HMS Networks AB

STO:HMS

Earnings Call Transcript 2022-Q1

[Operator]

Welcome to the HMS Networks audiocast with teleconference Q1 2022. [Operator Instructions] Today, I am pleased to present CEO, Staffan Dahlstrom; and Joakim Nideborn, CFO. Please begin your meeting.

[Staffan Dahlstrom, executive]

Thank you, operator. Good morning, everybody, and welcome to this beautiful beginning of Easter morning here. So it's a pleasure to present our Q1 report. As normal, I will start with a summary and introduction of our business, short business update, but I know you all are waiting for Joakim to update on the numbers. So he will take the financial results at the end.

So let's quickly make a review of Q1. I must say that we are pretty happy with the situation despite the component shortage and the challenge we have there. Order intake continues to be very strong. But keep in mind that part of the strong order intake is not only market demand, it's also a compensation for long lead times. So also, our customers are building out inventory, and we try to be very transparent about the boost order, and Joakim will dive into this later. But also net sales growth of 14% in considering the chip shortage is good. We've been fighting a lot for reaching this number. We are very satisfied that we are keeping growing despite the challenges we see on the component side. So this is fine.

And EBIT, note that we have an event here where we have a balance sheet change revaluation. Joakim will talk more about this. Take a look on the adjusted EBIT and adjusted EPS, that we are maintaining a good strong EBIT. Adjusted EBIT margin, 21.7%, over our target. We are happy with that. Cash flow is good, but not as good as it used to be. Reason why is that we are building up more inventory, but trust us, we are very happy that we are building up some inventory as well because this will help us going forward.

So all in all, positive Q1, and I think we can skip the rolling 12 and move into our business updates.

Some of you know our business very well. Some of you are new. But just a summary, we are -- HMS is hardware meets software. We make sure that industrial machines and devices can communicate both with each other and different IT systems. We have the integrated offer of our 4 brands of Anybus, Ewon, Intesis and Ixxat, and this is integrated and use the same go-to-market channel around the world.

We made a couple of acquisitions, smaller acquisitions last year. German, WEBfactory, software company, we started with 75%, we now own 100%. Procentec, a Dutch company working with network diagnostics, very interesting. We started almost 2 years ago with 70%. And early this week, we acquired the remaining minorities. We own now 100%. And the small but very interesting Spanish, Owasys, working with communication solutions for mobile machines, where we own 60%.

So when we look on our business, if we move to the next slide, we have 2 major customer groups. We have the makers of industrial equipment, companies such as Atlas Copco, ABB, Mitsubishi Electric, but we also have users of automation system. These are companies that use automation systems such as BASF or Volkswagen or just kind of pulp and paper kind of companies.

And if you look on our go-to-market on the next page, this is quite important. Because on the maker side, we have 2 typical customers, either device manufacturers, making different devices, drives, robotics, these kind of machines. This is 43% of our revenue. And there, we have a business model that is very sticky. We are working with design wins. They integrate our technology inside their devices. But we also see that the flip side of that good, sticky design win model is that we also have a very -- we need to have a lot of sales initially before we get revenue. So it's a long sales process, but it also remains a design win for up to 10 years.

Secondly is our machine builder business. This is today or last year, 35% of revenue. There we try to be part of their bill of material. Of course, we always dream about becoming a standard part of bill of material. In most cases, we are more an option. So when this machine need a remote access or when this machine needs to connect to certain manufacturing line or something like that, then they add an HMS product to that bill of material. We go to market through direct sales with large customers and distribution sales with many, many small machine builders around the world.

And finally, we have our end users and system integrators. It is a smaller part of revenue, but we also see good growth here. Here, we either work with system integrators to help them in a large project where we help them specify the right communication technology and the right products from us to solve their big projects. But we also have like a traditional product sales. We advertise our products on our websites and marketing channels. And they just find that our product fits very good to the requirements they have there. So we work here with traditional distributors, quite good growing, e-commerce distribution as well towards this market of end users.

So let's take a look at our vision and our targets going forward. We have a vision to become the world's greatest industrial ICT company. We believe that the way to go there is to follow our mission, and our mission is to enable valuable data and insights, allowing our customers to increase productivity and sustainability. And this is a good market to be at because a lot of our customers, they realize that there's a hidden information inside their machines. And if we can liberate this data and connect this to their other system, it can help them with their productivity, but also for their sustainability in energy saving and doing things smarter.

Our group objectives for 2025 is environmental. We want to become a company that is net positive in our CO2 emissions. We do things here internally, but we also work a lot with our customers, but we see a big impact using our products, which is helping our customers to do a major savings in their CO2 emissions going forward.

We also believe that if we can have happy and high-performing employees, they will generate loyal customers, and we really like loyal customers. So we focus a lot on net promoter scores with our employees and also with our customers. And we rate well beyond our target at the moment. We are very happy about that. And we also keep on being a growing company with good profitability. So financially, we would like to be beyond SEK 35 billion in 2025 in our revenue, a combination of organic growth and some acquisitions and maintaining well EBIT margin well over 20%.

So this is our target. And how is it going? Well, if I start with a short business update from Q1, it's very similar to the previous quarter. We see a strong demand across all geographies we work in. Drivers are increased automation, digitalization, energy monitoring, remote access and now also more and more sustainability and also electrification -- and we see super strong growth on all markets. Part of this, as I mentioned before, it's a market where we and our customers and our other suppliers have problems to find electronic component. And we have long lead times. Our customers have long lead times, and this is also building up boost effects in the order book. So we are estimating that part of this good order intake is also a boosting effect orders that are placed earlier than normal, and we estimate this to be SEK 250 million in Q1.

We expect the situation to continue for the remainder of the year, but we are expecting that the situation will be better from second half of 2022 here. So we are seeing some light in the tunnel when it comes to component availability.

And as I mentioned, we acquired the remaining minorities of Dutch Procentec earlier this week. So we now own 100%, and we are super happy with this company. And we believe that as a 100% owner, we think we can accelerate the commercial success, especially in North America and Asia, where Procentec themselves have been not focused enough and they didn't have the local organization. We have that, and we can now scale this business up.

So all in all, a good business quarter for Q1, and we are, as you hear, quite positive about the future. So Joakim, let's talk about some numbers.

[Joakim Nideborn, executive]

Thank you, Staffan. I will do that, and I will start with our order intake, which is extraordinary SEK 857 million, as you already know. And looking at the graph in the top left corner, you see that this is continuing on the very good trend from 2021, also reaching now new record levels.

So with a 41% organic growth, we were, of course, quite satisfied. And as Staffan said, we have this boost effect of SEK 250 million, which is a large part of that. But the underlying market is also quite strong, and we see a lift from previous quarters also here. If we do the adjustment for this boost effect and also taking away currency effects, we see an underlying organic growth of 14% in orders compared to the already strong Q1 2021.

And looking at the book-to-bill, this is significantly better than our sales level and book-to-bill of 1.66, which is, of course, extraordinary for us and not a sustainable level to be at going forward. And we think what we will see going forward when we hope that the supply chain will stabilize somewhat, we think that the order intake will come down, this boost effect will go down and disappear towards maybe towards the end of the year or so. And then our sales levels will also increase when component availability becomes better. So that should be normalizing.

And all brands are growing. That's good to note. The driver here is our Anybus business with 60% organic growth. And the main reason why this is driving growth is because we see the sanguine business where customers have our devices as a part of the bill of material. They are very afraid that they're going to go dry on our stuff. So that's why we see this order placement for out in the future. And we already have many of our large customers that have placed the full demand for 2022 already now. And the expansion and this boost effect is really that more and more customers are realizing or that this uncertainty in the supply chain will continue for a bit and they want to make sure to have as much as they can in their own hands. So that's the main reason for this situation.

Going over talking about sales. Also quite okay quarter with SEK 517 million and 5% organic growth. We see that for the first time, we have rolling 12-month sales over SEK 2 billion. So that is a bit of a milestone for us, good to see. And we knew that we wouldn't be able to match the Q4 for numbers. We also talked about that in the -- when we released the Q4 report. We caught a bit of a break on the component side. And to be honest, right now, it's really component availability that is deciding our delivery levels. And Staffan talked about it a bit already. We know that Q2 is still looking quite challenging. We hope at least the picture that we see now is that Q3 and Q4 will be better. Difficult to say how much better, but we think that we'll be able to reach somewhat higher levels towards the end of the year on this side.

Also worth mentioning on the building automation side, that's been -- I'm not going to say bad, but it's been a bit more hesitant than the industrial automation part of our business the last 2 years. Here, we're now seeing good growth of 32% within the INSYS brand. So that's also a new record quarter for Intesis. And we think that now in the lockdowns are released, we'll be able to have a decent market also for the Building Automation business, even if it's a rather small share for us about 10% of the overall group. I wanted to show you, I think you maybe already made the analysis itself, but the order intake in -- or the boost effect of order intake in relation to the total order intake. Here, you see what we've been communicating over the last 5 quarters.

You also then announced that Q1 '22 is the highest level of this boost effect. It's also by far, the highest level in total, but we see that the underlying demand has bumped up a bit from levels around SEK 500 million to now beyond SEK 600 million. So the underlying market is strong. We're quite happy with stones been through the drivers and -- but still, we have this high boost effect. And how that plays out to our backlog. You'll see on this slide, when you see that our backlog has increased more than SEK 300 million from Q4. So we are now at about SEK 1.2 billion in order backlog, which is very high for us. right unused to this high level.

We also see that we have about 50% of our orders were delivered more than 300 times. And then there's still a bunch of orders that we haven't confirmed. So the real number should probably be more than 60% since there will be only a small share of unconfirmed orders that will be confronted within the coming 3 months. So it's an unusual situation for us. And we believe that even if now the supply chain will be stabilizing, we don't expect this to fully normalize to the levels between maybe 15% to 20% out of orders for delivery more than 3 months out. We think that customers will have adjusted to a different way.

The just-in-time thinking might not be back as we've seen before, at least not in the midterm. Sales per region looks like it normally does. We have about 60% in Europe, 20% in Americas and 20% in APAC. So this is pretty much a picture that we see for Q1 as well. So nothing strange there. -- let's then also take a look at our profitability. -- we -- as you've seen, we reported SEK 139 million, but the adjusted number, which is more relevant is SEK 112 million and 21.7% margin. The difference of this SEK 27 million is related to a revaluation of option-related debt for Procentec.

And as you understood, we acquired the remaining shares 2 days ago, and we already knew the purchase price that was pre-agreed. And we knew that when we went out of March, so we could determine this purchase price perfectly already end of March. And the difference than the SEK 27 million. That is a positive EBIT effect only onetime effect that we have now in Q1. No cash flow impact, but it's still there -- so the relent comparison is then SEK 112 million.

And I say we're quite happy we've been able to deliver 21.7% margin in this climate as we have at the moment. And the gross margins of 61.8%. We're also okay with that, even if it's a drop from the 64% we had in Q1 '21. We see a negative effect from price increases of a bit more than 3 percentage points. So I mean this is something that we had impact from also second half of '21, but it's escalating. So we see even higher effects now. And the same will be for Q2. I mean going forward, the price increases on the components will be there.

The difference is that we are now pushing that around our price increases that's been implemented just recently, and that will also start to show effect a little bit from Q2, but the main part from the second half of '22 step-wise improvement on that side. So we hope the gross margin should be able to improve during the second half of the year is basically what we're saying here. Also worth mentioning EBIT -- sorry, OpEx increase up 11% organically. -- pretty much related to sales and marketing initiatives, where now everything is opening up again. We can do more activities.

We think it is good investments to do for the long run, and we're happy that we managed to get some good new colleagues to drive new sales in actually in many of our markets. Going over to earnings per share, SEK 2.41, but maybe more relevant to look at the adjusted SEK 1.84, so basically in line with the last couple of quarters. Nothing strange to comment on here. It's good to see that we are on these levels. Let's have a look on the cash flow as well. So here, we have a pretty big drop compared to the previous quarters as well. And Staffan mentioned it already, we have a SEK 50 million buildup of working capital, out of which about SEK 30 million is related to inventory buildup, which this sounds strange to say, but we're quite happy that we've managed to do that. It's not easy these times.

And what we're trying to do is improve our odds to deliver when we get those key components that we hopefully will be able to get more of in the second half of the year. So this is in line with our plans. At the moment, we are not optimizing our inventory too much. It's -- we feel like we have a good -- we have the money we need, but we need to have the delivery capacity. So it feels like a given thing to do. Working capital, all in all, is still on very, very good level, 6.6% of sales. And this will move north a little bit. We still think this will remain below 10%. So all in all, in control.

Final slide before we let you ask questions, looking at the balance sheet, -- and here, we have a net debt of SEK 299 million. The main difference compared to last time is this revaluation of this option-related debt of SEK 27 million. Other than that, we've been expanding the cash a little bit, but a small decline from SEK 347 million in Q4.

So looking at the metrics, net debt-to-EBITDA, 0.52 in good shape, and we feel that we have the firing power we need in relation to our M&A pipeline. So that feels good going forward.

And with that, I'd like to hand over to the operator and see if we have any questions on the line.

[Operator]

[Operator Instructions] And our first question comes from the line of Joachim Gunell, DNB Markets.

[Joachim Gunell, analyst]

So starting off, can we please talk a bit about -- I mean in light of the stellar organic growth, thank you for being so helpful with describing what is actually on your perception of underlying organic growth. in the order backlog and what's driving that? Can you talk about the inventory levels that you're seeing in the channels at your various customer groups, if you can divide that into device manufacturers, machine builders, et cetera, and perhaps what is -- what are these customers -- what of these customer segments are actually driving growth where we stand out?

[Staffan Dahlstrom, executive]

I think if I start with that, and Johan can fill in. If we look on this picture I show here with device manufacturers and machine builders and end users, we feel that most of the device manufacturers, they fill up their inventories, they place orders much longer than they used to do in the past. So the majority of the boost effect is coming from here. And as Jose mentioned, we have a lot of the Anybus business in this group.

When it comes to the machine building and end users, we feel when we talk to our distributors that they have real demand behind each order, at least when we talk to them, sometimes we get a feeling that this is the story they give us just to be -- so we don't prioritize other orders. But I think that the major buildup is on the left side of this picture. And on the right side, we have very little inventory that is excess inventory. What we have there is sold by the distributors very quickly.

[Joachim Gunell, analyst]

Understood. And can you say anything about what Certain verticals if it's general manufacturing or if the process industries, et cetera, that is really, I mean, standing out in terms of pockets of growth.

[Staffan Dahlstrom, executive]

I will say that it's very broad. In some markets like in Japan, we've seen especially good development in automotive, electronic manufacturing, of course, but the traditional industries, manufacturing in general, process industries, food and beverage, pulp and paper, we see that there's good demand in almost all segments, semiconductor. So I think it's broad based, both in geography, but also in verticals.

[Joachim Gunell, analyst]

And how should we think about -- historically, we've seen this trend where when you're showing this positive trend in the book-to-bill that has obviously a boost effect on the margin trajectory in HMS. So how should we now balance in that we are seeing book to be last very high levels. You expect this to be real demand and then all less equal, it would be fair to assume that, okay, we'll see a declining trend in the book-to-bill as we deliver on this order book. balancing in that, okay, gross margin is obviously also higher in HMS at this stage. Would it be fair to assume that, okay, for this year and perhaps the next based on what you see in the order book, they shouldn't necessarily have to be, call it, a margin decline from current levels in HMS? Or is there anything that is different in this time around, so sale?

[Staffan Dahlstrom, executive]

I must say that it's very -- I understand your question and it's difficult. It's a good question. We work with this on a weekly basis here. We were expecting the boost orders to go down. And this is what we see in quarter 1. So we are -- obviously, we were wrong. So it's difficult to say. I think a lot of our customers are feeling that let's play some extra orders, it wouldn't hurt. They have good demand, and everybody is positive. So I think this boost -- we expect the boost orders to level off later in the year, but it will probably take longer time than we think. That's our feeling right now.

Secondly, with margins, we see a quite dramatic price increase on electronic components. On some components, we see 10x or 20x higher prices than regular. So we are fighting this quite much, but working on the spot market, then the price is high. So we are trying to mitigate this with price increases to our customers and balances. But our ambition is to maintain our margins through this, but it will be some changes per quarter based on product mix and how successful we are, but also the timing effect, some of the price changes we do take a longer time to get impact on when we have this big order book. So it's -- I understand I don't give you a clear answer because we don't -- we simply don't know. We are following this very careful, but it's very difficult to estimate. Joakim, do you have anything more to say on one here?

[Joakim Nideborn, executive]

Yes. Now maybe as I think right now, maybe it doesn't matter so much when we get orders. That's not going to make a big difference from when our sales come. What we think is that what we see that the underlying demand is strong and it's growing. So we believe that sales will, as long as we manage the source components, sales will have a solid journey for the coming quarters. And with that, yes, well, I don't see why we shouldn't be able to maintain decent margins as well.

[Joachim Gunell, analyst]

Perfect. And more to other top-level question. Can you say anything about -- I mean, what your current priorities are from an R&D standpoint?

[Staffan Dahlstrom, executive]

I think right now, unfortunately, I must say, we put a lot of effort on redesign of existing products, just to be able to ship them. So unfortunately, we need to allocate R&D resources on things to maintain our business rather than developing it. So I would say that maybe half of our R&D resources today is allocated into projects to maintain our current business. If you look at them on technology, we haven't talked so much in this report about new things such as 5G.

We are continuing that journey, but we've seen some success there. But we -- as we've been saying for quite some time, these new technologies take time to get success in industrial automation. But we are -- keep on seeing some good success in mining and special applications, but it doesn't really move the needle from a top line -- total top line at the moment. But I think R&D on new things is related to 5G, IoT. We spent quite much time now on energy battery energy systems, storage and stuff like that. So that's a new area there in R&D.

[Operator]

[Operator Instructions] Your next question comes from the line of Viktor Högberg of Danske Bank.

[Viktor Högberg, analyst]

So just a couple of questions on your current visibility on delivery capacity and what to expect because you're quite clear there is a daily challenge in terms of sourcing components what to expect in the near term? Will you be able to maintain this level in terms of deliveries for Q2 as you saw in Q1? Or do you expect it to be gradually better Q2 and then materially better in Q3 and Q4? Could you help us along the weather?

[Staffan Dahlstrom, executive]

Q2 is very difficult. I think if you look at Q1, we had a weak January and February better than expected in March. So it's a little bit the timing effects on deliveries and components. We are quite concerned about the short term like Q2. And after that, we are expecting a gradual improvement, but very difficult to say what we land in revenue in quarter 2. We don't have that visibility today. It's too much uncertainty.

[Viktor Högberg, analyst]

Would you dare to say, a range of possible outcomes?

[Staffan Dahlstrom, executive]

Not me, but Joachim, do you have the guts to do that?

[Joakim Nideborn, executive]

Yes, I can give you a wide range. But I think honestly, I think we know that Q2 will not be great. It could be plus, minus 10% from where we are today and probably more likely on the minus side. We think what we hear is that Q3 and Q4 should be better, but it's still only promises from suppliers that's been changing many times before. So we don't know, but we think it looks better from what we hear. And there, I do not want to give a range because it's way too uncertain.

[Viktor Högberg, analyst]

I get that. Given the order intake now of it with deliveries further out in 3 months, how much of that is for deliveries in 2023? Because I assume there are some orders for 2023 as well in the order backlog. Just thinking about what to expect in terms of delivery, the mismatch in delivery capacity and the orders customers might want it in H2, but will you be able to fulfill all of these -- the order backlog given the current situation?

[Staffan Dahlstrom, executive]

So that we think we will be able to. And about 10% of the current backlog is for 2023. The problem there is that on the pricing side, it's still quite uncertain what the component pricing will be. So it's a bit difficult to agree in a price with the customers for 2023. But we think we'll be able to -- we're quite convinced that we'll be able to get out to the backlog for 2022.

And that was dominate to the sorry. And there also actually, I would say, large portion of our order book is not even fixed in delivery dates from HMS yet. So we are still struggling with some of these things. So it's a high uncertainty on some of these orders. And if it comes in quarter 4 or quarter 1 next year for delivery, it's -- I just want to flag for this uncertainty that we don't really know that.

[Viktor Högberg, analyst]

Yes. No, no, I get it. So the order intake level here seems to be on an underlying level, some SEK 600 million. Previous levels have been around SEK 500 million. And you're quite clear that you see strong demand all over the place geographies and products and verticals. Do you think you've taken another step here in terms of underlying demand? Or is there something special now in Q1?

[Staffan Dahlstrom, executive]

I think the drivers we are seeing longer term is really supporting our business, and I talked about these drivers. Even if there are uncertainties in the world around us, we still believe that these things are strong when it comes to improvement in automation and digitalization in our industries. We think this will continue. If the SEK 600 million is a new level, we are -- maybe we are -- we would like to grow quarter-by-quarter. So the SEK 600 million is not surprising to us. But if it comes in this quarter or next quarter, it's difficult to say. But of course, having a revenue on that level is our ambition for the future, of course.

In terms of price increases, you said that you pushed another round now to your customers. Can you help us with what kind of magnitude we're talking about? Here, we're talking about single digit -- high single digit. We did this at starting the year. We do another round of a high single-digit increase across the line. We are also doing a smaller single-digit adjustment on the order book, and we are having good discussions with customers. Of course, they are not happy with prices, but they -- quite many of our customers say, "Okay, you as well. So a lot of suppliers are raising prices. We don't feel that we are sticking out with our increased prices.

So I think we are following the -- what almost about to say the norm in our industry with these price increases. So I think we are getting away with it. The question is always that what is the conversion? Do we get 100% to convert to new pricing or 80% or 60%. So there will always be customers with pushback and that we need to deal with in some ways. But we are happy to see how successful we've been on price increases beginning of the year, but also this new thing we did from 1st of April has been quite successful, I would say.

[Viktor Högberg, analyst]

Do you think this -- in a situation sometime down the line when sourcing on a global level normalizes customers or not everyone's grading to get the same stuff at the same time. Do you think there's potential for prices to come down again? Or will these price levels stick. I'm thinking about your prices and the prices your suppliers say that you will have to say here, what are you thinking about the price level in the normal market again when that will be?

[Staffan Dahlstrom, executive]

Yes. I think that today -- this is just guessing, but I think today, we are on a high level. I don't think it will go back to what it was a couple of years ago. Competition is still there. But commodities, energy and everything, transportation is changing. And until these go back to 2018 levels or something like that, I think will remain on higher pricing.

We also see that in summer application, the pricing on our product has been less of an issue than we thought. Now we see that some customers, they say, we are still only a few percent of their machine cost. So we are -- we don't feel that we get super high pressure on the price. So I think in some applications, we believe that this high price will remain. In some, it will go back. But I don't think it will go back to what it used to be. But our cost is also increasing. Our ambition here is to maintain margins. That's our outlet goal here. And margins you're speaking about EBIT margins then...

In Dean gross margins.

[Viktor Högberg, analyst]

Okay. Because you're trading at an elevated level compared to your targets which were set before the situation really accelerated. Your growth consider to be above organically considerably above the target level or the target implied level and margins considerably above as well. Do you see a need to revise those targets? Or do you think they're still valid on a longer-term horizon that we are just in a very special situation last this year.

[Staffan Dahlstrom, executive]

I think we look on what we said here, when we started the journey towards 2025, we said that we would like to be over pie billion Swedish, SEK 3.14 billion, and we said that would be a combination of M&A and organic growth so far during these 2 years. Our organic growth has been way, much better than we expected back in 2020. But we've also been a bit slower on the M&A side. So right now, we have no plans of changing the targets in the short term, but maybe this is something for now 2023 to revisit. But right now, we feel that we still have work to do to reach the SEK 5 billion, but let's see how that develops. I think we feel very comfortable about the targets. And then maybe that's a good indicator that there should be changed going forward, but we are not there yet.

[Operator]

And there seems to be no further questions from the phones at this time. So I'll hand the floor back to our speakers.

[Staffan Dahlstrom, executive]

Thank you very much. Joakim, any additional comments from your side?

[Joakim Nideborn, executive]

No, I'm happy with this.

[Staffan Dahlstrom, executive]

Great. So then it's up to me to say thank you very much. Thanks for following HMS. Thanks for joining this call, and I wish you all a happy Easter and some days off, and then we are back on work to keep on fighting for components and increase revenue for the coming quarters here. So have a nice Easter, and thank you.