Smartoptics Group AS

OSE:SMOP

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Magnus Grenfeldt, executive]

Good morning and welcome to Smartoptics financial results presentation for Q2, 2024. Slightly different format today. We are doing this remote from Stockholm. So we hope that technology is with us as we go through this presentation. As usual, I will start by discussing the highlights of the quarter, a few of the financial metrics that we normally talk about, and a few comments to do those.

So Q2, 2024, it is a quarter that's very, very similar to the quarters that we have behind us, Q4 and Q1 in this year, Q4 of last year, obviously, and Q1 of this year. What does that mean? Well, it means that we are, to a large extent, still relying on revenue from our classical home markets, smaller service providers, and enterprise, and we are not seeing any major projects materializing in the quarter, which is the main cause of the difference between this Q2 and last Q2.

If we go back in time about a year, I would describe Q2 of last year as the last of the good, the good market quarters that we were operating in, where we had a larger project in the EMEA region of roughly $2.5 million. In addition, it was the last quarter where the company moved into the quarter with a significant backlog, partly caused -- well, of course, related to the large projects, but also partly caused by the delivery problems that we had 18 to 24 months ago.

So in Q2 last year, we went in with roughly half of the quarter in backlog, which is not the case and which has not been the case for the past certainly 3 quarters where, as we have discussed previously, we are to a very large extent, booking orders and converting that to revenue within the quarters, which is, of course, made possible by superb lead times and also the fact that the majority of the revenue is -- or nearly all the revenue is smaller projects that we can deliver really, really quickly.

So yes -- so clearly, no major improvement in the macro around us. I'm not going to comment as [indiscernible] there are probably people on the call who are better suited to do that. But one thing is clear, we haven't seen any major differences that is kind of driving an improved investment behavior. Looking at the performance, financial performance of the company, I'm quite okay with that. We are still producing very good gross margins above our long-term targets. And we are also producing EBITDA and profit, which is, of course, below the expectation that we have, and it's something that we're, of course, working on improving, which will improve as revenues come back, of course, but still acceptable and still good enough for us to continue to invest in the company, continue to invest in people to a large extent and to capture future growth.

As you can see in the report, and Stefan will comment more on that later on, we have a fairly stable and flat OpEx, both compared to last quarter and a quarter year ago. So what's happening here is as we are recruiting new people into the company, of course, we're doing some other actions like less dependency on consultants and things like that.

So -- and as we continue to invest now in the near term, I'm expecting some of that to go on too. So, there will not be any dramatic changes in the OpEx number over the short and to medium term. Having said that, the market for us out there is phenomenal at the moment. There is -- the access to qualified people with good domain competence in the optical space has probably never been better. So -- and given the fact that our belief in the market ahead of us is unchanged, more or less, we still see the same reasons for growth. Going forward, those 2 put together, makes this period in time, an excellent period to invest in the company and in our market. So all very good.

A few words around that, returning to growth and what are the drivers for growth acceleration going forward? Well, macro is one thing. And I think here, we have to rely on analysts around us and the industry, in general, talking about better macro driving investments at a higher pace from the second half of this year. We are not doing any different analysis or any analysis over and above what we're hearing on that side.

What we are doing though is, of course, looking at Smartoptics and what is over and above the market becoming better and the macro situation becoming better, what reasons do we have to believe in returning to growth within short, and those are listed on this slide.

So one thing that we've been talking about for some time is, of course, a large account strategy. On top of our core markets, growing the enterprise, the smaller service provider and not to forget our device business, we are continuously working on capturing a number of larger opportunities. And we see very good progress in that side. In Q1, we talked about 2 new customers, one of them a service provider from the U.S. who had placed the first order. The other one was a cloud service operator, Global One, where we had signed a contract. We have now captured the first purchase order from them, a project that is going to be delivered here shortly. And we have conversations around the next 3, 4, 5 geographies where investments are needed. So good progress on that. We're also seeing -- finding ourselves in -- as we progress these accounts, we have now come to a point where we have a couple of very good opportunities where we are in final rounds of vendor selection. So clearly, things that may happen in the coming second half of the year.

The new thing, I think, today compared to a quarter ago is that we -- not only are we talking about Americas here, but also EMEA, we have a couple of very good opportunities in EMEA here that can materialize in fairly large revenues within short. I should also have mentioned that, yes, we have such conversations in APAC too. But for the most part, we're talking about Americas and the new thing is EMEA. So activity level, this is something that we have talked about and talked a lot about in quarter 1. And to begin with, I should say that Americas is unchanged. We still see very good conversations going on, lots of them, high resource utilization on our presales team. Those are the architects discussing network designs and creating bill of materials and so on and so forth for our customers in America. New thing is that I think what we talked about as early signs of improvement in EMEA in Q1, I think we can clearly say that EMEA has improved now, and the situation is somewhat similar to the U.S.

And of course, looking at the left side of this slide, the fact that we are in advanced conversations around bigger projects in EMEA, obviously, then we can say that EMEA has improved. LATAM still contributing very nicely to the revenue and looking into the second half of the year and onwards to next year, we are seeing quite significant projects out of the LATAM region, too.

A good thing in this quarter is that it is absolutely one of the top quarters in our APAC region. I will come back to that and talk about where that revenue is coming from. So -- but clearly, good to see progress in APAC too. Our new products that we see as clearly a way for us to become much more competitive in kind of the upper end of our addressable market, the most advanced and biggest networks with our 34-degree ROADM product and equally important, our latest release of our SoSmart Software Suite 5.0. Those products have been released very similar to -- with our previous products.

We did receive orders for both a 34-degree ROADM and the new software suite ahead of release. And that is unusual in our industry. Our industry is normally -- yes, the normal situation is that you go through some sort of tender, you do quite a lot of qualification testing, lab testing before you see orders starting to flow. And I think with Smartoptics, we've always received orders for our products ahead of release, which is a very positive sign and a very good proof point that our PLM organizations are steering the road maps in the right way. We are producing products that are relevant for the market when they are released. And just a reminder, these products, well, what do I mean by making us more competitive at the high end? Well, it means effectively that it will significantly increase our relevance in regional networks, which leads to larger customers and larger projects. Last but not least on this slide, we're talking about AI traffic driving growth going forward. When we talk to industry analysts, they kind of see AI as really 3 phases, where the first phase, building up huge data centers where the cluster -- AI clusters for training of models, that's been going on for quite some time now. It is really a large data center play driven by the biggest consumers of bandwidth on the planet right now, the hyperscalers and such.

Phase 2 is what's going to happen when you grow out of data centers and also when other organizations, not only hyperscalers, but really all organizations are investing in their models and building up data centers. If we're seeing the classical data center phenomenon such as lack of space, lack of power, but also redundancy -- and with all compute technologies over a very long time, the same thing is happening that you start to break this apart, utilizing several later centers instead of 1 or 2. And that will drive demand for data center interconnect, which is a large part of what we do, connecting data centers to each other to ensure communication between machines effectively. So that's Phase 2. That's something we're anticipating more demand for data center interconnect services across a broad range of customers in the future. And last but not least, is kind of when AI is no longer consumers sending text strings into a computer and getting text back, which is not really driving that much bandwidth.

When we see video services, people producing video services and a lot of video content and things of that nature starting to be distributed around the planet, it's really another Netflix and YouTube this time, probably on steroids, 10 billion people sending 5-minute videos across the planet. So that's really an additional driver to the ever-growing demand for bandwidth that we have been talking about. So there is no reason whatsoever to expect that to slow down, rather the opposite, accelerating as we go forward. So that's good news. And a reminder there, whatever grows in terms of bandwidth consumption, it's always good for Smartoptics. So yes, positive there. So good reasons to believe in a return to growth over and above the world coming back to a better investment climate in general.

I'm going to take you through a few slides looking into the revenue and break that down and look at what's going on in the company. And we can see -- I did mention earlier that Q2 is very similar to Q1. And indeed, it is, to a large extent, the difference from last year, the problem, if you so wish, lies in EMEA and lack of larger projects in EMEA. Americas is down a little bit. Please remember what I talked about earlier, that Q2 last year, we were moving into the quarter with a very large backlog. We are not doing that anymore. That will return when we see the bigger projects coming on board again, that's when we will see bigger backlogs coming into the quarter and more predictable growth as a consequence of that, of course.

But okay, Americas is down a little bit. I do not think that is too dramatic, to be honest. Clearly, EMEA with a bigger revenue drop is clearly where the major impact is. Here, we're seeing, as I discussed earlier, that APAC is looking quite good, the second-best quarter ever for the company. And a reminder there, our best quarter was a couple of years ago where we delivered a very large data center project to an Australian bank. This time, it's Australia and New Zealand, driving about half of the revenue growth here and other geographies driving the rest. So not only Australia and New Zealand, although those -- that particular geography is very good in this quarter, about half of this revenue to be precise, but also other APAC geographies performing rather well.

Looking at the product mix, well, obviously, we're seeing exactly the same phenomenon. The larger projects will be in solutions, software, and services. That's where they were a year ago. And it's really the same drop that we're seeing in the solutions revenue in the quarter. So yes -- so EMEA and larger projects to a large extent. I will hand over to Stefan to take us through the balance sheet and working capital and some more financial details.

[Stefan Karlsson, executive]

Thank you, Magnus. We see a strong balance sheet with an equity ratio of about 61% compared to 60% last year. We have non-current assets of $7 million compared to $6.9 million last year, and it's mainly related to capitalized development costs, tangible assets and leases, and deferred tax assets. Current assets amounts to $32.8 million compared to $33.5 million last year. It's mainly inventory and trade receivables. And the cash position is $ 5.1 million compared to $2.9 million last year and it's a reduction from $11.5 million in March this year, and that is mainly driven by the dividend of $4.4 million and that we have net operating cash negative impact of $1.9 million.

On top of the $ 5.1 million cash, we have $7 million available in credit facilities. Our non-current liabilities is $1.5 million compared to $2.8 million last year and consists of lease liabilities of $0.9 million and long-term loans of $0.6 million to Innovation Norway that will be fully repaid in Q3 of '26. Current liabilities, excluding deferred revenue amounts to $9.4 million, the same as last year, and it's mainly AP, tax liabilities, and personnel-related liabilities. Deferred revenue amounts to $6.8 million, up from $5.4 million last year, and it's a result of a larger revenue share from business areas, software, and services.

The working capital amounts to $17.3 million compared to $19.4 million last year. And here we see the inventory increased to $ 14.6 million from $14.1 million, which is a result of -- that we have shorter lead times compared to earlier, but we still have forecasted periods where we have commitments to buy goods. Trade receivables decreased to $17.2 million, down from $17.9 million and we still have a trend that we see that we are invoicing later in the quarter why we keep trade receivables up a little bit. Trade payables are down to $3 million from $4.3 million. And in this quarter, we did earlier purchases of inventory, resulted that a lot of those has already been paid end of quarter.

Net other short-term liabilities increased to $11.5 million compared to $8.3 million, and that is related to increase of deferred revenue and tax liabilities. The revenue decline of 23.5% down to $13 million from $17 million is due to -- we had a strong Q2 last year, as Magnus mentioned, and we are now missing larger projects in EMEA.

We have a stable high gross margin of $47.3 million compared to $49.2 million last quarter. The EBITDA is $1.0 million compared to $3.2 million, and the drop of $2 million is mainly related to revenue, of which the revenue drop is $2 million, and the difference in gross margin is $0.2 million. We are flat on OpEx, even though we are growing in full-time equivalents. We had from 105 to 119 employees. But we are converting consultancy costs. That's why we have the stable OpEx still. We have a negative cash flow from operations of $1.9 million this year compared to $1.6 million last year, and it's coming from the lower revenue, but still, we are profitable, but then we have consumed some cash for inventory for -- mainly and as well a little bit of accounts receivable.

[Magnus Grenfeldt, executive]

Thank you very much, Stefan. So looking at our long-term ambitions. I'm going to reiterate what we have been saying in the past 2 quarters that we have no reason to change our long-term ambitions. We see good opportunities ahead of us. We are still targeting our $100 million in revenue in 2025 and 2026 time-frame with the financial metrics that you see to the right in this slide.

Now what I have said and what I'm going to repeat is, it's, of course, 2025, are there projects out there that could take us to $100 million already next year? Yes, there are. However, that would kind of be goal post and in on everything, I would say, to use a reference to sport. Everything has to be phenomenal for that to happen in 2025. So I'm quite pleased that when we originally set this target 5 years ago, that we did range it a little bit. So 2026 is assuming that the market comes back now in the second half of the year and that we can return to growth. These ambitions still feel achievable for us. So very good. So with that, we have concluded the presentation part, and I believe there are some questions.

[Operator]

Yes. We have the first one from Christoffer Bjørnsen at the DNB.

[Christoffer Bjørnsen, analyst]

Yes. So I think focusing on outlook, looking back on Q1, you were quite confident that Q1 was going to be the bottom, if I heard you correctly back then, but now you don't really seem as certain that this is the bottom. We're still seeing high activity level across Americas and EMEA, but we're not really seeing that converting into revenues. So what are you seeing, like among your customers, anything in the backlog that gives you confidence in growth returning? And at what point?

[Magnus Grenfeldt, executive]

Okay. Yes, I think what you may be referring to is as we saw quarter 1 being up compared to quarter 4. And I was speculating whether or not Q4 last year was the bottom. I don't think we have the answer to that yet, and I don't think I called it out at that time, it was just a discussion that it may very well have been that case. And we will see whether that is true or not. Do I have something in my backlog that is kind of telling me anything relevant about the 2 quarters? Well, we have never really been discussed that other than I can reiterate that we are moving into our quarters with a fairly low backlog, certainly lower than wanted and certainly lower than we would expect in the normal market.

So backlog is one thing. The other one is pipeline. Looking at the projects that we are currently working with, do I have things in my pipeline that makes me believe in a return to growth? The answer is a clear yes. We have to convert them. I cannot give you a time-frame on exactly when that's going to happen. But we have a lot of projects in our pipeline where I rate our win probability as very high.

So yes, I have good reasons to believe in the return to growth.

[Christoffer Bjørnsen, analyst]

I think you noted in the press -- or in the presentation that you're in final round of vendor selection from larger accounts in both EMEA and the Americas. Can you just help us understand what is like typical timing on those and larger accounts? How big opportunities and orders are we talking about?

[Magnus Grenfeldt, executive]

Well, I think those are opportunities that kind of look like the bigger projects that we have had in the past. It's not -- well, we've had 2 kinds of large projects. One is the kind of BT Wales, Vodafone Ireland, Irish government projects, very large projects that is going to produce revenue over time, but not to the same extent. The other large projects, typically Crown Castle, where we have recurring revenues coming year after year. And I mean these are both more similar to the latter here. So service providers and data center operators where we see potential for build-out over a very long period of time. As I said, we have projects in our pipeline right now, where we are in the final phase of vendor selection. What does that mean? Well, it means that we have been working with them for a significant amount of time. And then it's about closing the deal at the end of the day, and I cannot really speculate in how much time that's going to take. Hopeful that we will have good news in the second half of this year, as previously communicated.

[Operator]

Next question is from Markus Bjerke at SEB.

[Markus Bjerke, analyst]

So yes, if I can just follow up a bit on the revenue trajectory here because if you can discuss the seasonality of your business once again for us because, of course, Q2 is normally substantially better than Q1 from the past, say, 5 years, why do you think we didn't really see that this year? And are there reasons to think that Q3 will break that normal pattern that normally Q3 will be slightly lower than Q2? Is there reason to think that maybe Q3 this time will be a bit better than Q2? And in relation to that, maybe on EMEA, because you say that's clearly improved, but in your revenues, EMEA is down quarter-over-quarter in a quarter that typically is better than Q1, some -- a bit more flavor, maybe could be helpful.

[Magnus Grenfeldt, executive]

Yes. So when I talk about EMEA improving, I'm talking about activity level, number of conversations, a number of opportunities, and projects that we are working with. And I agree with you, it has not yet resulted in major revenue, which is obvious from looking at this report. And I guess the most important part of your question there is related to Q3 and onwards. And yes, Q2 and Q3, there have been cases in the past where Q3 has been on par or better than Q2. Can that happen this quarter? Well, it's -- we are about 15 days into the quarter, and it's way too early for me to speculate. But if you put a very big maybe in front of what you said because I believe that's how you asked the question, can we believe that maybe Q3 is better than Q2? Yes, maybe that can certainly happen. We have opportunities that can make that happen, but it's a bit too early to talk about it in any detail. Was that an okay answer?

[Markus Bjerke, analyst]

Yes, maybe also a bit more on the current quarter that you have behind us because Q2 is normally a seasonally high level, but it didn't really materialize from Q1. Is there anything in the seasonality that -- so that would imply that the market is actually getting worse in Q2, right? Because normally, Q2 is better than Q1, but that didn't really happen. Or is that the wrong interpretation of the seasonality of your business?

[Magnus Grenfeldt, executive]

Well, yes. I mean, clearly, the market is not great in Q2. We can conclude that and I agree with you that Q2 should be a little bit better. I think it's related mainly to -- and if we look at what happened in the second half of the quarter, did we have opportunities that we were working with that we thought was going to close to make Q2 better? Yes, we did, absolutely. They didn't materialize. We haven't really lost any projects or anything. Things are taking a longer time to close and to materialize. Clearly, is that worse in Q2 than Q1? Well, maybe a little bit, maybe a little bit that we have a little bit better traction at closing deals at the second half of Q1 compared to the second half of Q2. If you ask me in 6 months, I think it's going to be easier to answer the question related to what we have discussed earlier here, Q4, Q1, Q2, which is -- which was really the bottom in this market. I don't know the answer to that yet. To an extent, yes, coincidence and things that can happen in a softer market. I don't think seasonality is forever and ever broken. I think it will continue to be Q1, the smallest Q2 or Q3, the second highest, and Q4, clearly the highest quarter.

[Markus Bjerke, analyst]

Final question for me for now is on the industry consolidation that you're seeing and some structural changes in your industry. And maybe you can shed some light on how you see the opportunities or are there any threats from the -- particularly the recent announcement some weeks back from your perspective? It's interesting.

[Magnus Grenfeldt, executive]

So right. So if I may take a step back to -- over the years, as we have been discussing what is the strategy of Smartoptics, we've always had 3 major elements of our strategy being fill the gap in the market caught by consolidation, the lack of mid-sized players who can do innovation in simplicity, who can do innovation at the edge of the network, and things like that. Second one being the open and disaggregated trends, someone who can really rely on that. And the third major element of our strategy is to grow our addressable market by strategic development of hardware and software for our customers. And this one is spot on, number one, the gap is getting bigger with every consolidation that happens. So what used to be, well, I guess, #2 and #3 in the relevant markets is now the #2 and fewer competitors out there and clearly, a larger gap to be filled, meaning more opportunity for us. So I cannot see anything negative with what was communicated some time ago, 2 to 3 weeks ago, rather the opposite. It's probably a good thing for us.

Do we have any questions on the portal?

[Operator]

Well, we do have one more from Christoffer Bjørnsen at DNB.

[Christoffer Bjørnsen, analyst]

Yes. I'm just sorry to kind of bug you on this again but -- so the high activity level in like exiting Q1 and through Q2 in places like EMEA means kind of you're knocking on doors, you're engaging, people are interested, and you haven't lost any opportunities. So what are they telling you? Are they telling you like we'll put this in Q3? Or -- just trying to understand the -- yes, I was just trying to understand the dynamic there. You have, like, open 300 different active buyers according to the statistics you shared, was it 1 or 2 quarters ago? So a couple of examples. What are they telling you? They're saying maybe Q3 or are they saying like you're so worried now might be next year? I'm just trying to understand because it's really difficult to gauge the outlook here.

[Magnus Grenfeldt, executive]

Well, I think we have -- honestly, we have everything in those conversations. Absolutely, we have the maybe Q3s out there. I mean, we have the ones who are communicating with us in a very, very careful way wanting to make sure that they don't overpromise to us, much like I don't want to overpromise anything to you or our investors. So there is a little bit of everything in those conversations. But what I can say, as I've already mentioned in this call, are there such larger opportunities that may close in Q3 or Q4? Well, let's isolate Q3. Yes, sure. Those opportunities are out there. They may slip to Q4. I don't know, but they can materialize in Q3.

[Operator]

So we have one more question from Øystein Lodgaard at ABG.

[Øystein Lodgaard, analyst]

So just a couple of questions from me. The first, a bit of follow-up to Christoffer's question here. Can you tell us these customer dialogues that you are in, which type of customers is it? What regions? Are they mostly like telcos in the U.S.? Or can you give some more flavors?

[Magnus Grenfeldt, executive]

Sure. So right now, I would say if we isolate, I said EMEA and the U.S. Let's take 3 examples then to illustrate that. We have a European service provider talking about building a larger network to connect certain larger data centers in certain larger cities in Central Europe. That's one example, service provider. And we have a data center operator owning and operating hundreds of data centers around the world, selecting platforms for data center interconnect for future growth. That's another example. It's a U.S.-based company, but certainly with a global footprint. We have larger service provider customers in Americas that kind of belong to the Tier-III space, but being bigger than just a local ISP, connecting many ISPs together in different -- so kind of state-level networks that are going to be built. So that's a third example of such a customer. And with all these, it's not only one. It's a couple of them in each category.

[Øystein Lodgaard, analyst]

And on the gross margin, the gross margin is a couple of percentage points below what we've seen in the last few quarters, while the mix between the different segments stays roughly the same. Can you give us a comment on this? Is there some extraordinary items that affected this in Q2 or can you give some more flavor on the gross margin?

[Magnus Grenfeldt, executive]

We have a really small effect on onetime, but it's not really relevant to discuss, I believe, in any major detail. I think it's just natural fluctuations. Sometimes we're a bit more aggressive to win our deals, and this may happen. And this is, I think, in line with what we have talked about that we have never raised the long-term aspiration on gross margin.

Why is that? Well, that is because we're going to continue to be the challenger in this market. We want to be aggressive. We want to win market share, and we want to win new customers. And therefore, we are cautious in promising to high gross margins.

[Øystein Lodgaard, analyst]

And last question from me. We've seen, of course, the -- recently another 2 large competitors going together. There is now basically 4 players in your industry dominating over -- well over 90% of the metro DWDM market, means it will be very tightly consolidated in the top and I guess, less focus on the smaller customers.

Will that -- I guess that opens up a big opportunity for you. Will you change anything in the way you work or how you do business or just continue to do the same in response to those that increased consolidation?

[Magnus Grenfeldt, executive]

No. Well, I think, as I said earlier, it is a very good time to invest for us. We see good opportunities ahead of us. We see access to qualify the people with good domain competence, partly related to these acquisitions, probably right that when these acquisitions occur, there are people out there on the street looking for new opportunities. We can capture some of that. So positive from that standpoint. And then also, I don't want to kind of comment too much on our competitors' strategy but I can say, in general, the bigger you get, the more you have to focus on the Tier-Is of the world, right? And that opens up opportunities for us in the Tier-II space and down, which is a very, very big market compared to our revenue numbers. So yes, no, good, good for us, I think.

[Operator]

We do have a question on the portal. It's from George [indiscernible]. Regarding pipeline and potential larger accounts processes/vendor selection processes, during the year, have you lost any potential customer wins? Or are you still in the same discussions as you were entering the year?

[Magnus Grenfeldt, executive]

Pretty much, yes, the same discussions, yes. And a few new ones, of course, but no major losses.

[Operator]

Thank you. That was the last question that we had today.

[Magnus Grenfeldt, executive]

Then thank you very much for attending and listening in, and have a great summer. See you shortly. Bye-bye.