HMS Networks AB

STO:HMS

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen, welcome to the HMS Networks AB Q2 Report 2020. Today, I'm pleased to present Staffan Dahlström, CEO. [Operator Instructions] Speakers, please begin.

[Staffan Dahlström, Co]

Thank you. Good morning, everybody. Welcome to this HMS Q2 report. Myself, Staffan Dahlström, will start this, and then Joakim Nideborn will take over and give you some more details about the numbers. Next, please, Joakim. So let's start with the summary, and we'll go into the numbers. And I suppose some of you have seen the report already where we have weak development on the net sales and order intake, minus 15% and minus 19% mainly due to corona. And Joakim will talk a little bit more about this. However, we've been working quite hard to mitigate the reductions in revenue, and we've been working quite well on -- maintained the EBIT margins. So on EBIT, we are more or less on our long-term goal of 20%. We are 19.4% on the EBIT margin, and we also work very hard on the cash flow. So we feel that we have been managing things well, the things we can control, during this quite weak market development due to corona. And we have a good EPS of SEK 1.24. So weak on the top and better further down in the P&L. Okay. Just a few words about HMS for you who are not so familiar with our business. Our business is to connect devices, mainly in industrial applications, high reliability applications. We have 4 brands, Anybus, Ixxat, Ewon, Intesis. And last year, we also bought 75% of a German software company, WEBfactory, and this is our step into more of a software and digitalization of data. Our customers, next please. Our customers are divided into 2 groups. We have our main business with makers of industrial equipment. This is a company who make industrial machines like packaging machines and medical machines, windmills, AGVs and these kind of things. And we also have companies doing industrial devices such as drives, robot controllers, circuit breakers, et cetera. This is majority of our business. We also work with users of this equipment in industrial automation where our 4 main areas is manufacturing, energy and infrastructure, buildings and HVAC and transportation logistics. And here, we provide these customers with communication solutions that integrate different things normally in their manufacturing or industrial process side. So users and makers are important to know. If we then look at our revenue in quarter 2, between users and makers, we see this looks, more or less, in general, quite much the same as previous quarters. The major business we have is with makers. We have our business with embedded product that is integrated deeply into makers' products. This is half of our revenue to makers. We also do routers, gateways, these kind of communication products that integrate different systems and products on the industrial processes. And here, we have a mix of users and makers. And we have a small but growing part of software and subscriptions and services. This is only 5% of our business today. And it's divided more or less 50-50 by users and makers. Okay. Let's move into a business update in this difficult corona times. It's been a challenging macro situation, especially, I would say, on our European markets, Germany, France and Italy, where we've seen big impacts on lockdown and also customers are waiting to make decisions. So this is where we see the big impact. U.S. was quite okay, quarter 1, but now been impacting more on the order intake due to the situation we see in U.S. at the moment. However, we are almost surprised, but happily surprised that both Japan and China are holding up well, and we show growth on order intake there. So it's a mixed picture. But the decline we are seeing in general affects all our brands. We are seeing double-digit decline in all order intake. So it's not only 1 business. It's all over our brands. We've also been very focused on converting into more digital events during these days of limited traveling and customer interactions. We have done 128 digital events last month, generating over 5,000 leads and registered attendees, so we have over 5,000 engagement hours with customers' leads at the moment. So we are pretty happy that we've been able to move from traditional trade shows and customer seminars into digital events, and we see a quite good interest in this. And of course, our customers, they're also grounded at their homes so they also have time to attend these digital events. If you just look on our corona update, we are very happy that our teams are okay and healthy. So from a health point of view, our organization is okay. We've been implementing a short-time work in Germany and in Sweden for part of the time in quarter 2. And we've been successfully mitigating any problems with supply chain. We have some issues in Spain where we have our factory there closed for a couple of weeks due to regulations in the Barcelona area. But I must say that we are impressed about our supply team, how well they've been working during these difficult times. And I can't recall any customers complaining about lead times or lack of equipment, so it's been working out very well. Looking forward, we expect that this will continue for quarter 3 and a couple of quarters going forward. We see a soft market, and we will also continue to work with short-time work in Germany. However, in Sweden, we grew up to 100% work time now since we see that we have a lot of projects in the pipeline, and we want to focus on some R&D projects, and we need our staff back at 100%. But we are monitoring this, and we can also go back to short-time work in supply chain and things like this, if needed, going forward. But right now, we focus on full-time work, except in Germany where we have limited timework still. We also canceled most of our fairs for rest of 2020, and we continue the successful path on digital events. So the strategy we have is unchanged. We want to sure make that we keep our teams intact and we do what we can now to focus on gross margins, cash flow, OpEx reduction, but also long-term investments in R&D and innovations. Because we believe that when this corona time is behind us, we think that's a good market opportunity for automation and digitalization. We think that some of the things we have seen during corona will probably increase the level of adoption of these systems at our customers. So all in all, from my side, it's been an eventful quarter, weak on the top line, but better further down in the P&L. But Joakim, please take over and talk more about the numbers.

[Joakim Nideborn, Chief Financial Officer]

Thank you, Staffan. I'll do that. And I'm going to start with the order intake summary as we normally do. I mean as you know, SEK 302 million, that is not where we want to be. But given the situation, it is a tough, tough market out there. So I think we saw this already when we released the Q1 report. We guided that we were 20% down in April, and then we basically saw that the same pace should continue in the short -- in the near term. So that's what we've been seeing. And on top of that, we can also say that, I mean for the first quarter, I think in a few years, we are actually having some headwind from the currencies. So organically, we're only down 17%, but reported 19% down. We had also, as you might recall in Q1, a few stocking orders in March. That was extremely good order intake in March, which probably meant that some of those orders would normally come in Q2 otherwise. That also affects a little bit the big deviation from Q1 to Q2. But then we have the main thing that we have there, Continental Europe market, that's been slowing down rapidly. And our 3 biggest markets there, Germany, Italy and France are all down substantially. Italy and France are actually down more than 50%. Germany, a bit less, but still, I think, 20% down in Germany. And also U.S. is now coming on to that 20% decline compared to a decent Q1. So there you have the big things impacting. It doesn't help us that much that we have Japan and China which is very positive, but they're growing actually more than 20% both in Q2 and year-to-date. So we're very happy with that development. But when the bigger markets as Continental Europe is down, it's tough for us. And as Staffan said also that all of the brands are down more than 10%. Anybus is leading the decline. And on the brand side, I think we're down 18% in Anybus, and then the other ones are between 10% and 18%. So it is a wide decline on all markets across our customer segments. And currently, we expect about this situation will continue on a similar path. We don't see anything getting worse, but we don't really see an improvement either. I think July has started in the same pace as we've seen now for Q2 on the order side. Okay. Let's have a look at the sales. I think we had a decent backlog going into Q2. So I think the sales is not that badly affected, SEK 355 million, even if when we compare to Q2 last year, which was a record quarter for us with a lot of backlog being delivered out in Asia to our bigger customers there. But comparing to that, I think we were down 15%, organically 14%. So of course, that's a big decline. And here, it's a little bit of a different picture. It's still EMEA that is responsible for the majority in this decline. Americas is actually plus 4% with a good backlog from previously. And then Asia is minus 8% compared to the strong comparable. Asia is actually not that bad in absolute numbers, it's just that the comparison is really, really tough for us. And I think now with the order intake we've seen in Q1 -- sorry, Q2, obviously, Q3 will be challenging on the sales side. And I think it will be tough for us to reach the same levels as we did in Q2. So looking at the sales per region. This looks a little bit different compared to what we normally see in Q2 since EMEA is down a lot. We're now actually on 56%. And normally, we would be just over 60% of our total sales in EMEA. Americas is on 24%, and Asia is now on 20%. So maybe now over to the better part of the report when we go down the P&L, looking at our EBIT level. Here, we are quite satisfied being able to deliver SEK 69 million or 19.4% margin given the weak development of the top line. So we're actually almost at the same level as last year even if we had a decline of 15% in sales. So a couple of things that are helping us here. First is the gross margin that is a bit better, 62%. I think we've been doing some good things on the cost side, also some selective price increases that has been helping. And we have a good product mix, especially within Anybus, where we have less embedded sales to our bigger customers that normally will have a bit of a lower margin. So that is helping a bit on the mix side as well. So despite the lower volumes, we managed to improve the gross margins, and we're very happy with that work. So also the OpEx decrease is, of course, helping to impact. And we say here that we have a decrease of SEK 21 million. Organically, it's down SEK 25 million. And just to help you understand, those SEK 25 million, what that consists of. It's basically 2 things: one is the fact that we made this restructuring program in 2019. That is helping with about SEK 11 million. And then we also see some corona effects of about SEK 15 million, so about SEK 5 million per month where we have less traveling, less customer events. Instead, we're doing the digital activities that Staffan talked about before. So I think this is something we can definitely learn a bit from the future as well to be better on the digital side. But we see this decline with a SEK 5 million per month, and we expect that to continue for the coming time as well. On top of this, just to make it a bit more complicated, we have some other things impacting the OpEx as well. We have received some governmental support, in line with the short-time work we've implemented that's helped us with SEK 8 million OpEx reduction. And as we said before, we have now stopped, 1st of July, we stopped the short-timework in Sweden, focus more on the future development for the brighter times after the corona crisis. So it means that we will have a slightly lower governmental support for the coming time. Also, we made a write-down of WEBfactory goodwill of SEK 14 million, which is also impacting, of course, negatively then on the result side. So this disbursed the situation a bit. But organically, we're down 25%. And the other 2 items, I think we will not see that much of going forward. So also, year-to-date, I think we've been doing quite well protecting our EBIT. We're actually up SEK 4 million compared to previous year despite a substantially lower top line. So I think we're happy with that work. And also, the gross margin has been good in Q1 as well. So we're happy to see an improvement year-to-date of about 2% on the gross margin side. And currently, we don't really see why that should decline if the volumes would be on the current levels. So EPS, I don't have a lot of comments here. I think it's pretty clear -- pretty clean from EBITDA to EPS. Good to see that we can actually do one of our better quarters with SEK 1.24 on the earnings per share. So we're very happy with that. And then over to the cash flow situation, which is very strong in the quarter with SEK 115 million, I think it's our best cash flow ever in the quarter. And I think, first of all, we have a good underlying EBITDA that is helping this. And then, of course, we're doing some things on the inventory side, getting down the inventory with SEK 12 million. And then we also have some positive working capital improvements that helps by, in total, SEK 18 million on the cash flow side. On top of that, you might remember that in Q4, we got a tax return or we got a decision that we will get a tax benefit in Belgium. So now we've also gotten this tax return of SEK 10 million, which is helping the cash flow, but the impact from the tax is very low on the cash flow side. Also, first 6 months, we're doing good with SEK 170 million cash flow compared to SEK 103 million. So it's good to see that we're managing to convert -- also in these tough times, we're managing to convert the receivables in a good way and deliver this nice cash flow for us, which then has also helped us to take down our leverage substantially. We're down at SEK 263 million in net debt. So you see we've taken down the net debt by 50% compared to a year ago. Of course, the fact that we decided to cancel the dividend helped a little bit on this side. But still, the nice cash flow is really helping us. And I think we have now with net debt -- I think net debt-to-EBITDA were 0.73. That's right, yes, it is 0.73, so I think we have a very good situation when it comes to going after further acquisitions and invest in R&D. And I think that is why we're now going back to 100% work in Sweden. And we're also looking for, as we always do, for some interesting candidates for further acquisitions. And we also -- on top of this, we have the possibility to issue new shares up to 5% of the market cap. So we have the firepower that we need. Now we just need to find the right targets and be able to execute. So thank you for that. I think let's hand over to the operator for potential questions.

[Operator]

[Operator Instructions] We have a question from the line of Joachim Gunell from DNB Markets.

[Joachim Gunell, Junior Analyst]

Staffan and Joakim, so obviously, impressive margins and cash flow, I must say. But can you give us a sense here of what portion you would say is, say, permanent and carries into 2021? I mean you provided here a split on the, I would say, short-term work as well as government support. How should we think about the OpEx levels going into 2021?

[Joakim Nideborn, Chief Financial Officer]

Okay. So maybe I'll take that one, Staffan. I think what we've been doing, of course, we've been quite careful on taking on new cost for the full year when we saw this situation approaching. So we're running a little bit skinny at the moment. I think if we look at the relevant parts with the sales, admin and R&D parts, we're doing SEK 146 million in OpEx in the second quarter. I think for now, that is a pretty fair run rate that we have. And at the short term, until we see any major market improvements, I think we're going to try to be running at this pace basically. And we have, of course, the, as I said, the SEK 8 million governmental support. We're now canceling that in Sweden. So that will maybe impact them with some -- let's say, that's half of the SEK 8 million benefit. So with everything in the same way in Q3, we would be running with SEK 150 million. Then we also -- in Q2, we also have some vacation effects and stuff like that. But I think a fair run rate would be about SEK 150 million at the moment. And currently, that's where we're going to stay.

[Joachim Gunell, Junior Analyst]

Very clear, Joakim. And as I think about demand in your end markets and how it has -- I mean how you have experienced this in previous downturns. What is different perhaps, I mean now that -- I mean have some visibility returned? Or how do you expect the end markets to rebound now? Once again, you -- 2019 was already weak. So I mean we have some easier comparables, et cetera. So how do you think about that?

[Staffan Dahlström, Co]

I can take this, Joakim. I think it's a bit too early to say. If we look back on, for example, 2009, it was a quick downturn, but then a quite quick ramp-up again. I'm not sure how this will develop this time. I think we're adjusting the situation there. People really don't know how the rest of the year will look. And the people are also concerned about 2021, I think, depending on what customers talk about. Then we have some customers in, for example, automotive where we see quite big changes in the structure and how they build their cars and stuff like that. But on the other hand, we have a lot of customers making paper or beer or things like that in food and beverage. So we have quite many traditional customers, and they are still quite successful. But of course, there's a little bit wait-and-see at the moment. So we expect that the next maybe 1, 2 quarters, this weak market will continue. But we are expecting that 2021 will pick up again, but maybe a little bit different when it comes to adoption of digitalization and things like this. And we believe this could be beneficial for us. But it's too early to tell, I think.

[Joachim Gunell, Junior Analyst]

All right. I just assumed that with limited visibility into H2 2020, I guess that is holding back industry consolidation. But can you comment a bit on, say, pipeline? How many potential targets you're tracking? And perhaps what sort of acquisition candidates you're looking at?

[Staffan Dahlström, Co]

Well, I think we've been fairly successful last year of doing bolt-on acquisitions on companies that are smaller than us and have very good products and want to take the next level in their development. For example, Ewon and Intesis was very typical applications -- acquisitions where we bought the company from the founders, but the founders saw the opportunity to work with HMS to create more value. I think there are more opportunities like that. I think also there might be openings now when markets are tougher that some of these, especially German-led entrepreneurial companies may feel that the market is tough and maybe it's time to do something. So we are actively looking, but it's very long cycles with these entrepreneurial-led companies. So it's very difficult to say when we get results of these efforts we are having out in the market.

[Joachim Gunell, Junior Analyst]

All right. But it's -- so it's roughly the same type of companies that you've been tracking for, say, the past year.

[Staffan Dahlström, Co]

Yes, that's right. Smaller than us, things that can bolt-on to our organization in a good way and expand in our -- around our core markets, more or less. So it's -- we are still in the same playing field when we look for acquisitions.

[Joachim Gunell, Junior Analyst]

Very clear. And just a final more, say, long-term question. When you think about, say, the impact of COVID-19, you mentioned this to some extent in the CEO letter, Staffan. But as you think about the impacts on industrial automation longer term, where are HMS, say, best positioned to capitalize on those bigger trends that could obviously potentially be accelerating from here?

[Staffan Dahlström, Co]

I think one of our biggest opportunities that may not be so sexy, but this is -- most of our customers or end-users run industrial plants, industrial processes. These plants is not rip and replace, we would suddenly change everything. So we see a lot of move in to new technologies. There's a lot of interest in 5G and IoT. But this will not take over quickly. So you need to integrate the existing machines you have into this new technology. So there, we see a quite good opportunity to provide some of that bridge, the legacy with the new technology. So there we have a good position, and this is something customer needs in the near future.

[Operator]

And the next question comes from the line of Viktor Högberg from Danske Bank.

[Viktor Högberg, Analyst]

So my line was partly disconnected, so maybe this question was asked. But just have a question on the WEBfactory acquisition and the reversal of the additional purchase price and the corresponding write-down in Q2. If I recall correctly, WEBfactory had a good Q1, didn't they, in terms of orders. So could you just elaborate a bit on that specific acquisition and how it's performing?

[Joakim Nideborn, Chief Financial Officer]

Yes, sure. We can do that. I think you're right, Viktor, Q1 was good. And then Q2 has been very, very slow for WEBfactory. So there's a lot of projects that have been postponed. And well, we don't know if they will be brought up again. So Q2 was very weak. And we had a pretty aggressive plan for the company. So Q2 was -- or Q1 was good, but it was also in line with the plan, you could say. Now Q2 was pretty far from the plan, which made our earn-outs became pretty much impossible to -- for the sellers to obtain. So we felt we need to take -- and reverse that one. And then we also -- since we're deviating quite a bit from the plan, and we were actually a bit shorter to the plan also in last year, we made an impairment test. And they realized that, okay, we need to do something on the goodwill side here as well. So I think the aggressive plan is pretty much what's behind. And with the aggressive plan, we could also protect the goodwill. But given that, that hasn't materialized, we needed to take the consequence of that.

[Operator]

And the next question comes from the line of Jon Hyltner from Enter Fonder.

[Jon Hyltner, Fund Manager of Equities]

Can you hear me?

[Joakim Nideborn, Chief Financial Officer]

Yes.

[Jon Hyltner, Fund Manager of Equities]

Super. So on your orders that you took in the quarter, is it possible to say anything in general what the nature of those were, if it's from existing customers building out a part of their factory or connecting up machines that they already have? Or if you see more expansion, bigger expansions from your customers that's running into your order intake perhaps from decisions taking maybe 6 months back? Or can you see that some of your customers are daring to take bigger decisions to expand factories, move forward in their capacity decisions, et cetera? I hope that question was understandable.

[Joakim Nideborn, Chief Financial Officer]

Yes. Staffan, do you want to take or shall I?

[Staffan Dahlström, Co]

I'll do that. Sorry for the delay here. We are sitting on 2 different lines, and therefore, it's not clear who will answer. But let me take this. When we look on the orders, I think in quarter 1, we saw quite many orders from large existing customers who want to build up inventory. It was a bit insecure when it comes to supply chain and things like this. So order intake was really good in Q1. What we've seen in Q2, I would say, less orders from large established customers, but then a quite broad mix. And you saw this on my slide when we're looking at the users and makers that mix between different type of customers and applications are pretty much the same. So we can't really see a trend change in orders. The only trend change we have been -- change we've seen is that this kind of buffer stocking that we saw in quarter 1 that's passed us now and they are shipping out in Q2. But otherwise, I don't really see any big new trends in the order intake.

[Jon Hyltner, Fund Manager of Equities]

Okay. And it's a bit of a debate in the industry right now if this crisis will perhaps lead to companies moving their production and sourcing closer to home and not being too dependent on sourcing from Asia or other faraway countries. Can you see anything of that in your dialogue with your customers? Or are everyone still in crisis-handling mode and not really thinking further ahead at this moment?

[Staffan Dahlström, Co]

No, I think we see this. It started with U.S. There, we've seen this for a couple of years as a discussion topic. We haven't seen too much manufacturing moving back from China to U.S. yet. But we see that a lot of new manufacturing is not moved from U.S. to China anymore. It's moved either to Mexico, that's the start-up in Mexico instead of expand in China. And we also see a trend that both Japanese -- or many customers, I would say, American and Japanese move from China to Vietnam. That's a pretty clear trend. If we look at Japan, we see that the government, at least unofficially, is sponsoring Japanese manufacturers to move home manufacturing from China back to Japan again, and they get sponsoring for doing that. In Europe, we are seeing discussions about that people would like to be closer to their manufacturing. I think this will be a long-term trend that people will not rely on global supply chains only. So I think this can help investments in, I would say, especially in Japan, U.S. and Continental Europe. But it's too early to see this materialize in orders. But the discussion is there for sure. And decisions are taking where we make these investments. On the other hand, we also see in China that the government is also investing a lot in building their own capacity in semiconductors and others to make sure they get less dependent on other country's technology. So also in China, I think the investments will continue, but much more of a domestic in nature compared to just manufacturing outsourcing.

[Operator]

[Operator Instructions] Our next question comes from the line of Ramil Koria from SEB.

[Ramil Koria, Analyst]

Staffan, Joakim, just one pretty high-level question from my side on the nature of the digital events that you've had and what you foresee will continue and that you've canceled your physical trade fairs. What are you seeing with customers in terms of response rates? Perhaps, at the end of the day, it's a question of demand, so it doesn't really matter. But are you coming through in the same way that you did in a physical environment?

[Staffan Dahlström, Co]

Yes, I would say that it's more efficient. We get longer -- I would say, we have 2 types of digital events. One is more future-oriented, talking about what's the benefit of 5G and more marketing us as a company in that area. There, of course, we don't -- we get general interest, but we can't track it back to real orders. That's 1 category. Other category is to learn more about our existing offer more deeper. Like, technology, how does this product really works? How you can take better benefit of this product? And there, we see better engagement, I would say, than traditional trade fairs. We are sitting with them for 1 hour, and I would say that this is even more efficient than traditional trade fairs and this kind of walking around in a physical place and maybe bump into somebody that have interest in your product. So I think it develops well. We need to work a little bit more in our marketing systems, how do we qualify these new types of leads and how do we take these relationships to the next level. But we are positive about it, but we need to change a little bit our selling, our sales process when we have this kind of new leads, I think.

[Operator]

And as there are no further questions, I'll hand it back to the speakers.

[Staffan Dahlström, Co]

All right. Thank you very much for attending this morning session here. Thanks for interesting in HMS. We are not happy with the top line and the orders. Unfortunately, we don't see a short-term fix we can do for the next quarters. But we can work more on our gross margin, our OpEx and cash flow and keeping our eyes on the long-term ball. That's our strategy. And we'll keep on doing this for the rest of the year. This is our feeling right now. So now let's take a couple of weeks of vacation. I hope you get the same opportunity to relax in coming weeks, and then we'll be back in August ready for more business. So have a nice summer. Thank you.

[Operator]

This now concludes the conference call. Thank you all for attending. You may now disconnect your lines.