more software. It is the pricing management. It is the procurement savings and so forth that is gradually pushing up the gross margin. And let's see how far we can push it. But it is a general strong underlying trend.

EBITDA and EBIT also up, very stable performance. The margins, EBITDA and EBIT margin, 18.5%, 15.5%, in line with the ranges that we have talked about, and the long-term targets, the midterm targets. So very happy with the stable profitability.

We are driving the company to sort of build the company. So we're not optimizing the profitability yet. We want to grab market share. We want to grow, but at the same time, it's very positive that we have a very solid financial performance.

Operating cash flow, Magnus mentioned it, USD 5.8 million. Very happy to see that. That's a result of customers paying in Q1 for the business in late Q3 and Q4 coming in during Q1. So very positive performance. Okay.

[Magnus Grenfeldt, executive]

Thank you.

[Mikael Haag, executive]

Thank you.

[Magnus Grenfeldt, executive]

Okay. So dividend, we did get the question back in Q4 about this. And what we said then was effectively that we want to see now how the cash is flowing in as expected, and it has. So my coaching to the Board on this particular number is that we feel super confident with this level of dividends. And in fact, we have formulated a dividend policy here that you can see on the right side of the slide, so 25% to 50% of the -- well, it's called the profit for the year in IFRS terms.

So basically, net profit. Assuming then that this doesn't hinder us on our growth journey, which is what the second bullet here means.

And I did get a question. We have a question on the portal. I might as well answer that. Again, is this year's dividend in line with the long-term dividend policy? Yes, it is because in 2022, we had a tax shield. So we are not paying any tax. So therefore, we consider this to be in line with the policy. And you can study if you have further questions on that, Mikael can answer.

So very happy for this and very happy that we have formulated a longer-term purpose, also for investors in terms of dividends. Okay. So financial targets, you recognized the $100 million. We're 60% there, looking at last 12 months of revenue. We're pretty much dead in the center of our long-term EBITDA and EBIT targets.

So also very good. Meaning with the investment level that we have now up and starting to -- again target the longer-term growth. We're still good. So I'm very pleased with that. And gross margins, well, okay. So we are a little bit conservative on our aspirations here. Clearly, we have outperformed this now for a while.

But I think it's still good to have this in mind. We -- and think of us as being the challenger in the market, we are here to win market share and to grow the company.

And last comment on the $100 million versus the investments that we are making in our product offering, when we exit 2023, from a product perspective, we have the capability to be a way bigger company than $100 million in terms of the products we have, the networks we can build with those products and the customers that are out there, the available market for such products. It is way bigger.

So clearly, what is this going to be all about? Well, it's going to be all about our execution and our ability to win these accounts going forward. The products are there, the investments are there, and we will continue to invest further.

So all in all, very good traction towards our long -- well, it's not long term, it's 2025 and 2026 financial ambitions. We're maintaining this, and we feel confident that we're going to hit this. So with that, we're happy to take questions, and I will now look at the portal.

We can start with the questions on the portal and then take questions from the room. So we have one question. Will the new growth target require funding. Well, as you know, we have set ourselves on this profitable growth journey. We have defined a dividend policy.

And -- so the answer is, as long as we're continuing to grow organically, the answer is no. If we decide to move down another path at some point, M&A or such, then, of course, that's a different question. But for now, for what we can see and with the current strategy, the answer is no on additional funding.

And we have a question also that 2024 and 2025 is not so far away. How is the outlook for the years after 2025? Will the growth we have seen in the recent years continue? Or is it expected to slow down any time soon?

Well, I would like to postpone the answer to that question because we are kind of in the middle of this. Internally, we have new targets. As I've said many, many times, those are more qualitative than just a number and just a growth trajectory. It is more related to market share in certain areas of networks and certain parts of this market that we want to achieve long term.

What remains to be done is, of course, to translate that into more numbers that we can start communicating with you guys gradually as we move along. But I think please don't expect any details on that in the next couple of quarters here. But rest assured, the number is higher than $100 million, the target, the new target.

Exchange rate effects on this year's -- on this quarter's result. Do you want to elaborate a little bit on that? Yes. And we have two questions. One is about the FX gains in the quarter, and then we have detail on how exchange rate affects the results. I guess, both.

[Mikael Haag, executive]

Yes. Okay. So the effect of exchange rate changes is quite small this quarter. To reiterate, we sell in dollars. We buy in dollars. So we have a very good natural hedge on the gross margin and the cost of sales versus the revenue. OpEx is the biggest part in the Swedish krona, a bit in Norwegian kroner, a bit in U.S. dollars, a bit in British pounds and a bit in euro. So that mix has an effect that if the dollar strengthens primarily versus the Swedish krona, OpEx goes down. So there's a slight effect of sort of squeezing the OpEx down a bit.

However, if you look back 9 or 12 months, the exchange changes SEK to dollar is not that material. We don't have sort of rapid changes in the SEK versus as the NOK has had during Q1. So -- but there's a slight effect. There's also an effect in the sort of the financial -- net financials that you see in, for example, in the cash flow statement or lower in part of the loss statement, where our receivables denoted in dollars translated to NOK will appreciate if the USD appreciates versus NOK.

All in all, that will probably even out over the year, but that is a slight effect. But that's lower down. It's more a financial effect. Down to EBIT, slight -- sort of slightly lower OpEx due to a fairly strong dollar.

[Magnus Grenfeldt, executive]

Thank you. All right. So I do believe we have answered all the questions currently on the portal. Are there any questions in the room? Yes.

[Øystein Lodgaard, analyst]

Oystein Lodgaard, ABG. I have a couple of questions, first on product development and then on partner strategies. So to start with product development, can you say anything about or give some flavor on how many of your R&D staff is working on, say, new products within the existing product families? And how many work on new product families for different use cases than the one you have today?

[Magnus Grenfeldt, executive]

Yes. So product families -- our product families, the DCP-2 chassis housing, all our transponders, muxponder, all our DCP-F line systems, nearly everything we do as individual projects -- sorry, products housed by the DCP-2. And then we have the DCP-M line system point-to-point and the DCP-R line system family -- all of them are families here. I'm talking about for more advanced networks such as more mesh network rings, stars, whatever.

So all of the development is currently ongoing within these three product families. I would say we will probably be looking at second half of this year before we kick off projects outside of that scope that I just talked about.

So more infill units, new products to feed the DCP-2, such as new 400-gig transponders, new 400-gig more capable muxponders and so on and so forth. More additions to the DCP-F family in order for us to build bigger networks with DCP-F2. A lot of activities on the DCP-R. Right now complementing that product portfolio with more products. So I would say the whole R&D team is right now adding on to this. I believe that was the question, right?

[Øystein Lodgaard, analyst]

And just to understand, you talked now about investing for the growth beyond the $100 that you have communicated. Is -- does that mean that you think that you can reach also beyond the $100 on just the existing product families without having to expand into new product families for different use cases?

[Magnus Grenfeldt, executive]

If we stopped R&D today, we could still reach $100 million. Yes.

[Øystein Lodgaard, analyst]

And beyond or is that...

[Magnus Grenfeldt, executive]

And beyond. But I haven't done the mathematics. But I mean we have products for a number of very attractive applications to date that we can easily reach $100 million.

I mean, the trick and the long term, how do we get to the next goal? Well, that spells larger accounts. And the way we work with larger accounts is that you enter an account with a niche application, one application, and then you start working on broadening the scope with that particular customer.

Hence, we have to have a constant flow, a road map of new features that we work together with our big customers to develop, of course, to make sure that we hit their requirements not in this quarter or next, but in 1 year or 2 years or 3 years. So yes.

[Øystein Lodgaard, analyst]

Exciting. And on partners, do you -- you have now become a much bigger player, starting to make it [indiscernible] with some larger customers. Do you see more interest from partners to collaborate with you?

[Magnus Grenfeldt, executive]

Yes. Yes, absolutely. And in this quarter, we signed up one particularly big partner servicing the so-called Tier 3 space in the U.S. Those are the rural telcos. We have had some partners who are strong in part of that market, but far from all of it. This is thousands of potential customers. So we needed to add a little bit there to have kind of a full scope, and we secured the first purchase order from that new partner into one of these U.S., they are called ILECs, or Tier 3 operators, effectively very similar to the European regional networks.

I mean, [ Lisa, Troms Kraft ] whoever, right? City carriers. They are much bigger in the U.S. Of course, everything has in the U.S. than what we have here, but the principle is the same, that they are servicing a smaller geography with Internet services and things.

Yes. So yes, is the answer. We are -- I mean we are constantly adding new partners. Sometimes very strategically that we go after a particular market, such as in this case, we have to strengthen in this market. So who do we seek collaboration with?

That takes a bit of time, of course. And we were successful in this quarter. And sometimes, a partner comes to us with a deal or an opportunity and say, "Look, we want to work with you on this particular case." So yes -- so it's driven from both sides.

Clearly, you are investing to maintain growth, but what external scenarios could represent a headwind to your sales over the next 12 months?

Well, as I said, there are very, very strong trends in our industry that we are riding on right now. I have a very hard time seeing that those wouldn't necessarily stop in the next 12 months. I mean things can always happen. If the world economy is deteriorating even further, and the climate for investments, in general, goes down, that's going to be completely out of our reach in terms of what can we do about it, right?

So a major backlash on the supply chain, the global supply chain could, of course, have an impact of us. You have probably noticed that we don't talk about supply chain anymore, and we have no intention to talk about supply chain, unless something dramatically happens because we are more or less back to normal.

So yes -- so it's probably things out of our control that could have an impact. And yes.