HMS Networks AB

STO:HMS

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, welcome to the HMS Networks AB Q3 Report 2020. Today, I'm pleased to present Staffan Dahlstrom, CEO. [Operator Instructions]Staffan, please begin.

[Staffan Dahlström, Co]

Thank you very much. Hello, everybody. Welcome to this quarter 3 call. And it's myself, Staffan Dahlstrom; and Joakim Nideborn, our CFO, who'll be joining you for this afternoon. And we have a couple of topics. I'll start with a short summary and a business update. And then Joakim will drill down into the details of our numbers, just presented an hour ago. And then we end with a Q&A. But let me start with just a short overview. For quarter, we are continuing to see a quite weak development on our net sales and also order intake, a little it was expected. Keep also in mind that quarter 3 last year was a fairly good quarter for us. We have strong comparable, so we have a weak top line. It looks better further down. We are good happy with a good EBIT. We are up compared to last year. We are SEK 77 million compared to SEK 56 million. But you also need to keep in mind that last quarter 3, 2019, we made a SEK 25 million provision for our restructuring program. So we are similar to the EBIT level we had before that provision. So we land on 22% EBIT margin, better than our long-term target, which is 20%. That's quite good. And I must say, we are very pleased with the continued good cash flow from operations and landing at SEK 116 million. Result is getting quite good earnings per share. So that was the quarter, and this accumulated over to the 9 months with a similar development, weak order intake, weak net sales, as expected, but we are on par with last year's profit before that provision for restructuring. And we are landing last 9 months on 20% EBIT margin on our target. So we are quite happy with that. And we've been maintaining good cost control. And of course, we've also done some savings from the restructuring program, but also COVID-19 situation helps us to also review some OpEx cost, which Joakim will talk more about that.So just a few words about our business. What we wake up every morning doing is to think about how we help our customers connecting their devices and machines to different networks. We have millions of critical applications, critical machines that are connected in our plants, in automotive plants, in breweries, in this kind of industrial automation applications. We have 4 brands. We have Anybus. We have Ixxat. We have Ewon. We have Intesis, all with different functionality and a little different focus area. We also have our fifth area for software, WEBfactory, and I'll talk more about WEBfactory in a minute. We focus on 2 areas. We focus on makers, makers of industrial equipment and industrial devices, companies such as local automations, Schneider Electric, Caterpillar, and we help them with their connectivity built into their device or into their machine, which allow them to connect to any type of system that the end user may have.We also work with these users. This could be companies that produce the beer or the car or the electricity that you use. And here, we have different products for interconnect, different systems and machines in their plants or in their remote installations. So these are 2 very important areas for us.And if you look on the distribution of our sales, it actually looked quite much the same as previous quarters. So even if we see a downturn on our top line, the distribution is quite much the same. We have 47% of our quarter 3 revenue on the designing models. This is the long-term model where we embed our technology in the makers' products and this long-term business. But of course, we need to have makers that sells a lot of products that can buy our products as well. So we're a little bit depending on our customers' success. And -- but we've seen some headwinds in this business the last quarters.We're also working with our gateway routers and other products. There's a mix. We sell to both the users and the makers, and this comes together to [ 48% ], quite much the same as we've seen before. And software subscriptions services is an area we want to expand, but we are still on the low 5%. And we are -- we have long-term targets to grow that. That is still on a single-digit percentage.What we and our Board of Directors have done in the last couple of months is to spend a lot of time thinking about the long-term future. Of course, we need to have two things in our minds for the future. The short-term activity we do in this kind of challenging market, but we also need to make sure that we focus on our long-term activities.So we have now set a new goal, and our ambition is to -- for 2025, which our revenue that year should exceed SEK 5 billion or more than SEK 3.14 billion. We are engineers, so we like this kind of easy-to-remember kind of numbers. So SEK 5 billion is very important for us, and that's our ambition to grow there, both by organic growth and also by selective acquisition, and maybe the mix will be approximately 50/50 to grow that.Profitability, we are around 20%, and we will maintain that target going forward. That's an ambitious target that we've seen that we can deliver that, and we would like to maintain this profit level over the business plan for this year. We are doing a slight change to our dividend policy. We used to have 50% of EPS should be in -- approximately 50% of the EPS should be in dividend. We're now saying 30% to 50% to also allow some more flexibility when it comes to keep preserving some cash in the company for acquisition, et cetera. But at the same time, we are saying that dividend is important for our shareholders.For the business update, let's move quickly in there. We have a couple of companies, acquisitions we have done. We bought 70%, the majority of the Dutch presented group. The remaining 30% is owned by 3 senior executives in the management team there. We work with them to develop this company. And what they do is hardware and software for surveillance and diagnostic of the network traffic in industrial applications. This could be in a steel plant or in a paper plant, where they attach their sensors and equipment to the network, and we can then monitor potential problems in the sector to have service. They do the service. We can predict also that there are areas that might impact their network traffic going forward. So definitely, they can also proactive services in these things.Specialized company, and they are headquartered in Rotterdam in Netherlands and have all sales office in -- sales offices in Germany, U.K., and Italy, and they are around 70 employees. It's a small company, but a very nice technology, and it is very good to our users and our ambition to do more business within software and services, which we think we can develop here.EUR 12 million, approximately, going forward, we expect maybe single-digit growth and a double-digit EBIT margins. And of course, our vision is to include the growth by helping them, but we also know that this is -- the users in this industry takes time to generate new business models. But the idea is also to develop their business with them, more from a -- this kind of products they have today to explain why things doesn't work, to also have predictive maintenance and have more intelligence in this product, to help our customers to have preventive maintenance, complementing maintenance to something like -- that's more intelligent, that can predict future potential problems. We see a good market and a good fit with percentage going forward.As you may remember, we bought 74.9% of the software company, WEBfactory last spring. And now with the founder owned the remaining 25% -- 25.1% to acquire his shares. And the idea now is to speed up the integration and use more of their products, integrated with our other hardware offering. So far, the business with probably German -- Germany and Central Europe has been quite challenging. And we've all seen a lot of delays with customers in this kind of software and monitoring applications where we focus on. But we strongly believe that being a 100% owner of WEBfactory can help us accelerate how we use the product, how we sell the product, and also how we bundle the software together with other product maintenance to make a solution based on those hardware and software. We also see continued impact from COVID-19, but it's a mixed picture. We see customers' good exposure towards MedTech and food and beverage. They are performing quite well. But we see continued challenging business related to automotive. We've seen that for quite some time. This is still a challenge. In China, we see a quite good pickup in some verticals like wind power. We see that our order intake in China reported fee is up 50%, and this is quite good. But in general, we see a low or hesitant CapEx investments in the industrial applications in general. But what we know from other earlier downturns is that this lower CapEx investments normally doesn't take away CapEx long term. It's more a delay. So we believe that there's a good opportunity post COVID that these investments will come. So we're quite positive in the mid-term. We see in general that Europe has been down, both in sales and order, especially in Germany, France, Italy, Spain, where we see a lot of effects from corona. Asia is down in our revenue, but a good pickup in orders, so that looks promising. And U.S. is, I would say, sideways, low growth. That is quite okay. But there's also big uncertainty in U.S for the near future. So we see Germany and Central Europe is down. We see that Anybus is down compared to our other brands, and our geographies is quite okay. Look at this picture.We have stable gross margin despite lower volume and also despite a current situation that is a bit unusual for us. We have had years of positive FX, but now we see some headwinds on this, and this is also affecting somehow our gross margins, but we're deciding to really be more efficient here internally, and we are quite happy to maintain a good stable gross margin here.Finally, from my side, a short COVID-19 update. We still have a team that is fully functional, fully healthy. So we've had no viral impact in our teams for COVID-19, but we are very careful. We have continued home office work for most of our staff. Now the policy is that we would like to have our different teams at least 1 day a week in the office, and their manager decides what is the best day. And we try to organize it so we don't meet everybody at the same time. So we are finding new ways to work and new ways to meet to make sure we can do our business going forward. We continue some short-time work in Germany, in smaller -- it's around 20%, where in Sweden, we work full time. And most other countries, we work full time as well. We have full function in our supply function in Sweden, in Spain, in Belgium. So we are fully up and running there. Looking forward for quarter 4, we can say that the quarter 4, so far, has started to be in line with quarter 3. We don't see a big change upwards and downwards, so it's more sideways. Keep on rolling here. We see challenges in Germany. So we maintain short-term work until further notice. We continue COVID-19 very much, and of course, like we all -- we are quite concerned about this second wave coming up here in many of our markets. So we need to be careful that our customers are also learning how to deal with this and taking countermeasures. So most of our customers are up and running and have a business that is working quite well. But we are canceling all these traditional affairs and face-to-face meeting with customers, so we see a lot of big digital events. And I must say, I'm quite both surprised and sometimes also impressed how well this works and the customer interaction that it goes on, and we see a lot of digital meetings with our customers. And customers appreciate this as well for their safety but also for their efficiency.As we said last quarter, we believe that even if we have a little bit of headwind right now, we see good market conditions for automation and digitalization going forward. And we are quite optimistic for medium-term our business when we have corona behind us, so we focus on our long-term business for the time here.With that, I would like to shift over to Joakim to give us a little bit more details on numbers.

[Joakim Nideborn, Chief Financial Officer]

Okay. Thank you, Staffan. So we're going to start out as normal with our order intake situation, which is maybe the softest point in the report. Even so, I mean, we see a bit of an uptick from the weak Q2. Things are definitely moving in the right direction, even if that is pretty slowly so. So we are showing now SEK 336 million in comparison to the SEK 372 million. Organically, a decrease of 7%. And it's really isolated to a couple of countries where we see the big drop. And it's in Germany, Italy and France that is representing this challenging development. Otherwise, we had a small decline in the U.S. and the positive, as Staffan also mentioned, is Asia. Both Japan and China is doing well. China is doing extremely well, and we're winning a lot of new interesting projects in China that is probably going to help us a lot in the future. So a very good order intake there.Ultimately, the first 9 months, we're down pretty much SEK 100 million. Organically, 9%. And as Staffan said for the first time now in some years, we're actually seeing some headwind from the currencies, which you will see throughout the report is affecting us on many lines here. The picture is pretty much the same as in the quarter for the first 9 years. We have Germany and Italy being the main reasons for the decline. U.S. is pretty much flat and Asia is growing very nicely. So that's, of course, very positive.So a bit of a change, a different picture depending on what geography. Staffan also commented on the customer mix. That is also quite different. We have some customers performing quite good. And the ones that are more into automotive and industrial investments are having more a bit of a more challenging time.So let's have a look at the sales, which is a slightly different view than on the order side. As you see, we're now pretty stable around the SEK 350 million level. If you look at the last couple of quarters, we had SEK 345 million in the quarter to compare with SEK 377 million for Q2 1 year ago.Organically, we're down 6%. It's the German market, and clearly that is behind most of this decline. And the difference compared to the order intake is that we have also Asia being down on the sales. But obviously, this is going to change in the future given the strong order intake that we see now.Also in the first 9 months, pretty much the same view here. We're down SEK 111 million in sales. Organically, that means 9%. And as you see, it's pretty much the same view on the different markets as in the quarter. So I think for the coming, I think we wrote in the report for Q4 that what we've seen is that order intake is continuing pretty much in line with the pace that we see in Q3. So I think we believe that it will be a pretty slow recovery from this situation, but we are a little bit positive and hope that we will see at least as good numbers as we see now for the coming quarter as well.Then the sales split per region in percent, maybe not that interesting. We have 60% of the business in EMEA, which is quite normal. We have a bit more in America with 23% and 17% in Asia. This will probably change a little bit in the coming quarters for Asia, and we'll have a bigger percentage given the strong order intake. Otherwise, it's pretty much what we normally see here.Then maybe what needs a bit more explanation is to understand the result and the gross margins, because you might get a bit of the wrong view just looking at the numbers without understanding the underlying reasons. We just start with the EBIT level as such. It's actually a record quarter for us, SEK 77 million, even if we had adjusted SEK 81 million in Q3 last year, adjusted for this restructuring provision that we had. But it's also good to see that we have margins of 22.3%, which I think is the best that we've seen in many, many years and also above our target. And the reason is, of course, the low OpEx, and there's still a quite solid gross margin that makes us achieve this good number.And just to understand the gross margin, 61.9%. You might also see that this is actually down compared to Q3 last year. But we think, if anything, we're quite satisfied with that number in the report, actually. We have negative impact from the fact that we have lower volume, SEK 32 million lower sales, which gives an under absorption of our manufacturing overhead. And that is impacting with about 1 percentage point negatively. We also have a currency headwind, which is also giving about 1 percentage point negative effects compared to the number 1 year ago. So I think all in all, we managed to do some good things internally. We did have some good things in supply. We managed to get through some price increases. So to achieve the 61.9% with this low volume, we think, is actually quite good. Then looking at the OpEx is, of course, dramatically down SEK 44 million, but then you also should remember that SEK 25 million of that is related to this provision that we had for the restructuring program. And the organic number is SEK 30 million down, so 8%. Also, I just wanted to mention the short-term work impact, which might be interesting to also know. In total, that's SEK 4 million, where SEK 1 million comes from governmental support related to this. That same number for the full year is SEK 7 million in -- sorry, SEK 5 million in governmental support and then SEK 7 million for the other impact.To my comments on the first 9 months, it just happened to be so that the EBIT level is exactly on the same number as for the first 9 months last year. So SEK 230 million, which, given the lower sales, takes us to precisely our target, 20%. And here, you can actually see that the margins are up 1 percentage point. So 62.1% compared to 61.1%. And this is due to the reasons I mentioned before and also quite positive to see that we can actually increase this margin even if the volume is working against us.OpEx is, of course, dramatically down SEK 70 million organically, and adjusted for this, the SEK 25 million restructuring provision. It's SEK 53 million. And out of that SEK 53 million, we have about SEK 33 million related to the restructuring program. And the rest is just basically lower run rate in terms of our activities with less traveling and less customer events and so on due to the macro situation.So we're also now -- and we're pretty much through the effects of the restructuring program. Happy to see that we will get the SEK 25 million -- sorry, the SEK 45 million yearly effects that we had planned when we did this last year.Just some comments on earnings per share. There's not a lot of interesting things happening here. We have a good underlying result, which is basically us falling through. No strange things happening within that financials or tax in the quarter. So we're happy to be able to present SEK 1.33 in the quarter and SEK 3.58 year-to-date on the earnings per share.Looking at the cash flow, we have also record cash flow, SEK 116 million. Of course, we do get some help from some working capital adjustments. So we have a positive effect on the cash flow by SEK 20 million due to this. The 2 main items is we have some inventory reductions compared to last quarter. And also, we have substantially lower receivables by SEK 28 million. With that said, I just also wanted to say that we still have pretty much the normal level. We're actually up a few million compared to year-end in receivables. It's not that we just empty out this. I think we managed to get some help. And maybe we'll not have the same effect in the coming quarters, but we're very happy with the SEK 116 million. And, yes, even if we get the help from the working capital, we still think that's quite healthy.So in relation to sales, we're at 10.7% working capital, which is where we normally expect to be around this 10%. So nothing's changed there.Year-to-date, also a very strong number, SEK 286 million compared to SEK 193 million. We get some help from working capital reductions, not so much for the first 9 months, only SEK 8 million. And here, we have the big change is actually the inventory that is down SEK 23 million compared to year-end. But we might see a bit of a buildup in inventory for the coming quarters since we will have to take on some components that we see a bit longer lead time due to some corona impact, one thing being common for us, but we need to have those components. So we'll take a bit more inventory of those that we normally keep.Also what is behind the very strong cash flow and the improvements is that we've got some tax returns that I think we talked about and also Q4 related to the Belgium business. And overall, I think we have pretty low financing costs due to the fact that we have a low debt at the moment. And we also -- when we get the lower net debt to EBITDA, we also get better financing cost as such.So yes, we are back with the leverage, and then the debt situation here, we have, as you can see in the graph, a very positive trend. Of course, the fact that we didn't give a dividend this year helps a little bit. But still, we have -- we've been able to convert pretty well to our cash and to work down the debt level. So I think we have a very strong situation now going into Q4. As you understand, we made the acquisition of Procentec in October and also the last 25% of WEBfactory. So that will, of course, increase the net debt for -- in the quarter. But still, it will be on very low levels. And I mean, going out of the quarter at 0.42 net debt-to-EBITDA. Even if that will be a little bit higher after Q4, we will still be on very comfortable levels. And we will have a lot of firing power left for new investments and interesting acquisitions.And before I leave back to operator for questions, we just wanted to say also that we will have a Capital Markets Day that will be digital. It will be in November 18, between 9 am to 12 am, Central European time. And we hope that you will want to listen in to see what we have to say about the coming time for HMS. So thank you for listening. Operator?

[Operator]

[Operator Instructions] Our first question comes from the line of Viktor Högberg from Danske Bank.

[Viktor Högberg, Analyst]

So I've got a couple of questions. First, on the new revised financial targets and the implications from them. It implies a slightly lower growth rate over time than the previous targets and a slightly lower organic growth rate. That is at least my take. Is that due to the higher revenue base? Or do you see something shifting in the market or from the competition? Or could you just elaborate a bit on the organic part of the growth target up until '25?

[Staffan Dahlström, Co]

Maybe I can start with that, Joakim. I just want to say that me and Joakim are in different locations here. We don't see each other. But let me start with this. I think this new target of exceeding SEK 5 billion in 2025 represent growth of what can be 18% per year, something like this, which is lower than our original, but it's still not that far away from it. I think this is a combination of bigger numbers and what we see is challenging but also realistic going forward. And our estimation is that this will probably, let's say, 50-50 mix based on organic and M&As. So organic will be 8% to 10%, something like that, and the same for M&As going forward.And Joakim, maybe you can give a more detailed picture on this?

[Joakim Nideborn, Chief Financial Officer]

No. But I think it was a good description, Staffan. And I think the fact that, as you say, if you do the math, it will probably not be a little bit lower than 20% that we have said before. And our feeling is the asset, we don't really have that. The market isn't really there, and maybe we've overestimated the potential before. If we look at the market reports and so on, we still think this is quite ambitious and then in line with the higher intervals on the industry reports. That's the reason behind it.

[Viktor Högberg, Analyst]

Okay. So turning to the M&A part, half of this growth. Where do you see your pipeline? You just executed on a deal a couple of weeks ago. And so how is the pipeline looking? What are you looking at? I know software multiples are higher than hardware multiples, but you are still wanting to grow your software business. And also, how do you see your balance sheet over time? How much gearing will you be comfortable with?

[Staffan Dahlström, Co]

Joakim, will you take this?

[Joakim Nideborn, Chief Financial Officer]

Yes. Sure, I can take it. I think it's a mix, what we're looking for. I think you'll probably see us doing some software acquisitions more than the WEBfactory business. But I still think that the majority will be maybe a little bit closer to our more -- I was going to say, base business, so to say. I think the business for remote access and remote data we have with mostly through E1 is also an interesting area for us to see what more there that can be done. So that's 1 area that we're going to look more to.And what else did you have with the gearing? Well, I think as you see, now we're at very low levels. I think going up to like 2.5 or so will not be a problem at all, net debt to EBITDA. They were quite comfortable. I think it will go higher than that. It might happen from time to time, but that will probably be in a limited period if that happens.

[Viktor Högberg, Analyst]

Okay. And just the last question on growth. Procentec, you said you expect single-digit organic growth. Is that to be expected over time? Or is that near term expectations? Or what do you see for the Procentec business, maybe for '21 in a recovery year with easier comparatives, maybe above that? Or what do you see from Procentec, short-term and longer term?

[Staffan Dahlström, Co]

Maybe I can start. When we say single-digit growth for that business, that is how we are standing and growing today. So they have growth on their current business. I think the first, maybe 2021, HMS will not be doing a lot of changes. We need to support them and help them. Going forward, I can see more engagement from us to help them find new markets like in North America, in Asia, where they are not really present today. So we hope that can also, over time, help them to grow faster than the single-digit growth. But for 2021, I would expect HMS will not be having the time to accelerate that faster. But in the midterm, we will be able to grow that business more than single digits, I think.

[Viktor Högberg, Analyst]

Okay. And on the gross margins, you had some headwinds here, both in volumes and in FX. You quantified it to around 2 percentage points, and you still managed at 62% gross margin or slightly below 62%. What does that imply when we will see volumes coming back, presumably next year? Would the 64% would be a relevant target or 63% on the gross margin? Or what do you see over time? Or will that be -- will you meet another headwind in gross margins beside this?

[Joakim Nideborn, Chief Financial Officer]

Well, maybe I start, Staffan. I think what we also should remember that I think I mentioned quickly is that we also, given all those headwinds, we have the help from a good product mix. As we saw when Staffan presented, we have the embedded business. The design business was only 47% of revenues. That is normally around 50%, maybe 51%. So that is actually helping us a little bit. We have some low-margin custom products. So I think on one hand, when the volumes comes back, it will also probably coming back on those offerings with a bit lower margin. So that might be working a little bit in our disadvantage. With the currency situation, it's very difficult to say. But I think when volume comes back, to be slightly north of 62% shouldn't be impossible. We want to be a bit careful guiding as we still think that 62% is -- we've been improving from like 60% to 62% in the last couple of years. But some are 62%. Maybe slightly north of 62% should be achievable, we think, for the coming years.

[Viktor Högberg, Analyst]

Yes. Okay. And just last commentary or a question on the gross margin. Procentec, we got the EBIT expectations. What about their gross margin? Is it in line with your business or slightly below? I would assume it to be closer to 50% and 60% given the EBIT margin.

[Joakim Nideborn, Chief Financial Officer]

Yes. I think you would think maybe, but actually, it's very much in line with our gross margin. So we don't really see that, that will have any impact in any direction from that point of view. I think where there might be some potential is that it's still a relatively small company, starting to set up a bit of a group structure with some sales offices. So I think that's why maybe you see the OpEx being a bit higher in percentage compared to, for instance, us. So that's what we think we can work a little bit on to, to maybe get the EBIT margins up slightly. But the gross margins are very healthy. So that, we're happy with.

[Viktor Högberg, Analyst]

Okay. Last question. ABB comments their robotics surprised positively for them, but their comments were that we're going to see on orders. This is going to be seen in the numbers in '21, not in Q4. So could you -- what do you see for Q4? We have a very much easier comparative when it comes to growth from Q4 '19 than we had in Q3 '19. But is the market there for returning to growth, slight growth already in Q4? Or what do you see? You added the comment on positive data points but still on uncertain markets. On a net basis, what does that pan us out to?

[Joakim Nideborn, Chief Financial Officer]

Yes. That's a very good question. And to be honest, we don't fully know. We look on the macro data and the PMI indices are looking quite good actually going forward. When we talk to customers, we still see some -- they are nervous and a bit hesitant. So it's -- we get mixed feelings. So I think our conclusion is that it will continue to be sideways for a couple of quarters. We don't see a strong momentum yet. Even if the macro data seems to be better, we can't really see that we see this in our own orders and in the comments of our customers yet.

[Operator]

[Operator Instructions] And as there are no further questions, I will hand it back to the speakers for closing remarks.

[Staffan Dahlström, Co]

Okay. Thank you very much, and thanks for taking time on this Friday afternoon to join HMS here. And as I want to highlight again, Capital Markets Day, digital format, November, 9:00, Central European Time. You're very welcome to join, and we talk more about the strategy. We'll have some other team members from our management team as well joining, and we hope to take this time to give you a little bit more detailed information about our business and our view of the future. So thanks a lot for this meeting and look forward to see you soon again. Thank you. Have a nice weekend.

[Operator]

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