Smartoptics Group AS

OSE:SMOP

Earnings Call Transcript 2022-Q4

[Magnus Grenfeldt, executive]

Good morning, and welcome to Oslo -- to a rainy Oslo. Welcome to all of you in the room, my favorite room, [indiscernible], the corner in Hotel Continental, Oslo and also welcome to everyone on the webcast. We are here today to present the quarter 4 and 2022 results for Smartoptics Group. And with no further ado, I will move to the agenda.

So the presentation will be done in the same manner that we usually do. So I will go through some of the details of the strategy of the company, a breakdown of revenue and such. And Mikael will cover -- Mikael Haag, the CFO, will cover the financial details before we come back to the to the outlook for the years to come.

So the agenda today is a little bit different than Q3. We have talked to the market about being a little bit more into the details of the products and the strategy 2 times per year in Q4 and in Q2, where we do after our regular strategy update in the company. So you can view this as kind of a midterm update on what we're doing in terms of product development and et cetera, of course, operational highlights and the business overview.

So quarter 4 and 2022, it is, of course, an absolutely fantastic quarter for us where we are growing in all ways possible. You will see when I go through the details of the slide, we're growing with all our products. We're growing in all our customer segments, and we are growing very nicely in, well, not all markets, but certainly, the 2 ones that really matter from a revenue perspective, Europe and U.S.A. And in particular, United States of America, it's grown really nicely.

So $18.1 million, which is a record, also very good profitability. I will not talk so much about the details. Mikael will come back to all of the numbers on this slide in greater detail in a few minutes. So let's turn to the highlights of the quarter. So 3 areas that I would like to talk about, our growth, how are we growing, what is growing, et cetera.

The operational situation as many of you are aware, we have gone through a very turbulent period with semiconductor shortages, shortages in other component classes over the years, supply chain disturbances, et cetera. I will give you an update on that and then also what we're doing to build the company for the years ahead with further growth in building the company to become a much stronger and bigger company.

So if we start in the growth numbers. So as I said, growth in all product areas. I think notably, in quarter 4 we saw a tremendous growth in the product areas solutions, software and services, which is the big investment areas for the company solution -- sorry, software and services grew up by nearly 200%, 198%. Another factor that is very important is that the communication service provider business that we do, I will come back to details on that, too is growing tremendously, and that is by far the biggest addressable market for the company. So very, very positive.

We are winning new projects with our new product families. As you probably remember from when we listed the company, one of the main strategies of Smartoptics is to continuously broaden the addressable market for the company by developing products, targeting specific applications. And this is a very good example of that the DCP-R platform, which -- where we have taken significant customer wins in quarter 4. In fact, more than 30% of the revenue in the -- sorry, in the second half of the year is related to products that we have released in the same time period. That is fantastic news for us for a number of reasons.

Number one, it shows that our products are coming hot out of the gate. There is a demand. People -- customers take on the products, use them, place purchase orders and implement them in their network applications. This is not the norm in this industry. The norm in the industry has always been that you release a product, customers start testing it, you go through lab qualifications, you go through trials, you go back into tenders, you test a little bit more and then eventually, volumes come. That has never been the case in Smartoptics. We have always been fortunate to deliver our products immediately after release, and this quarter is no exception. So that's one positive thing.

The other positive thing is, of course, that this proves that we are on top of the technology trends, currently being that what used to be 100 gig is now becoming 400 gig, and this 30% is nearly all related to 400-gig network solutions. So that's very positive.

Components and semiconductor shortages, the situation is at the moment under control. That is due to 2 things. Number one is the -- all of the actions that we took 1 year, 1.5 year ago, the bets that we placed that turned out to be very successful. A few difficult decisions, I have to admit on a few sleepless nights to take those decisions. But at the end, it has proven that we have been able to deliver our products through this period. And looking at -- at it from that perspective, right now, it looks really good. We have secured components and similar for the near and midterm. That's one side of this coin.

The other side of the coin is, of course, that the market is improving. We're seeing way fewer notices and warnings on long-lead times and postponed shipments coming into the company, et cetera, et cetera. So the situation is much, much better, which is, of course, good for us.

We are growing the company, we're building the company not only in R&D and sales and such functions to capture new customers to develop new products, we're also adding to our improved CSR, improved support systems, et cetera. We grew our full-time employees by 11% in quarter 4. So that's also good news that getting access to high end, for instance, software developers, which has been cumbersome over the years, is now much easier for us, and we managed really, really well.

And we will continue to invest. This company is far from being a cash cow. We are operating in a huge market, and growth is still, in my opinion, by far the best way to build shareholder value going forward.

Okay. So our position now to capture the new trends, how can we continue to grow from this position we find ourselves in right now. As I mentioned, the first bubble to the left, the trend towards open optical networking. That's a strong trend. We're seeing more and more people looking at this alternative to the traditional ways of building networks. This is all driven by the introduction of 400-gigabit technology. 400-gigabit technology is something that every player in any market is right now looking at. I'm not saying that all of our customers and potential customers have taken the leap. But as the middle bubble indicates, this technology is now slowly migrating from the early adopters to the early majority, meaning a lot of new customers will take the leap to 400-gigabit technology.

And when they do that, Smartoptics becomes a new alternative for them to look at when they build their networks. And as I said, we have proven that we have a good position with these new solutions. And I think the second half of 2022 is a very, very good proof point with really good growth. In fact, nearly all growth is related to new technology, which is very good for the future.

Okay. So where are we investing? And let me remind you of the strategy of the company. So we are targeting to become a leader in what we refer to as open optical networking. So that's open networking in the sense that APIs and such, how you program these networks, how you work on a day-to-day basis with these networks, are open. You can use a broad range of platforms in your operational environment to do that. But perhaps more importantly, disaggregation, which means that you take a big problem and you break it apart into several small problems and a supplier can choose to be super good at this particular part of the network but not necessarily all parts of the network.

So a good example, what maybe used to be a Cisco customer that bought 100% of their products from Cisco 5, 10 years ago, may now well buy the router platform and some software solutions from Cisco and buy the optical part of the network from Smartoptics, and that will interoperate very well. That is the main part of -- one of the main elements of our strategy.

That also, why are we doing this? Well, it brings down CapEx for our customers. That's -- and it brings down OpEx, that's a positive thing for Smartoptics because when you look down into your -- the supply landscape and look for how do I optimize my CapEx, you will find smart optics as an alternative to a traditional solution. So we are well positioned also to service our customers from that standpoint. So that's the base of the strategy.

So where does that materialize in terms of our product development? Well, I'm highlighting 3 areas here: the SoSmart software suite; and 400 gigabit and beyond; and last but not least, network flexibility. So if I start from the right in this, the right most part, network flexibility, that is the ability for us to build bigger and more comprehensive and more complex network solutions for customers, targeting the communication service provider market predominantly. That is a huge market for us.

So we're continuing to develop our ROADM platforms effectively, optical switches that -- where you can route your optical traffic wherever you want to go in a point or multipoint or mesh network architecture. We're continuing to develop that. We're continuing to enhance the performance of our products in order to build bigger networks.

Going to the middle now, number two here, 400 gigabit and beyond. That's a number of development areas. Network performance, again, is very important, making our 400 gigabit signals go longer in networks, which makes it possible for us to build bigger networks and, of course, compete for larger projects and larger customers. That is very important, but also things like higher density, more capacity per rack unit in our product and last but not least, wider scope, several products that can solve slightly different problems in a network, all targeting really, really high-speed capacity transfer in networks. Of course, that's another way to broaden the addressable market.

Then coming to the SoSmart software platform, what is that all about? Well, I've listed 3 main functionality areas here, domain orchestration. That is about controlling the bandwidth in the network. If I'm here in [ Oslo ] to program the network to transmit 400 gigabit between Oslo and Bergen and the particular data centers that I wanted. Equally, if I want to send another 400 gig to location in Oslo somewhere, and I have a smart optics network, the SoSmart domain orchestration takes care of that problem for you. So that's one thing.

The other thing is network planning and network simulation. In our networks, there is generally a very difficult [ fix ] to figure out how long can these optical connections really go in a network? And how can we design our network in the most optimal way? Well, the SoSmart software suite helps us with that when we do quotations to customers, when we do network designs for customers, et cetera. So it streamlines our processes. And it helps our customers to do modeling of their networks to plan for future builds, et cetera.

Last but not least, inventory, fault and performance management. This is more related to the day-to-day operation of a network where engineers constantly 24/7 monitor the performance of our customers' network and isolate faults, do troubleshooting, et cetera, et cetera. The SoSmart software suite also helps with that problem. So the SoSmart is very important. It's an important tool for us. I will tell you why in a second.

So let's talk about the revenue and where it's coming from. I told you already that the CSP, communication service provider market is important to us. Let me remind you that Smartoptics is operating in a market which is worth roughly $16 billion. Out of that, we normally say that about half of it is related to intercontinental networks and network spanning East Coast to West Coast of the United States, et cetera.

That's things we don't do. We focus on metropolitan, regional networks where all the data centers are. So about half of it is available to us. Looking at the big number again, enterprise, which is the black piece of these bars is about $1.6 billion of that $16 billion. The rest of it is communication service providers and cloud, and communication service providers is by far the biggest one.

Hence, our product development in the past 3, 4 years have been targeting applications in communication service provider networks. That's where we can see tremendous growth going forward. And we're seeing that we're getting good value for money here. Our communication service provider business grew by 51% in 2022, very similar development as in 2021. For those of you who remember that year, also very high growth in the green and the red, and at that time, fairly flat in enterprise.

I'm very happy to see that enterprise is starting to grow a little bit here, probably based on the 400 gig rollout into that segment. Two, clearly, we have an untapped potential in enterprise to put more focus on that and grow that faster too, no doubt. But to me, this proves that our strategy is right and our investment is yielding very nicely into the most important area.

Solutions, software and services and optical devices. Optical devices being the classical business of Smartoptics from many, many years ago, which is an area that is not growing as fast as solutions, software and services. So of course, another area where there is untapped potential where we can put more focus and invest a little bit more, than we do it to see growth also in that area.

However, we have been driving solutions, software and services really, really hard over the past 5 years. Why have we been doing that? Well, bigger customers, bigger markets by far, at least 10x bigger markets for that, better margins, more IPR, more stickiness with customers, et cetera, et cetera. So we have had very, very good reasons to focus -- to put laser focus on the more advanced products and do investments.

And we're seeing now that the growth of solutions, software and services is far higher than the growth of the overall company, which, of course, is very promising for the future, too. So that's good. But everything is growing. That's also very, very nice. And we can see in quarter 4, specifically, as I said, software and services growing by nearly 200%. Solutions growing by 61%, and we can see that the split between the different product areas is then about 75% of the company being solutions, software and services. So that's very good for us.

So when Mikael talks about improved margin as a result of product mix, this is what he's talking about then. The product mix is such that when we sell more software and services and solutions, we earn more money. So that's that. So very positive numbers there.

Going to the geographies. This is difficult to track on a quarter-by-quarter basis because those of you who have followed us have probably noticed that some quarters, Americas grows faster, some quarters, EMEA grows faster. I would not, as an investor, put too much into that information. It is related to where we choose to ship products. It is a matter of what our backlog looks like at a particular moment. So you can't draw any reasonable conclusions from 1 quarter, whether EMEA is the more important market or Americas is the more important market.

The way I look at this is we have 2 super good markets and they are both growing very nicely. Looking at it from a bigger perspective, 4 quarters in a row, namely 2022, we see a much more important trend. Americas is growing faster and Americas is the biggest market for the company as of today. This is the first time over this long period that Americas come out as our biggest market.

So very, very positive, and I've talked about that for years that Americas is important. That's where the trends are set. It is a great market. The American dream is working for a challenger like us. We can always get the meetings we want. We can always get into the labs we want. And that's not necessarily the case with all European customers who tend to be a little bit more bureaucratic and complicated to work with. So Americas is a better market for us. And I'm super proud that we, as a Scandinavian company has succeeded this well, and I see us continuing to succeed.

APAC, still so small that you can't draw much conclusions from APAC either. One project can tip this one way or the other, really. However, we're seeing very positive signs from APAC, and I believe in APAC in 2023. Yesterday, a customer of ours in Pakistan announced that they had chosen Smartoptics together with Edgecore and iPi, a software company to build what they claim is the largest open optical network in the world. They are probably referring to geography in that standpoint.

The deal is a little bit less than $1 million for us. So it is kind of a business as usual deal. However, what's not business as usual is that it's Pakistan, obviously, a new market. It's APAC, obviously, a market that we have a belief in, in the longer period. And moreover, it's a project that's done in collaboration with TIP, which is one of the leading industry initiatives for defining what open networks should look like. They also support geographies like Pakistan and other countries of similar development state to build networks.

TIP is shared by Facebook, Deutsche Telekom and a few other reputable organizations. So definitely an interesting project to look at. So that press release can be found on the TIP homepage and if you Google it, if you're interested.

All right. So we now come into the balance sheet, and I would like to hand over to you, Mikael, to take us through the financials.

[Mikael Haag, executive]

Thank you. Thank you, Magnus. So our financial position is very strong. We have a high equity ratio, around 64%, very little debt. So very strong financial position. The long-term debt position is about USD 1.5 million. This is the last quarter where we see increase in inventory related to the semiconductor shortage regime. We're now moving into a more normal state without the sort of massive inflows of inventory that we had to sort of take on in order to get anything. So that's why we see an increase in inventory.

We also had, again, quite late revenue. So December was a very strong month for us. Therefore, a lot of sort of growth in the accounts receivable. On the payable side, it's slight up due to increase in inventory. Going forward, we see a possibility to reduce inventory and improve cash flows. So a very positive outlook on this one.

And the financial sort of summary, we see the 45% growth in revenue. Very happy with that compared to quarter 4 last year. Strong increase in gross profit. We see the gross margin down a bit in this quarter related to partly spot purchase recognition that we had to take on in order to get material during semiconductor shortage.

However, if you look at sort of the underlying numbers, the gross margin is a bit -- is more or less flat over the whole year. So very strong underlying gross margin. So -- and that also is higher than the year before. So improving gross margin is the story here, although you see a slight dip in Q4.

Improving EBITDA and EBIT related to the growth and strong gross margin. The EBITDA margin, EBIT margin, again, very strong ahead of the curve compared to where we want to be. We've communicated on the next slide, the financial ambition, we're in that range, meaning that we're ahead of the curve. Also, without these one-offs, we would have been slightly higher in the 24% range of EBITDA margin and the 21% range of EBIT margin.

On the cash flow side, Q4 was slightly negative. The year as a whole was positive. Again, related to the semiconductor shortage we had to take on inventory in order to get product into the company. So we had to increase the inventory. Going forward, we expect a normalized situation and improving cash flows. So a very positive outlook. Thank you.

[Magnus Grenfeldt, executive]

Thanks. So full year 2022 number that I track all the time is, of course, last 12 months revenue in relation to our $100 million goal in 2025, '26. So obviously, very, very good, also very, very good in relation to our longer-term targets.

So we often get the question, why don't you set a new target? Well, we have, of course, we have set new targets. But in order to get to that target, we have to pass this, so we have decided to stay with this as the reference for the financial market going forward because, obviously, our new targets, although a little bit more qualitative than just a single digit like we have here, is, of course, north of this. So it's not a case where we know what to do until 100 and then we have no clue. We know what to do to continue to grow this company and we have the strategies in place to do that.

Also on the financial performance of the company, why don't we guide up when we have already exceeded it. Well, we want to kind of send the message here that growth is, as I said, the best way to create shareholder value in this company, and we will continue to grow this company. We will continue to invest. And there are many, many years before we decide to turn it into something else than what it is.

So we have absolutely no reason to doubt our long-term ambitions. We know, of course, that people are talking about a change in the economic environment. But it's very difficult to talk about something that you don't see. We are not seeing any weakening in demand for our products, and that goes through Q4. It also goes into Q1. We have now operated 6 weeks in 2023, and we continue to see a very, very good demand for our product and inflow of orders, et cetera.

So it has not happened yet. And will it ever happen? Well, coming back to what I said, we are the challenger in the market. We are the low-cost alternative to -- in many, many applications for transporting bandwidth. So I would like to reiterate that if you go out and you start looking for a way to optimize your CapEx as a customer of this type of technology, you will see Smartoptics. You will find Smartoptics and everyone has a good reason to talk to us at that point.

So yes, one should be very humble when talking about these kind of things, but I'm actually seeing a great possibility for us in relation to this. So all of the financial targets remain, and we are keeping laser focus on these numbers, and we will continue to grow. So that's it.

[Magnus Grenfeldt, executive]

We have a portal here with potential questions. Give me a sec. Okay. So we have one question on the portal, which is how is cash flow start of 2023? Is the accounts receivable down in 2023? Do you need more cash? Mikael, do you want to take that one?

[Mikael Haag, executive]

Yes. So short answer, very positive start. No need for any more cash. So very, very solid position and very sort of -- the accounts receivable that we built up in Q4 is now translating into cash in January, February and March.

[Magnus Grenfeldt, executive]

Very good. We have no further questions on the portal. And if there are no questions in the room, then thank you very much for listening in, and I hope you get a good day. And to those here in Norway, have a good vacation, if you're going up skiing on the school holiday. Thank you. Bye-bye.

[Mikael Haag, executive]

Thank you.