HMS Networks AB

STO:HMS

Earnings Call Transcript 2019-Q4

[Operator]

Welcome to the HMS Q4 2019 Results presentation. [Operator Instructions] Just to remind you, the conference is being recorded.Today, I'm pleased to present Staffan Dahlstrom, CEO; and Joakim Nideborn, CFO. Please begin your meeting.

[Staffan Dahlstrom, Co]

Thank you. Good afternoon, everybody. Welcome to this call, where we'll present our Q4. And the agenda for today is that I will do a short summary of business update, and Joakim will take over and explain more details of the financial results, since there are some things that need to be a little bit more in-depth explained this time.But let me start with a summary. So we are seeing a weak Q4, a little bit in line what we have reported before and expect. I think the net sales, slightly negative, minus 5%. We are not happy at all with this, but we're also very unhappy with the order intake of minus 13%, and we see, in general, quite weak market on our markets, and I'll come to that a little bit later. We are talking quite much in the report about both adjusted EBIT and adjusted EPS, and I will let Joakim explain this a bit later in the financial presentation.Quarter 4, quite good cash flow. And with close to 2019 to be not the best year ever, but some 11% growth. But keep in mind that one part of that is currency translations, one part of that is the acquisitions we have made. So organically, we are seeing a weak growth of 1% organically in 2019, something we are not happy with.Order intake, also a small growth, but according to what we would like to see. We talked about in EBIT, that is adjusted level, slightly lower, but we keep on running on a gross margin -- sorry, EBIT margin that is beyond -- below our targets. Right now, we are seeing 16%, and we come back to the adjusted EPS. But let's take a deeper look into our business.First of all, as you know, we are talking about connecting devices in industrial applications. We have the [Audio Gap] years, more than 7 million products installed in the market, and our 4 brands, Anybus, Ixxat, Ewon and Intesis, are well-known on the market.What's new from 1 January, 2020 is that Intesis has now been integrated in HMS, and we are using the full scale of HMS sales force, also for Intesis, and maybe you know, there's a slightly new longer time for Intesis, including that they're member of our family now. Last year, we also acquired WEBfactory. We own 75% of the company, and they are not fully integrated with HMS, and -- but they provide a quite good value on software application on top of our products.All right. So let's move into a little bit of a general business. We are talking about 2 parts of customers. We have our large part of makers. Makers for us are companies who make industrial machines or industrial devices, and they use our networking technology to interconnect their machines with other machines or to different Internet of Things applications. This is the majority of our business, and we normally go to this market with our direct sales force from our 16 offices in 16 countries around the world. We also have a focus on the user market. These are users of industrial automation systems, and we focus on manufacturing, energy and infrastructure, buildings and the transportation. And here, we mainly go to market through our system integrators, distributors and solution partners.If we take a little bit deeper dive how this is distributed -- how our revenue is distributed, we see that our original business with design win of our embedded products, that is a very sticky business with makers, this is about 50% of our revenue. We are selling other things to makers, such as routers and gateways and other products, that's around 25%, and since a couple of years, we have a high focus on [indiscernible] to sell more industrial communication products to users, and that is, right now, around 20%. We have a smaller business that is software, software subscriptions and services. It's only 5% of our revenue, but we also want to follow this going forward since we see this as a future potential growth area for us. We see that many of our customers are, at least in the future, more interested of software-as-a-service and this new business model, even if they are, right now, not ready to move into that.So if we could take a deep dive into the design wins. This is a very sticky business model. This means that our customers, they decide to integrate our technology inside their products, and when they sell their product, they will use our components or software modules as part of their solution to their customers. We call this design wins. And the first thing is that they integrate this technology into their design, and then they move over to what, we call, production win, and then we get a recurring revenue, or at least, the revenue every time they sell a product, where our technology is included.We've done this many years, and every Q4, we published the numbers. And as you see on the graph here, we continue to be successful. Number of new design wins are increasing, but also -- a number of existing customers are also increasing. This today represents 49% of business, keep on growing, but we'll have other businesses that grows faster than this.We'll see a quite small churn. 95 customers went out of the business for -- normally, it's a reason because they have an older product that they discontinued to manufacture. So all in all, we see a good growth, a continued growth and the long-term trend is still positive. I think it's important to emphasize, this also means that we have an attractive product offer that attract new customers to design in our technology. Okay. So if we just look on history. If we look on the last decade, we have targets of 20% growth. We've been on that target, if we take the CAGR over the last 10 years, so check box on that. On the EBIT, we have 20% as a target, and we are, on average, 18%. And on the dividend side, our policy is to distribute around 50% of EPS, and we are including, this year, around 46%.So I think we are on or slightly under our targets, and we do have a fairly weak market at the moment.So let's take a business update and look into this. We see that the weak market development, as we talked about in Q3, continues here in Q4. We have business in building automation with our Intesis. That is quite solid. It goes quite well, but most of our business is in manufacturing industry, and that continues to be a difficult market with limited growth and low demand from our customers and our customers' customer. Especially, as noted on Anybus and Ixxat brands, where we continue to see headwinds, and I think this is where we have the biggest impact on a weak market in the manufacturing industry.Ewon had a better quarter in quarter 4 and also Intesis continues to show good growth for the building automation.Biography. We are seeing that Americas and EMEA, where Germany is a big portion, continue to be hesitant, I would say. We see similar development, as we see in the last quarters, with a weak market. We've seen a weak market in Japan for quite some time, but there, we are seeing somewhat better. It's not good, but I think, we are starting to see a turnaround in Japan. So we've seen in the best quarter since quarter 3 2018, but we're coming from the low levels. But still, we are trying to see this as a positive sign.Other events that is important to mention during this year has been our launch of HMS Hub, our software middleware that we've been launching. And I think this is an important technology for HMS in our ambition of future growth, and I would like to integrate to new cloud-based IoT systems.We continue our expansion on sales offices. We opened 2 small office -- offices this year, 1 in Dubai and 1 in South Korea. In Dubai, we started to see some good traction. In Korea, we still have a quite difficult situation with geopolitic situation in that part of the world.We've been investing quite much time in technology developments in 5G. We have done some early adopter installations, and we are around trade shows, talking to large industrials about the benefits of 5G. It will take some years before this make a big difference in our revenues, but it's important for us to be an adopter and show these new technologies to our customers.We made 2 acquisitions. This spring, we've acquired the German WEBfactory, a software company, and we also acquired our Dutch distributor, Raster Products. And we saw here during the summer that the market will be weaker going forward. And before that, we had a quite ambitious growth plan with increased OpEx. So we had to do a restructuring program here in Q3, and we finalized this in Q4. Joakim will give a little bit more details on this.And we also finalized the integration of Beck, where we take their technology and fully integrate to our IoT offer. And as I mentioned, we also integrate Intesis as a field -- full business unit within HMS Group.All right. So Joakim, financial results.

[Joakim Nideborn, Chief Financial Officer]

Yes. Thank you, Staffan. And as always, let's start with order intake.As Staffan already mentioned, not the best quarter for us, SEK 337 million in order intake, which means a decrease of 13% reported and 18% organically. And then, of course, all the markets are behind this. We have both EMEA and Americas having downwards trend both from Q3 and also from Q4 last year. With that said, we don't necessarily see that there is a big change in the underlying demand. We think it's pretty much the same picture that we've seen the last quarters as well. And then going forward, we expect maybe to be on these levels for some time.The positive sign would be then Asia, which is actually up 13% organically in Q4 from some low levels, but it's starting to look better, and we had the best quarter since Q3 2018. And the decline we see is pretty much across all industrial segments.The building automation part with Intesis is going much better. There we have growth of 30% looking for the full year. But in the industrial world, it's a tough market for sure.Looking at some full year numbers. We're doing SEK 1,470 million in order intake. This is an increase of 3%, but organically, a decline of 5%. And then most of the gap, if you look -- we have a book-to-bill of 0.97. The main reason for this gap is actually Asia, where we have most of this decline that comes from the buildup of inventory of some of our key customers during 2018.And if you remember, we talked about component shortage back then, which led to some inventory buildup on these customers. This, in combination with a tough market in China for Japanese exports, that's led to very low sales of these key customers.Except for Japan, I must say that Asia has developed quite good over the year, and we have good growth on all other markets. But since Japan is the main market in Asia that is not making up for the overall picture.Just commenting on the brands for the full year. We had Anybus and Ixxat, which are most cyclic of the businesses. And here, we also see a rather big decline. Ewon is holding up a bit better, plus 6% organic order intake, and Intesis, as we mentioned, is more than 30% up organically. So that's very positive to see.If we go over to the sales, it's a similar picture. It's pretty much the same brands developing in the same way and pretty similar picture also in the markets. We have SEK 346 million of reported sales in Q4, which means a decrease of 5% reported and 10% organically. And as you can see, we're down on all markets, the smallest decline in EMEA, but that's also where we have the biggest impact of the acquisitions that we made. So organically, it's a similar picture in EMEA and Americas, and a little bit worse in Asia.Looking for the full year. We managed to reach above SEK 1.5 billion with SEK 1,519 million, which means growth report of 11%, organically only by 1%. And also here, you have quite a similar market picture in EMEA and Americas with a slow growth organically and the decline in Asia.We're looking at the sales per market. We have 63% in EMEA, with Germany being the biggest market, representing 44%, and that market is almost 30% of group sales. Then we have Americas, with of course, U.S.A. being the biggest market with almost 20% of the group sales. And then we have Asia representing 16% of the overall sales.I think we will need some more explanation than normal to understand our EBIT and also our earnings per share. So we'll try to get through that. And I choose to present here the adjusted EBIT first, which is SEK 33 million, then corresponding to margin of about 10%. And then -- the reported EBIT is then is SEK 55 million. So what are the main things impacting this? We made a deal with the previous owners of Beck IPC to make an earn-out settlement already this year. That was expected to be done next year according to the contract, or for various reasons, we decided to have this discussion already this year and to try to fix this.The maximum potential earn out was EUR 2 million, and now we paid out EUR 200,000, and the rest comes down as a positive impact on the EBIT. So here we got a 19% plus. And then we had the restructuring program that we initiated in Q3, we had a provision of SEK 25 million for that -- for the program. We only needed to use SEK 22 million. So there is not a positive effect of SEK 3 million from that. So the interesting number to look at is the SEK 33 million in the adjusted EBIT.Just mentioning, the gross margins we normally talk a little bit about that. We see the quarter developing in the expected way. We have 61.2% in gross margin, which is slightly better than the Q4 last year, but a little bit weaker than Q3 this year.I think this is pretty much in the area that we expect the gross margins to be within mix we currently have. We have some positive effects from WEBfactory, but we also have some negative effect from Beck IPC going back before that acquisition. So somewhere around 61% is probably where we are with the business, and it is also in level with the lines -- the margins that we have for the full year and last year.Talking about the OpEx development. We have reported increase of SEK 12 million. If we adjust for acquisitions and currency, we're actually saving SEK 3 million, and this is an effect from this restructuring program that we initiated. I'll talk a little bit more about that in a second. For the full year, we're reporting the SEK 243 million reported EBIT compared to SEK 251 million a year ago, corresponding to margin of 15% (sic) [ 16% ]. And if we look for the full year, I think the adjusted EBIT number is very similar to the reported. So no need to talk too much about that.As I said, the gross margin is 61.1% now in the year, similarly at the level as the year before. So this is where we expect to be going forward.Looking at the OpEx number for the full year. We have a reported increase of SEK 121 million, but organically is only SEK 32 million increase. And then we adjust this for FX impact, acquisitions and also some currency hedging, where we report everything on the OpEx.So just to guide you through the restructuring program and how you should look upon that. I just made a very illustrative picture on the left-hand side showing where we came into 2019. And then as always, we had ambitious plans for the year, staffing up with both sales and R&D people. That's what we started doing over the year. And then early Q2, we made the acquisitions of the WEBfactory and Raster Products that just bumped up the OpEx level a little bit more and continued to expand from that.During mid year, sometime during the summer, we saw that okay, the market is not really there in the same pace as we were expanding OpEx. So we thought we had to do something. And that's when we initiated this cost improvement program that we then executed in October. That's where you see the downturn.So now to conclude everything. I think, we're back to the levels that we had on average for the year. So the program is fully implemented, and we had expected results. We have 43 people that left the company.And as we talked about before, the restructuring costs up to SEK 22 million. And as we also communicated earlier, we expect still to have the savings of SEK 45 million in relation to the run rate when we executed the program.But all in all, this means that we're currently running with the same OpEx that we had on average for 2019 or slightly below that level, and that's the way we go into 2020. And exactly how it will develop from here, we don't want to give any promises, but that's the way we have it now, and we're going to be looking at how the market develops before making big changes to the current level.Okay. So if we look at the earnings after tax and the EPS, we have even more impact than we had on the EBIT line. So I'll try to take you through this. We have reported EPS in Q4 of SEK 1.46 and adjusted is SEK 0.68. Now I was a bit understanding out a bit that we would have a positive tax. So plus SEK 20 million in tax in Q4, and there are several reasons behind this. If you look on overall result, we have the SEK 19 million from the Beck earn-out that is just falling through all the way to earnings after tax. And then we have a very positive thing. We think, in Belgium, there was a new tax regime in place, called Innovation Income Deduction that will -- and we -- just a few days ago, we got a positive decision from that -- from the tax regime in Belgium, giving us a tax deduction of SEK 19 million for 2019. And yet to understand that, the SEK 19 million is actually accumulated for returns for 2018 and 2019. So SEK 10 million of these actually relates to profits made in 2018 and the other SEK 9 million is from 2019. And the decision is made in that sense that it will also be valid for 2020. So we can expect to have a similar tax reduction in 2020. As that, we need to reapply if this regime is still in place after that.We also have some other earn-out related transaction that will give us a positive effect on tax of SEK 5 million. This is quite complicated. So I'm not going to go into that in detail. But all in all, this will hit Q4 and that's why we have this very positive effect in Q4. Looking for the full year. Of course, we have the same things in place that we had in Q4, but also, we have this restructuring program going into the other -- in the opposite direction with SEK 22 million that is impacting in negative way.So for the year, we report SEK 4.43 earnings per share, but adjusted is SEK 4.06. And with this in mind, the Board has decided to propose a dividend of SEK 1.9 to the AGM later this year.Okay. Cash flow from our operations. We have a quite good cash flow, we think, in Q4 of SEK 61 million. The main drivers, except for the result, is changes in working capital. We communicated already in Q3 that we're starting to make some inventory reductions as we see some of our customers doing as well. So here, we're now starting to see impact of that. We have SEK 15 million lower inventory now in Q4 compared to Q3, and we expect that to continue with maybe another SEK 10 million in the first quarter.And as a result of the lower sales, we have some low receivables of SEK 20 million. And all in all, this leads to a decent cash flow in Q4. Looking for the year, we have the cash flow and this is after then working capital changes of SEK 254 million to compare to SEK 193 million compared to last year. So even if the EBIT result is in line with previous year, we managed to squeeze out a little bit more in cash generation. And the main reason for that is that we have lower working capital going out of the year.Okay. So our final slide. We have to now talk about the debt situation and leverage a little bit. We have reported net debt of SEK 402 million. And then you should know the SEK 93 million of this comes from the IFRS 16 leasing standard. So underlying, it's SEK 93 million lower than that.And looking at net debt-to-EBITDA, we report 1.2 to be compared to 1.13 one year ago. But if we adjust this for the SEK 93 million of IFRS 16 debt, we have a comparable 1.03 to compare to the 1.13. So I think all in all then, the main message is that we would think that we have a rather strong balance sheet. Even if the market conditions are a bit uncertain, we still think that we have a decent earning level as it is, and then think that we have a very good position to go after more acquisitions with this leverage that we have.So with that, we would like to open up for any potential questions if there is in the audience.

[Operator]

[Operator Instructions] Our first question comes from the line of Joachim Gunell of DNB.

[Joachim Gunell, Junior Analyst]

So maybe you can start with diving into the order book trend. Perhaps, you can provide some more details here on what drove this steep sequential decrease? And also, if you could talk a bit more about what you're seeing in terms of OEM customer CapEx plans for 2020, perhaps?

[Staffan Dahlstrom, Co]

Well, we don't have too much more detail on that, but I think what we saw in December was a month that was really, really slow. So I think that December came out worse than we expected on the order situation. Maybe, this was a little bit of a seasonal effect as well, we aren't really sure. But in general, on most industrial markets with quite weak demands, people are hesitant to make investments and a little bit of wait and see.Of course, we see a quite negative scenario in the auto industry with slow investments there. But I think in general, we also see a lot of cautious customers that are not really planning for a lot of new growth. People are sitting, waiting, it seems like, to wait and see things are developing, and there's a hesitation in general.I think this is what we can say about the order situation in general.

[Joachim Gunell, Junior Analyst]

Understood. So if we see, say, flat volumes for -- at best for 2020, could you elaborate a bit on your ability to, perhaps, better expand margins with the cost reduction program mainly in place, despite the tougher industry backdrop?

[Staffan Dahlstrom, Co]

I think, for now, what we've done on the cost side, we think is what we would like to do in the first place. And as long as it doesn't get not a lot much worse than this, we're going to be -- we're not going to add a lot of OpEx, but we're not going to take out more. That's the plan we have now.What we're going to try to do, of course, is to look at our gross margins and see if there's something we can do there. So let's report back on that, maybe in Q1, Q2, when we know with more what we can see on that side.

[Joachim Gunell, Junior Analyst]

Great. One more question for me then, perhaps, and I'll get back in line. I know it's early days. We don't have a lot of information yet, but with regards to the potential of a pandemic, how do you see potential trends build over to your supply chain in China as of today?

[Staffan Dahlstrom, Co]

We have our team. We have an office in Beijing at the moment. So our sales activity there. We have -- all our staff are healthy, and we have a few -- 2 people working at the office. The other 10 are in their homes, working from home of -- well, from the computers, more or less, for the next couple of weeks.On the supply side, we have several quite important suppliers: 1 in Beijing and 1 in Ningbo. And there, they are closed a little bit extra till 9 of February. At the moment, we are expecting a 2-week delay on our supply or sub supply -- from some sub suppliers in China. That will have a limited effect on our capability to make shipments to our customers.If this -- it'll be longer than these 2 weeks, we need to make new calculations. But what we see right now is that if it doesn't get worse, we are okay, but we follow this on a daily basis. It's very difficult to say, midterm, how this affects our business.

[Operator]

And the next question in the queue is Viktor Högberg from Danske Bank.

[Viktor Högberg, Analyst]

Yes. So I also have a question about the order intake. If we look at it in terms of the order book when you closed Q3 and revenues in Q4 came in quite substantially below that, did you see any canceled orders or something like that?

[Staffan Dahlstrom, Co]

Not really. It's -- we don't really see it's been that bad. It's just that we have a slow -- slow inflow of new orders.

[Viktor Högberg, Analyst]

Okay. So it didn't fill up during the quarter?

[Staffan Dahlstrom, Co]

Yes.

[Viktor Högberg, Analyst]

Okay. And looking at one of your large clients, ABB, the CEO of which was in Davos a couple of weeks ago, saying they saw a slight turn in sentiment in their robotics division towards automotive. Is that something that you can see? Or is it -- in Q4, I know it was a weak market, but what about now, at beginning of February, do you see any signs of improvement or -- because automotive is quite large exposure for you.

[Staffan Dahlstrom, Co]

That's right. I think when we look at the macro, there are coming more and more signs that -- from a macro perspective, we are at the bottom. I think, for HMS, as we wrote in the report, we expect that the next couple of quarters will probably be tough on us as well. Will it be worse? Probably not, but we don't see positive signs from the macro materializing good orders at the moment, at least. But yes, it's positive that our customers, like ABB, feels that there's a positive outlook. But I wouldn't say that we can promise anything that at the moment. We need to wait 1, 2 quarters to see how this develops.

[Viktor Högberg, Analyst]

Okay. And so for OpEx, this year, you're going to keep it -- or short-term is at the same level as the run rate for last year. What do you expect, single-digit increase in OpEx, 3% to 4%? Or flat? Or 10% plus? Or -- what are the range? What are you looking at currently?

[Staffan Dahlstrom, Co]

I think, right now, we are looking into keep things as they are until we see a change in market conditions, hopefully, upwards. So we can be more, possibly, more active in doing other things. But right now, I think, we have a lot of activities that we can do with the existing resources. That is okay for the time being, and we don't want to increase OpEx the coming quarters at the moment.If we see a pickup here late in the year, okay, it's a new scenario, then we need to act on that. But right now, we're a little bit wait and see when it comes to new things.

[Viktor Högberg, Analyst]

Okay. So in terms of M&A, targets, discussions pipeline, and what are you looking at? What would you like to do? What are you seeing in terms of prices?

[Staffan Dahlstrom, Co]

Yes. We -- of course, we keep on talking to some customers on our potential types of our short list. As we informed earlier, this is normally very long processes. These are, in many cases, probably led companies and for them to sell their baby, it's not so easy. However, we think that this -- if it's more difficult times -- if the difficult times continue, maybe this will open up some opportunities. Companies that have, well, seen that they have a more difficult future, maybe they are willing to accelerate some discussions with us.Right now, it's too early, I guess. Market have not been tough enough to bring them forward. I think, we're working long-term with our M&A. And what we've seen, I think, over the last couple of years, look back, on average, we have done between 0, 1 and 2 acquisitions per year, and I think this is what we see going forward as well. I understand that is not a good guidance, but it takes long time and when things materialize, it's difficult to predict, but we are continuing to focus on M&A. That's clear.

[Viktor Högberg, Analyst]

Okay. And just to make clear here on current trading, you have not seen any, regardless of geography or product line, any signs of improvement going into -- or here in Q1? Or is it just as hesitant, I think, Q4? Or do you see any...

[Staffan Dahlstrom, Co]

Yes. We don't talk about -- this is a Q4 we talked about, and we don't talk about Q1. But in Q4, we've seen somewhat a better situation in Japan on the water side. I think that's one message we are conveying here. But otherwise, we need to give it a little bit more time to come back in the next report to talk about quarter 1.

[Operator]

[Operator Instructions] And we've just had a further question coming from Joachim Gunell from DNB.

[Joachim Gunell, Junior Analyst]

So just one more question. As the IT and OT increasingly converge, I mean, regarding the competitive environment, I mean, to what extent have you seen or come across new competitors in -- just, say, in the past 3 years? And what sort of verticals are you seeing new competition coming in? Because I mean, from a design win -- yes, based on design wins here for Anybus in 2019, we -- I mean, do you also still continued solid, so to say. So if you can, perhaps, elaborate a bit on that?

[Staffan Dahlstrom, Co]

I think the conversion we are seeing between OT and IT is normally taking place on a higher level than the field level or the PLC level, as we call it. So although, we'll -- what is controlled centric on the factory floor, whether all this industrial ethernet and these networks are, we don't see a lot of conversion from that level to IT. It's much more on the -- this from North of the PLC to scaler systems. There we see much more of a conversion starting into more IT.So I think our traditional Anybus and Ixxat business is not so affected by this convergence. When it comes to competition, we see much more of a potential for new partners. We have several of our solution partners that work in that, and they want the data that we can provide them from the field level.So right now, we see this more as an opportunity than an increase of competition for our products today.

[Operator]

[Operator Instructions] Okay. So no further questions come in for at this time. I'll hand back to our speakers for the closing comments.

[Staffan Dahlstrom, Co]

Thank you. Thank you all for participating in today's call. As I said in the beginning, we are not happy with quarter 4, and we keep working to improve things. We have long term as one of our core values, but we are not happy at all with this kind of short-term, not-so-good results, both on order, invoicing and EBIT.So we keep on fighting to keep on growing, and we remain with our long-term ambition to be a growth company, both organically and through acquisitions. So stay tuned, and we have to improve long term, but we have a couple of quarters here, where we expect that the weak market will continue.So having that said, thanks for attending, and thanks for following this call. Have a nice day.