HMS Networks AB

STO:HMS

Earnings Call Transcript 2023-Q2

[Staffan Dahlstrom, executive]

Thank you, operator. Good morning, everybody. Thanks for joining this Friday morning call, we just released our quarter 2 report. And myself and Joakim would like to give you a brief update, and I will start with the summary and the business update and then Joakim will open the standard procedure of diving into these financial results, and we end up with a Q&A session at the end.

But just a few numbers from Q2, we are quite happy to see a continued good growth on net sales, partly also supported by currency translations and also a little bit of better component supply than we used to have. So we have some good things there, but there's also some challenges in the capacity especially during the beginning of the quarter. Joakim be back on that. And we see, as expected, a lower order intake. But here, we spent some time later with Joakim to really understand because this is a complex material with destocking, boost orders, et cetera. So we need to take this step by step later, but we move back on that.

Profit-wise, better than last year, but compared to previous quarter, not so good, and we will be back on that. Keeping EBIT margin well above our target of 20% a little bit lower than the previous quarters. Cash flow is not so great. We see inventory buildup and we have done some things here to increase our resilience going forward. So it's better than last year, but we are not really happy with the SEK 78 million in cash flow. And as a consequence of this, EPS keeps on improving quarter-by-quarter. And I think we skipped the year-to-date numbers, it's quarter 1, quarter 2, and I'll do a very brief overview of the business. For you who are new on the call, I take this just as an introduction of the company. Industrial communication, we call it industrial ICT, that's our business. Well established in this market. It's a niche market. Worldwide, we have almost 10 million devices connected -- over 400,000 machines connected to our cloud solution, [indiscernible].

So we feel we are a market leader in this segment, and we have a good position here. We are around 750 employees around the world in -- actually 18 countries. We started a small office in Vietnam early in this quarter, last quarter, and revenue last year was SEK 2.5 billion. We are on a 2025 journey with 3 main topics. We are working with our sustainability and especially working with our customers sustainability where we have also in the ambition of helping them to reduce their CO2 conditions. We think that happy and high-performing employees generate loyal customers. So we focus a lot on our Net Promoter Score, both with staff and customers, where we score very high now with our staff. We see a reduction on NPS from a very high number to a lower number with customers due to longer lead times, increased prices. So we're working hard now to regain the good confidence we have had with customers in the past. But there have been some effects last 18 months in the lead times that makes our customers not so happy.

And we have our revenue target of SEK 5 billion for 2025. All right. So we talk about valuable data and insights from machines and systems. So it's about connectivity and getting data together from different machines, but also getting this data into IT systems to cloud systems, making sure we help customers to understand and use this data that is hidden inside their machines and devices. And we have 2 types of business. We have the industrial automation that is more than 90%, mainly in manufacturing, could be factory automation like automotive or semiconductor and food and beverage. We also have transportation infrastructure, we're working with infrastructure projects and also warehouses, AGVs and this material handling things. And we have a small segment in Power and Energy, both with power generation and also renewables. We work quite much with the battery system, we call it best battery energy storage systems. And we have a business with building automation, especially with heating, ventilation and air conditioning, how you communicate with different subsystem in buildings. Less than 10% of revenue, but actually growing quite well. The common denominator in these businesses is communication protocols, the communication technology that is used to make sure that customers have good systems, good uptime and can use their different subsystems to communicate.

We have 2 types of customers. We have the makers of industrial equipment and we have the users of automation system. Makers could be the Atlas Copcos and ABBs of the world, the users are more the Volkswagens and the organization that use automation system to manufacture or process their things. And we see 3 types of business, the makers are both device manufacturers and machine builders. And this is the big portion of the revenue, 44% of revenue last year with device manufacturers, 27 with machine builders. Here, we mainly go with our business or in some cases, with distribution. But in both cases here, we are specified with either in designs or part of a bill material in these machines. So this is a quite sticky business where when customers sell their machines, we get included as part of their bill of material.

In addition, we also work with system integrators and end users, 29% of our revenue. Here, it's more of a system integrated business, our partners, they integrate and develop different automation system, and they use our products, our hardware and our software and here we go to market, both through traditional partners and distributors. But also to a growing part also e-commerce, specialized industrial automation e-commerce partners here. All right. So if you take just a few highlights of the quarter, we see actually a quite continued stable demand despite some macro indicators. But in all segments, we see that business goes on. And we've been waiting for a slowdown, but still, business continues to develop quite well. And Joakim will talk more about this when we look on the order situation.

Our larger market, Continental Europe is stable. We see mixed things in Asia. Japan, our biggest market there is both some customers who place very long orders. In Japan, normally, they like to have more on inventory. But we also see other customers in Asia that do more of destocking to adjust their large inventories same as customers in North America, and we see good solid volumes, but you will see some elements of destocking in North America. As I mentioned, strong development in Building Automation. It's less than 10% of our business, but growing really, really nice, both in U.S. and in Europe. From a supply point of view, we talked a lot the last 2 years about semiconductors, component shortage.

We still see some issues, but it's much, much better than it was a year ago. There are some hiccups. We invest quite much in building up inventory to make sure that we have a good resilience for the future. We also have some challenges in our go live with our new ERP system that has made us going to in May, we had not full delivery capacity in the rollout. We are back on full capacity again, but we see this, I think we lost SEK 40 million in revenue in quarter 2 due to this rollout of the ERP system. Joakim will talk more about this. But this ERP system is also part of our ambition to take the next step in our growth. Last 2, 3 years, we invested a lot in more salespeople and more product development, but we also feel now that we need to move up to the next level in our support system. So we have new ERP system.

We have Richard, our new Chief Operating Officer, a new role starting here, focused on supply chain, focused on sustainability, focused on IP where we see that these systems need to come to the next level to support our growth going forward. And we also have Myra, who joined us now as the Chief HR Officer, we see also we need to have more structure in our HR work around the world. So these are 2 very important roles to build the next step we need to take to continue our growth journey. So with this, I would like to hand over to Joakim taking a deep dive into Q2 numbers.

[Joakim Nideborn, executive]

Thank you, Staffan. I will do that. So let's kick it off with the order intake. And I think this requires some explanation. A lot of things that are moving that we need to get to the bottom with and reported received SEK 703 million, which would be the 14% decline or 17% organic decline. And for the year-to-date numbers, just shy of SEK 1.4 billion, which would be equal to an organic 18% decline.

Before we get into this analysis, I just wanted to mention 2 things. And that's the building automation that Staffan is also referring to, this is continuing very well also in the second quarter. So we're more than 20% up or both in terms of organic orders and in sales. And here, we see some good orders from retrofitting applications with new requirements in place that you need to be able to connect some of those AC aggregates around the world. So that's very good to see that type of business. Some good project sales on top of the normal business. Then also due to the Swedish krone is weakening, we also have, I just mentioned, is the book-to-bill number in constant currencies would be [ 0.94 ] in sales and order intake has happened to be the same number, SEK 703 million, with the currency effects.

But let me take a few minutes to explain what we really see on the underlying order intake. And what we say is that we see that demand is really holding up quite well. You've seen this graph before. we've had about SEK 1 billion in '21 and '22, and those boost orders due to -- Staffan, can you mute your line, please?

Due to customers placing orders pretty far out in the future. And now we're starting for the first quarter to see the destocking happening. And we have 30 million of destocking in the second quarter. Also worth to mention then, again, the Swedish crown, we have SEK 35 million in positive effect from revaluation of the already existing order book. And this is primarily -- the destocking is primarily attributed to the Americas and a little bit in Japan as well. In Japan, we see a bit of a mixed picture, but in Americas, we definitely see this destocking. And here, I have just to explain what we really see. This is a bit complicated slide, I'll try to take it slow.

So yes, starting on the left, we had the order intake reported in Q2 '22 of SEK 850 million. And then to the right, we have the reported order intake in Q2 '23 SEK 703 million. So all in all, a 14% decline reported. Then going back to the left again, we have -- we adjusted this boost effect of SEK 150 million that we saw in Q2 '22 to get to a normalized order intake for Q2 '22 of SEK 665 million. From there, we see the revaluation of the order book, SEK 35 million FX effects and the FX effect on the order intake in the quarter, SEK 90 million. And then we have added an underlying growth of SEK 40 million in terms of order intake. But this gives us to a normalized order intake for [ Q3 ] of SEK 733 million. And obviously, we have to adjust to these destocking to get the report of SEK 703 million. So I think this is maybe one of the key points to understand in this call. We have -- underlying demand is pretty much on the same level as it was last year. So we don't really see that big change in ordering is not really what we think we see in the market.

Then continuing to the sales. We had also the SEK 703 million, a 10% organic increase for the first 6 months. Yes, shy, SEK 1.5 billion, a 24% organic increase. And here, as Staffan also mentioned, I just wanted to make sure that's clear we had this SEK 40 million that we had to postpone in deliveries. We went live with a new ERP system in the 2nd May this year. And as always, when you do that type of big projects, it's a bit difficult the first couple of weeks. So we had to run the supply chain on a slightly lower pace than what we normally do. So that built up this 40% gap to where we should have been. Now it's going well and June was going well -- the second part of June was exactly what we should do, but we don't really have the capacity yet to make up for this. We will get there during the second half of the year, and we'll be able to be on the capacity that we need.

So last few weeks was good, and we should be able to provide what we should. Also, one thing to mention is what we see from the customers in the market. I think we see quite different behavior. Some customers are still saying that they really want deliveries as soon as possible and are suffering still from the long lead time to components situation not been as it should be. But we also have some of the larger customers that are in a bit of a different phase where they are happy with their inventory levels and they are now back to managing inventory levels quite carefully, trying to, in some cases, reschedule some deliveries. So it's a little bit different mix than we've seen before. But still, the demand of customers that would like to have deliveries is rather strong. So we're not too worried about that.

Then a few notes on the backlog. So as you see here, we have an order book that is on the same level as it was in Q1, SEK 1.3 billion. And the reason for not going down more than that is that we have this SEK 40 [ million ] of sales that we discussed that should have been delivered and then also the revaluation due to the weaker Swedish crown. And we have about 60% of our sales in euros, 25% in U.S. dollars and then some part also in Japanese yen. I added a new graph to the right to put this maybe in more of a context, looking at the ratio of order backlog in relation to rolling 12-month sales. And you see we come from before the whole component situation started, we -- in 2020, 2019, we come from a ratio that is just shy of 0.2. And then when we peaked in last late part of 2022, we were at 0.65. And now we're moving slowly downwards again and closing the quarter at 0.46.

And we get a lot of questions. So where do you expect to get to? So what's the normal order book that you should have? And that's, of course, a difficult question to answer. We don't have a clear answer on it. But what we believe is that somewhere in between what it was before and what it is now is probably quite reasonable for us to end up meaning that the order book should, of course, come down a little bit more. And that's why we think also we will have a good base for the remaining part of the year. Looking at the sales per region, Americas was strong with SEK 169 million and 24% of sales. Europe about where it used to be at 59% and APAC a bit weak with 17%. And here is really China that is lower than maybe expected and what we see a pretty big impact from a really strong 2022 and big expectations of '23, which is not really materializing with economies, it's not really there where it was supposed to be. So a lot of customers have ordered too much and need to adjust that, which we see on lower sales in China.

China is not one of our bigger markets. Last year, it was about 6% of sales, and this year, it will probably be a bit less. Not a huge impact on the group level, but I wanted to mention it. Let's have a look then at the net results. And unfortunately, this graph is not looking as beautiful as it used to be with a bit of a drop here in Q2 and we reached SEK 150 million in EBIT compared to SEK 143 million last quarter and margins of 21.4%. So still okay margins above the 20% target, but not where we have been used to be the last couple of quarters. And we are not too worried about the situation. To be honest, we have -- we know we have the SEK 40 million missing in sales that should bump up the EBIT level quite a bit. We also have a lot of OpEx investments going on at the moment with the ERP rollout. We're also investing in our IT systems to make the customer journey more digitalized. So really good investments for the future, but it also consumes a little bit of cash at the moment. And good to note that the gross margins are on a solid level, 64.7%. We were 64.8% in Q1. So I think these are -- we've said it before, we're quite comfortable with those levels. I think we should be able to be there also going forward. And what's managed as to get there is really the price adjustments that we managed to push through to our customers towards -- especially towards 2022.

We have, of course, the Swedish crown is helping us a little bit here still and a big difference compared to Q2 last year when we were at 62.2% is that the spot purchases are pretty much gone now. We have a few small spot purchases of components. It was a completely different story in 2022. And just a final note on the OpEx. So to be clear with that. We've been through the main part of the ERP rollout. So the supply chain to a large extent, is already rolled out. We have our sales companies left. So it will not be as intense as before and the cost will not be as high for this, but it will remain in the rest of '23 and also in 2024, pretty much for the full year 2022, we will continue with this. We will also integrate some of our acquisitions in terms of ERP on the second half of 2024. So that cost will not disappear, but it will be lower than what it was now.

Looking at EPS, well, obviously, with the EBIT lower the EPS is also lower, not a lot of comments on this. We're at 2.48. We paid a dividend in May of 4 crowns. So that's basically it, I think. Let's go to the cash flow instead with the SEK 78 million in the quarter, which we are not fully happy with. There are some good explanations though. The main part is the inventory buildup. We continue to see some deliveries from orders that we placed more than 12 months out with those really long lead times. And here, of course, we went up in a bit of a squeeze when we did not deliver everything that we should in terms of sales. Also, FX is impacting that a little bit. So I think the underlying -- you see SEK 100 million when you look at the balance sheet, but maybe the underlying should be more than like SEK 70 million. That would be a normal situation here.

We think that we will towards the second half of the year, we look in to maintain or maybe even reduce these levels a little bit. And then my final slide, looking at the balance sheet, again, we see a very solid balance sheet. We have interest-bearing net debt of SEK 93 million, which is almost nothing. So we said it a couple of quarters before, we are in good shape and for further acquisitions, and that's something we're looking at and get back to as soon as we have something interesting to present. So with that, I'd like to leave to Staffan to wrap the presentation up.

[Staffan Dahlstrom, executive]

Thanks, Joakim. So just a few things and just highlighting what Joakim already said. I think we see that order intake is not as bad as it looks like, and we feel solid demand underneath that we just want to explain this in detail because, of course, we see the number, it looks kind of strange. We see this destocking effect. We expect this to continue. We really would like to get our order book down at least below SEK 1 billion. So we work on that as well because we need to get back on good service levels to our customers.

We talked about some of the postponed deliveries, we have around SEK 40 million. Of course, this is a hiccup. We feel we have full capacity again. So this ERP system, it's complex material. So this is something that we are not super surprised about it, but we are back on track here. We also mentioned the cash flow. We are building inventory with stronger resilience for the future, but we need to work more on the cash flow. This is not what we are happy with. So we see that stable gross margin, large order book, we are quite optimistic for the rest of the year. We have a solid base.

So we keep on tracking here. And we feel this is a hiccup quarter for us. But as you hear me and hear Joakim, we are not too worried about this. We feel that there's good business to do. And we have a good margin and a large order book. So we remain on the positive side. With that, I think we open for questions.

[Operator]

[Operator Instructions]

The next question comes from Viktor Hogberg from Danske Bank.

[Viktor Högberg, analyst]

Good morning. On the delayed deliveries, the SEK 40 million, do you expect to catch that up already now in Q3, and also the product is delayed, can you say anything about the mix? Did it affect the gross margin in any way in Q2? And will it have some effect in the second half when you catch up those deliveries?

[Staffan Dahlstrom, executive]

Maybe I'll take that one Viktor. So starting with the mix first. The mix was pretty much normal mix, so no big impact expected from the mix in the catching up on deliveries. And we said the rest of the year because we're not sure that we will manage to catch everything up in Q3, but probably will be more in Q3 than Q4.

[Viktor Högberg, analyst]

Okay. And also, could you just maybe quantify the cost isolated to the second quarter in terms of the ERP and the IT system upgrades. It's going to stay on a higher level, but not this higher? Just thinking about what was the actual cost in Q2?

[Joakim Nideborn, executive]

Yes. So I can help you with the Q2. I don't want to comment too much on the future pace, around SEK 15 million in Q2. And then lower than that. Yes, lower than the -- not exactly, yes.

[Viktor Högberg, analyst]

And are you surprised to see the underlying demand remain at this level given what we're hearing in the newspapers and what you see in your discussions with clients, are they surprised to see their underlying demand remains? Just kind of -- what kind of discussions are you having because you have this -- continue to have the saying about there are uncertainties out there. But what kind of discussions are [indiscernible] your customers in the second quarter and also the current discussions.

[Staffan Dahlstrom, executive]

Maybe I can take this. I think when we talk to our sales team, they are moving away from saying -- for a couple of quarters, they've been waiting for a decline, which is not coming. We see quite solid demand. Customers are investing in both digitalization, automation, and we see a strong trend of nearshoring and dual sourcing, energy savings. So I think these trends offset partly negative -- more negative outlook.

So in general, it's stable demand. And also most of our customers, they are quite relaxed about the future. Of course, there's topics about China and geopolitical things. But for most customers, things goes quite well, I would say.

[Viktor Högberg, analyst]

And I would say, my interpretation is that you're kind of surprised to see this as well.

[Staffan Dahlstrom, executive]

Yes, I think we are -- we've been waiting for decline. We now saying maybe that is not coming -- we don't see that decline at the moment. We see stable demand at the moment.

[Viktor Högberg, analyst]

Okay. And on the M&A pipeline. You've been talking about it a lot. A couple of quarters ago, you explicitly raised your ambitions when it comes to the size -- potential size of targets. Any progress there in your discussions with potential acquisitions? Anything changed in terms of their outlook, anything that went away from the pipeline or added to the pipeline, just help us to if some understanding of what you can do and also, I would say, in -- I'll take a second question on that. If you start with the M&A pipeline, that would be good.

[Staffan Dahlstrom, executive]

Maybe I can start, and I think we will talk about this, and we have high ambitions, but it's been -- we've talked about this before, it's been quite difficult to find the right targets. Of course, we have a pipeline. But what's moving in and out of that pipeline is also quite slow. So we continue the discussion. We have no will lose to come with here. We are working with it. It takes time. Our ambition remains that we want to do more acquisitions, but we keep on looking, but it's a slow-moving material.

[Viktor Högberg, analyst]

Maybe I might have more to say at the CMB this fall, I assume. Last question on price, price dynamics. I think in Q1, price hikes added some 80% or something to revenue growth. What was it in Q2? And any kind of discussions about reversing that those price hikes if we would enter a slower market, you start out of the question that it sounded like it was out of the question on previous calls, but what are your current discussions regarding on pricing?

[Staffan Dahlstrom, executive]

Joakim, would you like to take that? Or should I start?

[Joakim Nideborn, executive]

Yes, maybe I can start. I think we'd not stay at the level where it is, but you can say that is some single digits percentages up, maybe a bit more than [ 5 ], I think I'll leave it at that. And then for the future, we do not expect to lower any prices. That's not really on the agenda. And we don't really see that discussion going on. I don't know if you want to continue more on that, Staffan.

[Staffan Dahlstrom, executive]

I think we've done price adjustments that's been accepted last year. Of course, now when delivery situations are better, we have customers who want to have more conversations. I think this will result in lower price increase pace next year, but there will be some adjustments also for next year. We have some inflation coming up, and we see that especially on the semiconductor side, it's not returning to what it used to be in the old days. It still remains on a quite high level.

So I think there's a reason for us to keep this discussion with customers. But as Joakim said, we don't expect our prices or even gross margins to go down, we want and we think we can do a full compensation for the cost increases we are seeing going forward. That is still our ambition.

[Viktor Högberg, analyst]

Perfect. Sorry, just one final question on the order growth, maybe order intake. You said that you expect a continued balance destocking at your customers, would that entail a larger destocking effect in terms in absolute numbers, that is, [indiscernible] million in Q2. Is that what you expect an increased pace in absolute numbers or this pace, give or take?

[Staffan Dahlstrom, executive]

Very good question. I must say we don't really know. We thought it should be faster than we have seen. So maybe it will continue in this pace. Because it seems like customers, of course, over time, they will adjust the inventories, use their capital more wise. But I think many of customers, they're still remembering the difficulties they had 2 -- 1 or 2 years ago. So I think it's a slow correction rather than a quick correction.

[Operator]

The next question comes from Simon Granath from ABG. Please go ahead.

[Unknown Analyst]

I just have a couple of follow-ups to Viktor's earlier questions. But mainly on you mentioned that destocking is currently mainly happening in North America, also partly in Japan. Do you anticipate this to happen in Europe as well? Or are your comments on further destocking mainly for North America and Japan?

[Staffan Dahlstrom, executive]

We will see destocking in also Europe. That's clear. I think maybe this is also -- in general, maybe this is general more than HMS that in Americas, we see normally quicker reactions, ups and downs and Europe and Asia are normally slower. It will come in Europe as well. That's our expectation.

[Joakim Nideborn, executive]

I think maybe just to add, Simon, to that, I think what we believe is a bit -- what surprised us a little bit if we put it like that, is that we see the PMIs are coming down quite significantly also in Europe and we don't really see the effects of the destocking. So I think we would probably expect that to follow the PMI. So maybe the first question from Viktor there is -- we're a little surprised by that. And but it's very difficult to say what pays and when and so on. But we also say that we believe that the order book is going to come down a little bit more. And so at some point, we need to see it, of course.

[Unknown Analyst]

That's very clear and helpful. And you mentioned some of the weakness in China and as you point out during the presentation, it's a relatively small market for you directly, but indirectly, perhaps it's a little bit larger. Could you talk a little bit about how on the indirect effects potentially from a weaker Chinese market, perhaps relating to your APAC operations.

[Staffan Dahlstrom, executive]

It's clear that many of our customers in Germany, especially have a large end market in China. And when we talk to these customers, they are quite worried about this. Not so much for the local competition, more for the weak development. Quite many expected a great 2023, after COVID in China, but that has not really materialized.

So I would say, machine builders in Germany, all worry about this, but we don't see so many effects yet on this. They're worried but they still make good business, it seems like.

[Unknown Analyst]

Okay. That's also helpful. And then just a follow-up on the gross margin as well. Have we already seen most of the impact from lower electronic component costs? Or could you see more here? Yes.

[Staffan Dahlstrom, executive]

I think looking forward, correct me if I'm wrong, Joakim, but we think that the gross margin we have now at this level, that's our ambition to keep that on this sub 65%, [ 64% ] on that level. We see some improvements we can do in our intent on efficiency. We also have now going forward, a new Chief Operating Officer, who will focus more on these things. We think over time that this will help us to be more efficient and the consequence of that will probably be that we remain at this level. That's our condition.

[Unknown Analyst]

And then just a final question. You increased the net recruitment rate quite rapidly during 2022 and in the beginning of 2023 as well. Have we seen most of that increase already behind us? Or should we anticipate a similar increase going forward as well?

[Staffan Dahlstrom, executive]

.

Of course, it's almost difficult but the cost [indiscernible] recruitment is very difficult in most of our markets. So it's difficult to really assess the details when the cost is coming. But in general, we are feeling that we've done a couple of investments. Now we are focused on some of the IT system and supply chain systems for 2024.

Of course, we would like to see the effect of these things. So at least, we think that the recruitment rate will be lower in 2024, and that was more a catch-up year and to get more effects of the things we have done. That's the general feeling we have about that.

All right. We don't see -- no, I also see the questions for queue seem to be empty. So then again, thanks for joining this call on Friday morning. I wish you a wonderful day and a fantastic weekend. Thanks for joining. Goodbye.