HMS Networks AB

STO:HMS

Earnings Call Analysis

HMS Networks sees mixed Q2 with Red Lion acquisition and internal restructuring

HMS Networks faced a challenging Q2 with a significant move, the acquisition of Red Lion Controls, contributing to an overall growth of 20%. However, the organic growth dropped 20% due to weak market conditions. The company initiated a restructuring program, cutting 44 positions, expected to save SEK 41 million annually. Adjusted EBIT margin was 20.4%, and gross margins improved slightly. A dividend of SEK 4.4 per share was paid. Despite the tough market, the company remains optimistic about future growth, focusing on customer retention and integrating Red Lion’s operations.

Company Overview and Recent Performance

The recent earnings call for HMS Networks revealed both strengths and challenges following their acquisition of Red Lion Controls. The company operates in industrial ICT, enhancing connectivity across machinery and systems globally. In the second quarter, they reported significant growth attributed mainly to the Red Lion acquisition, with total revenue climbing by 20%. However, the organic growth without Red Lion showed a concerning decline of 20%. Furthermore, the company has acknowledged ongoing difficulties with demand, particularly marked by destocking across various markets, primarily in Europe and Japan.

Financial Metrics of Q2 2024

In Q2 2024, HMS reported an adjusted EBIT of SEK 172 million, reflecting a margin of 20.4%, amidst top-line challenges. Their gross margins stood strong at 61.9%, with improvements noted in both Red Lion and HMS sectors. Operating expenses were reported at SEK 423 million, indicating a 21% organic decrease, largely due to restrictive cost management strategies including cuts in travel and consultancy expenses. The adjusted earnings per share reached SEK 2.12 million, primarily impacted by amortizations and restructuring costs related to the acquisition.

Guidance on Future Performance

Looking ahead, the company anticipates a gradual recovery with expectations of an improved financial performance in the second half of 2024. The operational focus will shift towards enhancing customer relationships, integrating sales teams across regions, and optimizing their product offerings. Management believes that the first half of 2024 will serve as a platform for future growth as they continue to address internal integration challenges and market demand uncertainties. They project an EBIT margin target of 25% in the long-term, despite adjusting expectations in the short-term due to current market conditions.

Acquisition Integration and Market Dynamics

The integration of Red Lion Controls has been pivotal, though it brought discrepancies in order intake due to a heavy focus on integration processes. Despite this, positive sentiments about future cross-selling opportunities are prevalent. The management emphasized that improvements would take time, noting a backlog of SEK 713 million, with a normal backlog expected to reflect about 18% of sales going forward. They also highlighted potential challenges from underlying demand weakness, particularly in European markets.

Cash Flow and Debt Management

HMS Networks observed solid cash flows at SEK 152 million, indicating a small working capital release. However, their net debt reached nearly SEK 2.8 billion, resulting in a net debt-to-adjusted EBITDA ratio of 3.05. This highlights the company's leverage position, which will necessitate stringent financial management to ensure sustainable growth while balancing debt repayment and investments.

Strategic Focus and Sustainability Goals

The management reinforced their strategic pillars which include sustaining organic growth, pursuing additional M&A activities, and enhancing operational efficiencies by embracing technologies such as AI. They reiterated their commitment to sustainability, claiming a long-term goal to triple their CO2 reduction impacts for clients by 2030. Customer satisfaction remains a key focus, with efforts to enhance the female representation in managerial roles within the company as part of their broader corporate responsibility goals.

Earnings Call Transcript 2024-Q2

[Operator]

Welcome to the HMS Networks Q2 presentation for 2024. [Operator Instructions] Now I will hand the conference over to CEO, Staffan Dahlstrom; and CFO, Joakim Nideborn. Please go ahead.

[Staffan Dahlstrom, executive]

Thank you very much. Good morning, everybody. Welcome to this quarter 2 update from HMS. The agenda we have is quite standardized. I'll start with a short summary of our business since there are some newcomers on the call and then introduction. I'll do a brief update, and then Joakim will quickly move into what you're really here for, the financial results, and we end up with a Q&A.



So just a review over quarter 2, a quarter where there's quite many different things happening. We have been talking about destocking and this difficult market and how to predict really the market demand. We talk about a soft market, but we also talk about this new fairly large acquisition of Red Lion Controls that is coming in with the first quarter here. And total growth, plus 20%. Of course, this is driven by the big acquisition, but we see a organic growth without Red Lion, of minus 20%. So the bad order situation is now showing also in quite weak revenue. Order intake, mixed picture. Of course, we see a total add from Red Lion. We also see a sequential growth from last quarter with 9%. But in total, it's a weak situation with minus 22% organic growth. We'll talk a lot more in the financial numbers about our adjusted numbers, and Joakim will explain this more. So here, when we look at the adjusted number, it looks -- we're moving in the right direction, and our EBIT margins are quite fair coming in with the large Red Lion, but Joakim will move into this. And we see improvement of our cash flow.



But before diving into the numbers, let me just make a very quick update of our business for the people who are new in the call. We talk about industrial ICT, Information and Communication Technology, that's our business. We update this slide because we have more than 10 million devices connected through our Anybus brand. So we are very well connected in this industry, as we say here, millions of devices can't be wrong. So we have a very good position with the industrial market here. In addition, we have over 0.5 million cloud connected machines through our Anybus brand, where we also have a leading position. With Red Lion, we are now almost 1,200 employees around the world, around one-third in R&D, around one-third in sales and marketing, and that's where we wanted to be. The Swedish market is a small portion. We are with [indiscernible] companies in 18 countries. And the large market we have is U.S., Germany, Japan and most of the industrialized world is our big market. Last year, SEK 3 billion in revenue, EBIT margin, 25%. And we have a good history of growth, CAGR of 20% per year, last 10 years, where the majority is organic and some part of that is through acquisitions through the years.



We talked about our playing field, where we work with industrial communication technology in mainly manufacturing, transportation and infrastructure as well as power and energy, where the big portion of the business would be in the traditional manufacturing piece. Also Red Lion coming in and opening some new areas, especially in energy distribution, oil and gas and some of this application in more harsh environment. And we also have a business that is fairly small today in building automation that we see nice growth, and it's a little bit different market and different business for us there. 2,000 customers, we have the makers that makes the machines, the devices where we sell things to them that they build into their machines and their devices. And then we have the users where we sell normally for system integrators to applications where the end customer is using the automation equipment.



The go-to market is on the left side, our device manufacturers, which is quite a big portion of our revenue where we have direct go-to-market with own sales force. We make design wins and it's a very sticky business. We have the machine builders that we want to be part of every machine. In reality, we are more on the option list. If the machine needs this kind of function, we should be on their list as an approved supplier. And then end users and system integrators where we see a need to have more connections to end users to really understand the end user requirements. The acquisition of Red Lion does not have any device manufacturers. They focus on machine builders and system integrators.



And for our strategy, we have 6 pillars. We talked about organic growth, right now, quite weak. We talked about M&A, where we have a full plate with Red Lion but we keep looking for new smaller acquisition going forward as well. We have a people agenda, where we talk about happy high-performing employees. We work with our sustainability targets and the planet. And the last 2 years, we added also operational efficiency, where we use much more of AI tools and want to do things in a more efficient way. And we're also doing some changes in our go-to-market and learning from best practice in different countries to accelerate our sales excellence.



Targets for 2025, coming up here for next year. For Planet, we talked about our science-based target where we are working to get our targets approved. But we also talk about how we help our customers reducing their CO2 footprint where we have quite a big effect. Last year, we saved almost 1 million tons of CO2 for them, and we want to triple that by 2030. We want to have happy employees and happy customers. We measure Net Promoter Scores, and we also promote quite much our ambition to get more female managers where we are today, I think, at 23%, but the aim is to have over 30% in female managers in the company because we know that also attract more female engineers and female sales people. Growth, we have an ambition to maintain a 25% EBIT margin. We work hard now with the big portion of Red Lion coming in with a slightly lower EBIT. So that's the challenge we have to make sure we can get back on 25%. And we have our long-term target for 2025 to be plus SEK 3.14 [indiscernible] billion, where we feel quite confident -- with this new acquisition, this feels almost obsolete target.



Short business update. North America, we had a hiccup last quarter. It's getting back. It's a good market. We have good orders, and we see good projects in North America coming up here. But Europe is slower. Germany is a bit on the negative side and people are reluctant to -- I will say wait and see there. So the recovery that we felt should come here in the coming quarters, especially in Europe, it will take a few quarters more. And China, which is a small market for us, I think 4% is developing well. And Japan, we see some signs of improvement. But there, we have a lot of the business where we have big impact on destocking and stocking. So it's been difficult to really get our [ answer ] on the real demand on that.



On this call, we talked quite much the last years about 5G as a new technology. We see this is coming up as a runner-up for special application, especially in mobile application. We have AGVs and robot application, we need this new technology, but it will take more time before 5G becomes more of a general-purpose standard. But we are seeing good progress now with our first release for the broad market, and it's quite interesting to follow. But as we said many years, it will take some time for this to really kick-off. Joakim will talk more about Red Lion and important, we try to make it easy to understand in our reports. It's a nice company. Integration is following our plan. We see many opportunities to improve things. But of course, these are quite long processes. So we need a couple of quarters before we can explain to you with really numbers, these synergies. And we had a restructuring program, especially in Europe to do some changes. We talked about this, it's finalized, and we're moving on from there. With that, Joakim you should continue.

[Joakim Nideborn, executive]

All right. Thank you, Staffan. Let me dig into the financial results. And as you might have seen, this is from a CFO perspective, an interesting report, a lot of things going on. We also have the integration of Red Lion coming in. We present and report also a preliminary purchase price allocation, which is giving a lot of amortization on the excess values. And I just wanted -- before we go into the numbers, I just wanted to explain a little bit what we have been doing. So we have always been reported EBIT as our main metric for measuring profitability.



We will also have our targets and been trying to keep that as a clean number to just show reported EBIT and work with that. I think with the acquisition of Red Lion and the pretty big amortization of excess values, we've decided to make a change and to also report adjusted EBIT, and the reason we choose to go with adjusted EBIT is that we still want to take responsibility for the amortization of the balanced R&D costs that we do have as normally the biggest investment in the business. And that's why we don't go with EBITDA. So we still, we're going to work with EBIT. We have the adjusted EBIT, and we also will have the adjusted earnings per share that we'll have a look at as a consequence. Just wanted to make a note of that. And then as you saw also, we made a [indiscernible] on the report, trying to make it easy to understand HMS with and without Red Lion and then we'll see what happens for next year. But for now, this is how we'll report it.



Let's start then to have a look at the order intake, which is also a bit difficult to analyze in a sense. I think we have, all in all, we see SEK 769 million, which is a growth of 9% reported, which is maybe not so interesting since we had the acquisition coming in with a lot, adding SEK 253 million to that. So the organic decline compared to Q2, 2023 was minus 22%. What is interesting, though, is that sequentially, we are up 9% organic. So we see a continued improvement from Q4 to Q1 to Q1 to Q2. We might have hoped for a little bit more than 9% improvement. It's still in the right direction. And as we do talk about in the report as well, we see that this recovery has been slightly [indiscernible] in time. So we're still convinced that we will see good future. We think that Q3 will be better than Q2 and then we think that Q4 will be the quarter where it really starts to release. That's what we're hearing in discussions with our customers, looking at inventory that they carry.



We also had about SEK 100 million impact from destocking. I'll show you that graph in a second. And before I wanted to mention that I was just talking a minute on Red Lion. Staffan mentioned that our business in the U.S. that had a bit of a bump in Q1 was now back and showing good growth on the order side. And on the Red Lion side, we had a little bit of a slow quarter, and we hope that this is just going to be a bump. And there was a period of a couple of weeks where we were a bit lower than we should. And maybe we are putting too much effort into the integration. I'll talk to that in a second as well. Really happy to have that good progress on integration, but we also need to keep track on the ongoing business.



This graph, I think most of you have seen now for a couple of quarters. We've been doing it since Q1, 2021, trying to show what's the underlying market release, the dark blue and then the boost effect, the lighter blue and then the green, which is the destocking. And here you see that the underlying market is pretty much as it's been the last couple of quarters, SEK 625 million is what we estimate. We had about SEK 100 million in destocking, primarily in Continental Europe and Japan. And we actually expect this to be the last quarter where this is significant. Let's see what Q3 brings, but we think that will be a significantly lower number. And it might also be that we will stop with this graph going forward. Let's see how the future plays out. But this is really something that we think will have passed now, which is good, and then we can just be looking at the underlying demand and understand how the market is developing based on that.



I also included this comparison when we restate Q2 '23 compared with a normalized Q2, 2022. We see here that we had a decline of about 10% in the market. With that said, remember that Q2, 2022 was actually the strongest quarter that we have reported in terms of underlying demand. So for sure, the market is not as strong as it was a year ago, but it's not as dramatic as if you look on the reported numbers. Just to say, this one on the previous slide is, of course, excluding Red Lion, so the organic HMS business.



Going over to sales, SEK 845 million, keeping up fairly well. We have a 20% plus reported given the integration of Red Lion organic minus 20%. And this is also – well, we still have tough comps here throughout the year of 2023. We know that. And the organic growth will probably take a few quarters more until we can see growth in that. We expect the book-to-bill to maybe be quite close to 1. It was 0.92. I believe that this might be the last quarter where we've had book-to-bill less than 1. That should be more than one going forward. And Red Lion helps with about one-third of the business. What was really positive is that the E1 business is doing much better. It's coming back and we actually see a smaller gap on the installed devices and the sold devices, which is good, meaning that the destocking is getting lower.



And then we have a record quarter actually for Intesis, which is really good. There's been a bit of a different cyclicality for Intesis. We didn't see as much of a buildup on orders through ‘21-‘22. This has just been ticking on very well throughout the whole period. Very nice business we have in the building automation space. So I think in terms of net sales and it goes for orders as well, it's really down to Anybus and Ixxat, where we do struggle a little bit, and we need to get those big customers back to ordering, which we think they will do throughout the rest of the year and especially in Q4. So all in all, market's a bit in a -- still in hesitant mode. We hope that that will sort itself out with more calm around the macro situation and the fact that the destocking is wearing out.



I put together one slide on Red Lion, just to give you some [ also ] quarter data to understand what's going on. And I think the sales development, this is -- here, we do fairly well. The reason why the beginning of 2023 was really good, whilst this big boost of demand that was delivered out during that period. The order intake boost you don't see because that was before 2023. And again, I think the point where we're not super happy is that we didn't see continued recovery on the order side. We believe that we've been putting too much of effort on integration. We're really happy with that progress. The main thing that we are working on, the main value-add that we see is the cross-selling. So we've been doing a lot of joint customer visits and distributor visits in the U.S., which is the biggest market.



In APAC, we've been integrating the sales organizations completely, of course, some tweaks to be done to get that to work perfectly, but that's live as of now. And in Europe, we also do a lot of joint efforts trying to use the HMS infrastructure for Red Lion access. So I think this has been a high focus now for the first quarter with relying in our ownership. And I think we also need to balance that with having good focus on getting the big wins in the markets where we were lacking a little bit in -- on the order side here in Q2. Just having a look at the backlog, I think I changed this graph slightly now. You see we have the SEK 713 million of backlog, which I think is kind of normal level. SEK 115 million of those is within Red Lion. And since the Red Lion business is almost exclusively to distributors, which keep their own inventory, that backlog will always be quite small. So I think what you see here is kind of normal levels in terms of -- if you compare to sales. So I think this is something that you'll continue to see levels of this, maybe 18% of sales going forward as well.



The sales per region graph, this is completely changed now to what we normally see. We have a pretty good balance between the U.S. and Europe, 42% in Europe, 44% in Europe and then APAC being 40%. Again, I think this is what we can expect going forward with two, sort of, equally large markets in the U.S. and Europe for the HMS part. Then going into -- I remember what we have most explained, trying to understand ourselves because there's a lot of things going on in the quarter, and I have a separate slide to try to explain that. So what we're looking at now is the adjusted EBIT of SEK 172 million, 20.4% margin, which I think is an okay margin given the low top-line at this point. I think this is a quarter where we knew it would be tough on the top-line side. And hopefully, we can improve from here. And then the profitability should work with us as well.



So we have really, I think, was a good point first, maybe, gross margin of 61.9%. Here, we see already some improvements on the Red Lion gross margins. We see also okay margins on the HMS side, 63.9%, which was an improvement from Q1 given that the volumes are fairly low. So I think we're happy with that development that we can still perform these margins with this low volume. I think that's good to see. On the OpEx side, we've been doing a pretty tough effort to try to keep that in [ test ], given that the sales are a bit lower. So we're reporting now SEK 423 million in OpEx, which is an organic decline by 21%. Of course, a pretty big decline there. Majority of that is not personnel even if we have taken out some costs in Q2. I'll talk to that in a second. I think we're trying to hold back on limited traveling, freely trying to hold back on use of consultants, all types of consultants we're trying to hold back on. And I think our organization has really done a good job in listening to instructions and trying to be careful with the cost. And this is a result of that, that we see.



We do have SEK 69 million that are affecting comparability. And I want to talk you through that to make you understand what's going on. It's really 2 things that we have here. We have, first, the Red Lion acquisition where we have amortization of excess values of SEK 24 million that is impacting. This is solely related to the Red Lion amortization of SEK 24 million. Then we have a few million more in amortization of excess values from previous acquisitions. That's adding a few million on top on that side. Then we have transaction integration cost of SEK 50 million. We had the final cost for the transaction for insurance in the last [ order ] fees and so on that was paid in the quarter and then also some integration costs we have for continued integration work.



And then as you might remember, we communicated just in the beginning of the quarter that we're entering into this restructuring program that has been finalized. We've taken up 44 positions in total, 22 of them in the headquarters in Sweden. And the impact from the program would be a saving of SEK 41 million full year effects, where of SEK 23 million will impact 2024. And of course, some of that impact comes into Q2 as well, one of the reasons why we could have a lower cost in Q2. Then the bill for this program totaled SEK 27 million in restructuring costs that we take in full in Q2. So I think all in all, this was slightly lower than we communicated in the release. So I think good to see that we are within that space. And I think we're all happy with that. This program has been going fairly well. About equal parts on Red Lion synergies, the restructuring within Anybus and then some fine-tuning of the organization, primarily in Europe on the cost side.



Moving on to the earnings per share, here we have -- looking also at the adjusted earnings per share. So we have restated this, and we have SEK 2.12 million in adjusted earnings per share due to all these excess values amortization and restructuring costs and so on. What's a bit new for us is to have significant interest costs. We have a net financials of SEK 61 million, where the main part is interest cost, which is SEK 43 million out of that on the acquisition of Red Lion of course, that's a number that will come down with amortization of the debt. And also, we believe that the interest rates will be coming down, of course, not in our hands, but that should be coming down, the interest costs as such.



We paid a dividend of SEK 4.4 per share after the AGM that was held in end of April. And then let's have a look at the cash flow as well. And I think this was a bit of a positive for us. We're starting to see small inventory reductions. As communicated before, we see the majority of inventory reductions in the second half of the year, but we started to see this trending downwards a little bit already in Q2, which was good, at least to see that we are not building more inventory and building working capital. So a small working capital release and quite solid cash flows otherwise, to SEK 152 million and yes, the best for a couple of quarters.



And then to end off with a bit of a dramatic slide looking at second quarter on the net debt, almost SEK 2.8 billion in net debt. We've been looking at net debt in relation to adjusted EBITDA. And here we have reported 3.05. We've also made an adjustment for net pre-IFRS 16. As you see, we report separately the SEK 255 million there in the light blue. And that's in relation to adjusted EBITDA as well which is 2.58. I think this is maybe a more relevant metric, at least when we look at ourselves, looking at how highly levered the company is. So a little bit higher than we had expected due to the performance in Q1 and Q2. That has not been where we hoped it would be half a year ago. But I think, as we said, the return or the recovery is expected to come in the second half of the year instead. And then we hope that the results will follow that.



I also wanted to mention, I think you've all seen now we made a directed issue that generated SEK 1.39 billion in capital to repay a bridge financing on the acquisition. And we now have increased the number of shares by about 3.5 million to just above 50 million shares in total in the company. That was all we had on the financial update. Staffan, do you want to have a few summarizing words before we let in Q&A?

[Staffan Dahlstrom, executive]

Well, I think we can – there are 2 things we really want to focus on. We really want to make sure that you understand the numbers. It's kind of complex with Red Lion and all those things. But inside the organization, we have a big focus on what we call Win, Grow, Keep. We see that the market is weaker, but our commercial organization put a lot of effort now to win new customers, win new projects. We work with some existing customers, how to improve them but we're also making sure that now after Covid, we can be out and meeting existing customer to make sure we keep them and what we see in our [ weak ] order is not that our customer is leaving us for a competitor. So it's important that we are out to talk to this customer even if they see a weak market, we need to make sure that we stay and keep them.



And secondly, Red Lion, we are quite excited about Red Lion. And as I said before, it will take a couple of quarters before we see this in numbers, but the more we learn, the more excited we get around this because we see a lot of common things in the cross-selling, in future product development and supply chain and things like that. So we're really happy about this. But unfortunately, we have a situation in the market that is quite weak at the moment. So we need to focus on the things we actually can have an impact on, and we do quite a good job there. So with that, should we move into Q&A?

[Operator]

[Operator Instructions] The next question comes from Joachim Gunell from DNB Markets. Please go ahead.

[Joachim Gunell, analyst]

So we've talked about this topic, obviously, for the past couple of quarters. But can you say just anything with regards to what you see in terms of outlook here in relation to -- some of your largest customers have been, as I read it, slightly more cautious in their view on how 2024 will unfold. So can you help us just understand how you balance your own view with regards to perhaps that and if you can ultimately say anything with regards to new [ launches ] where we are today versus Q2?

[Staffan Dahlstrom, executive]

Maybe I can start. If we look on both our customers but also related to markets like semiconductors and others, I think in the beginning of the year, a lot of companies talked about EBIT, second half will be quite good. Now I think a lot of our customers are saying, it will be better, but we'll not see a big improvement already in quarter 3, maybe at the end of the year. But now our customers talk more about 2025 as coming back to growth in 2025. So I think most of our customers are talking about some kind of delay of maybe 2 quarters out from their previous outlook. So I think that's a quite clear message from customers there.

[Joachim Gunell, analyst]

Perfect. And with regards to Red Lion, can you just say anything -- you touched upon this already Staffan, but what stands out from a positive standpoint to date and also if there are any [ pollings ] that have proven more challenging than what you have expected thus far when it comes to integration?

[Staffan Dahlstrom, executive]

If I start, Joachim, I think what's really positive is that the more we learn about the team and about their capabilities. We see a lot of good quality people there. We see a lot of opportunities to do things together. And that's been a positive mood between the 2 teams, I think, which is very good. So there's no holding back and people try to make sure that everything just stay as it was, there's a big movement of doing, changing, embracing the change we're suggesting here. But we take it quite also easy and doing good changes. We need to learn the team. And right now, we talk about there's things we don't know that we don't know yet. So we need to be a little bit careful on this. And as Joakim said, we also feel that some of the projects we're doing is taking time from the regular sales with this kind of common things with customers. So I think we need to have a balance of how quick we do it and how much we can focus on the current targets.



But in general, also, customers have been positive. [indiscernible] nervous that have common distributors and channels and there'll be a lot of fighting actually being very positive that people see the benefit both from HMS' point of view, but also customer point of view. So I think that's been all positive. I think when we discover some of their supply chain, we see -- this is both good and bad. We see a lot of opportunity to improve. But the manufacturing side have too low but first pass yield and too low of this quality target we're having. So there we need, as expected, more or less to do more investments than they have done. So I think that side of the business has been a bit underinvested, but that was something we saw in the due diligence. We are not surprised about it, but it will require some investments and some extra work there to make sure they come up to the HMS standards there. Joakim, anything additional you would like to point out?

[Joakim Nideborn, executive]

I think you captured it very well, Staffan.

[Joachim Gunell, analyst]

Thank you. That's also encouraging. Can you say anything with regards to if all assets of Red Lion needs to be a part of that company going forward? Or are there, call it, certain parts of the product portfolio, which not necessarily must be a part of future [indiscernible] going forward.

[Staffan Dahlstrom, executive]

I think we're looking at -- I think for the Lion part, the Lion part of the Red Lion is a good fit for our products. But there are some pockets or products where we say maybe this is something that doesn't really fit fully to us. So we are looking into all the some smaller part that should be divested or changed or something like that. But I think the focus is really on the big [indiscernible] things and do the most things there so. But maybe in 2025, there will be some areas where we say, okay, now we learn more about this. It's time to leave this behind and focus on the big things.

[Joachim Gunell, analyst]

Perfect. That was it for me. Thank you for the granular reporting here with Red Lion as well and have a great summer.

[Operator]

The next question comes from Gustav Berneblad from Nordea.

[Gustav Berneblad, analyst]

Yes. It's Gustav from Nordea. Just to start off here, I mean, is it possible to get any more color on sort of what customers specifically you have seen coming back sort of in North America and also if we turn it to Europe as well, what sort of end markets is surprising to the negative, given your comment there?

[Staffan Dahlstrom, executive]

If I start there, I think Joakim already said something like this like where we see a faster bounce back is the remote access Ewon business to machine builders, we see a quite good pick up there. And also, the building automation business goes really well, but both these 2 -- the building automation quite small. The challenge we have is really on this embedded component side with especially Anybus and partly Ixxat, where we've seen that most customers are reducing their inventory, but they also have a weaker market. So it will take some more time until we get fully back there. So I would say that, that kind of Anybus and Ixxat business is the weakness at the moment. The other parts going quite okay.

[Gustav Berneblad, analyst]

That's perfect. Is it possible to say sort of what end markets though?

[Joakim Nideborn, executive]

I think what's difficult there, Gustav, is that we have on the Anybus think we sell to more or less all end markets. So we don't have that full transparency exactly how, what's driving. I think it's been pretty common over the range, nothing that sticks out that we've reacted to that {indiscernible].

[Gustav Berneblad, analyst]

Okay. Perfect. And then maybe in regards to working capital and inventory buildup, I mean, we have seen the inventory buildup for quite a while now. And I mean -- I think you commented quite positively in regards to Q1 during the end of the quarter that you saw the inventory returning there. But we only saw SEK 18 million in working capital release now in Q2. Are you still having a lot of inflow of inventory? Or how should we interpret this?

[Joakim Nideborn, executive]

I think that's the challenge to why it's not possible to make it faster since we do still have some inflow when we had really long order lead times. So that is still working in a negative way. And we need to try to work with that. And that's why I'm saying that we will see a better reduction in the second half of the year since that will wear off and then we can more quicker get down the inventory to the relevant levels. So that's the main challenge.

[Gustav Berneblad, analyst]

Yes. Okay. Perfect. But are there any risks sort of for an inventory write-down? Or that's not a risk?

[Joakim Nideborn, executive]

This is standard components. I think, of course, as a CFO, I'm not happy that we're consuming my cash flow. But it's really standard components, and it's a pretty good usage of those. I think we'll have a bit more longer period than what we would like, but we'll use it up. I'm not too worried about that.

[Gustav Berneblad, analyst]

Perfect. And then maybe just some last here on Red Lion. And just to clarify, maybe you have talked about this before, but are there any seasonality in the Red Lion, for example, the margin or so because, I mean, you have, for example, a stronger Q3 and so forth. So are there anything to look out for there?

[Joakim Nideborn, executive]

Not necessarily, not what we've seen. I think it will -- given the sort of boost orders and normalization of that, I think we expect to see gradual improvement throughout the year. And for the time being, if you were to look over a 10-year period of time, I can't really say that, what I've learned at least so far, we don't see any big seasonality.

[Gustav Berneblad, analyst]

Okay. Perfect. And then maybe just the last one. I mean, you commented sort of taking initial synergies here right away. And then I think in regards to the acquisition, you talked about synergies that could be sort of extracted 1 to 3 years out, maybe. But is it possible -- have you gotten a better view on what you can extract and what sort of is a longer-term fair margin for this business?

[Joakim Nideborn, executive]

Should I start, Staffan?

[Staffan Dahlstrom, executive]

Yes, please.

[Joakim Nideborn, executive]

I think what we said is -- and the main thing I want to reiterate this because I think this is important, this has never been a cost synergy case, right? We see, from a sales point of view that there is a good match between the offers and we get the presence in North America that we really wanted to strengthen, so I think the main synergies will come from cross-selling, and that's what we've been working a lot on already in the first quarter. And as we also said, maybe we need to balance this a little bit to make sure that we get the orders we should get in the quarter and Red Lion must spend all the time working together with HMS guys and see what we can do in a year or two from now.



I think the sales synergies will take some time before that becomes material. We still have some customers that have been trying some distributors that have been interested in the different offerings. So I think that's good. But we also need to get the infrastructure in place. So I think that's what we're working with to get the backbone in place, common ERP system, so we can have a joint flow of orders and goods. And that will take another year to get that in place. And then I hope we can start to see the real sales synergies, and we didn't put a number to that. It will be millions of dollars. We can't say exactly how much yet. So we need to get back on that.



I think Staffan also said, this is a bit of a long game. This is not a quick turnaround and fixed. We need to make this right and build a good company for the future. I think you need to allow a year or two before we start to see that. On the cost side, obviously, there are some things to do as well. We have some dual managers that we corrected for directly in the first quarter. And I think from now on, let's see what we can do. There's some tweaks here and there, but that will not be super material, the savings we can do, and I think that was never the intention. That would be my sense. Staffan, do you want to add something to that?

[Staffan Dahlstrom, executive]

Yes, I think we can characterize this in 3 different waves of initiatives. First, now we focus a lot on the cross-selling and these commercial things. And I think this is something we probably see effects on in a couple of quarters in revenue and cross-selling. The second wave is much more in this operational things with our ERP system, with investments in their manufacturing sites and these things. And I think that's probably a year out before seeing some big synergies there. And the third wave is much more this product technology and where we see elements of using the same technology and cross technology usage, and that's probably a couple of years out before we see that synergy. So there's different waves and different time lines for where we can collect the synergies.

[Joakim Nideborn, executive]

Yes, I forgot to mention one thing. Maybe there's a fourth on the supply chain and in operations to make those investments yet to yield up. Staffan talked about the low yield. And with that, grow the gross margins. Of course, it will come with some CapEx to get there. But I think that's something we're determined to do and working on to get it fixed as soon as possible. And then I think you also asked, Gustav, what was the long-term potential of Red Lion? I think the target for HMS is 25% on the adjusted EBIT. And I think that's where we would like to be for the group, so it should move in that direction.

[Operator]

The next question comes from Erik Larsson from SEB.

[Erik Larsson, analyst]

Thank you. And also thank you for all the details in the report and the presentation here. So I have a question on, first of all, on the gross margin, which looks pretty good, both in HMS organically despite the lower volume and also Red Lion, which seems to be a bit higher than you have previously indicated. So my question is, are there any specific items here? And do you expect any major changes from these levels going forward?

[Joakim Nideborn, executive]

I don't think so. I think what we put forward here has been moving in the right direction from Q1, both for HMS and for the Red Lion business. So we're happy to see that. And I think we should be able to -- I think this makes sense to levels that we show here in Q2.

[Erik Larsson, analyst]

Okay, great.

[Staffan Dahlstrom, executive]

Joakim you should maybe also mention that what we've said here is that we have a little bit of disappointment in the Anybus and Ixxat business, but Ewon and Building Automation goes well. This area does goes well, is also a little bit of the higher gross margin areas compared to the others. So we are not happy with the weak revenue, but it's the higher margin part that goes better. So that is also helping on the gross margin.

[Erik Larsson, analyst]

Okay. Great. That makes sense. And then on second question on OpEx, you talked about it last quarter and also now that you have some specific costs you're trying to hold back and you continue to report good cost control here. So I'm just curious, in terms of getting, I guess, marketing and traveling costs back, is that a thing essentially when demand is back? Or do you expect that to come back already sort of the coming 1 or 2 quarters?

[Joakim Nideborn, executive]

Yes. I think it's probably in that range of period. I think what we're trying to do is, of course, in our report 20.4% EBIT. We know that the 25% target will be almost impossible to reach this year, but we want to keep it at a decent level. So we're trying make, to balance cost, of course, not to hold back [ stupid ] initiatives or things that would benefit the business a lot. We're not trying to hold that back. But at the same time, we need to be a bit cost cautious. So I think it's fair to say that, and I didn't talk about it so much now, I talked about it in Q1 that we will probably see higher OpEx than what we've had now in Q1 and Q2 for the coming quarters, maybe with the exceptions of Q3 due to vacation period. But otherwise, we'll see the OpEx coming up a little bit since we're going to do more of these initiatives. I think that's something we need to do for the long term, but we also need to balance it with the current demand.

[Operator]

The next question comes from Simon Granath from ABG.

[Simon Granath, analyst]

It sounds like Red Lion sales are slightly depressed currently due to integration work in part. But do you regard current levels as relatively representative for the coming quarters in 2024? Or is it so that the company should benefit from the recovery in the North American market, which is looking comparably more encouraging than in other regions? It sounds unreasonable that the integration work is impacting sales, but does this mean that you lose some short-term sales or rather that it's a pent-up demand for H2? Sorry for a long question.

[Joakim Nideborn, executive]

I think you almost answered it as well. I think I agree with the statement. I think we believe it will improve throughout the year, both with the North American markets continuing to be strong and with a better focus on the existing business within Red Lion. So I think we are -- yes, of course, we would have hoped maybe not so much as sales, but the order intake, we would have hoped that, that would continue in trending in the right way in Q2. So we hope that that was just a bit of a bump on the road. I think the team is quite happy with what they're doing. So I think we should see an improvement throughout the rest of the year. That's what we expect to see.

[Simon Granath, analyst]

Very good. And we have not discussed price changes for some while. Is there anything you would like to highlight here or about the current status? I'm curious to hear if you're looking to make any price hikes either for HMS or for Red Lion or on the other side, whether there have been any price reduction in wake of the currently weaker markets?

[Staffan Dahlstrom, executive]

Maybe I'll start with that. I think during normal circumstances, we do annual price updates. I mean then we talk about small percentages or that is normally done at the end year of timing. So I think it's up now to start that discussion with our commercial teams and our product teams. So it's too early to tell. But I think normally in our industry, there's some kind of inflation compensation of a few percentage. But we need to come back to that a bit later, I think.

[Operator]

There are no more questions at this time. So I hand the conference back to the speakers for any closing comments.

[Staffan Dahlstrom, executive]

Thank you very much. Thanks for attending this quarter 2 call. We will keep on fighting to grow the business and affect the things we can't affect at the moment, as I said, Win, Grow, Keep, that's our focus. And we'll be back in a quarter with more updates. And until then, me and Joakim, we'd like to wish you all a very nice summer. Hope you get some vacation and let's be back after Q3. Thank you.