Note AB (publ)

STO:NOTE

Earnings Call Analysis

Earnings Call Transcript 2024-Q3

[Johannes Lind-Widestam, executive]

Welcome to NOTE third quarter presentation for 2024. As always, I'll try to make a short summary of the quarter. First of all, we did not reach our sales expectations. That is pretty clear. We had to go out and give a new guidance. With that lower sales, I think the profitability came in pretty much where I expected or even slightly better. I still believe we're doing good cash flows. And I think that means that we are -- how should I say, we're converting the results as it should. I mean, we're not growing.

That means that we have a positive impact on the cash flow. We have lower ARs. Inventory is going down or continues to come down. This also gives a positive contribution to the cash flow. So those, what I call, financial fundamentals in our world is working as it should. So therefore, we are expecting cash flow to be stronger than normal also for the coming, say, 1, 2, 3 quarters. It depends on when we are through all that. So I would say that we still have maybe SEK 50 million to SEK 75 million more inventory to be reduced in the coming quarters. And we also see that our debt to our suppliers is slightly lower than normal, and that is an effect of that we buy less at the moment than what we consume. So when that normalizes, it will also have a positive impact on the cash flow. So cash flow is expected to continue to be strong for the coming quarters.

With that said, it's also very tricky to have these calls. We're looking very positively on the future, and then we have a very weak quarter from a sales point of view. So how do you summarize that in a good way? I would say that the industry, when we went into 2024, were expecting a quite slow year. Expectations were basically flat. The latest expectation is, of course, quite more negative than that. So the complete industry is going quite weak at the moment.

If I look at NOTE, we will see that Q3, 20% negative on sales. That will be the lowest point in this dip as we see it. Guidance for Q4 is about 8% down if you look in the middle of our guidance. And that is -- yes, if you look at that guidance, you can see that normally a weak year like this than you close a few weeks more when you have vacation in Sweden, Finland and Estonia. And therefore, July will become a month where you have basically half the speed compared to a normal month.

If you would add in [ 0.5 ] month in the third quarter, we will be in the guidance of Q4. So we're not expecting Q4 to be better run rate than we have in, say, August, September. It's basically the same speed. So we're not expecting a big recovery in Q4. It's more that we normalized the monthly average that we were hitting in Q3 and Q2. So that's what we see. We don't see this as a weaker -- or we don't expect the Q4 to be a strong recovery. We expect it to be at the same level as, I would say, Q2 and onwards if you take the normal month level. So that's what we are looking at.

So why do we continue to invest in new buildings, expanding factories and so on? But the issue is that we're not seeing, one, the same trend for everywhere we are. We see China extremely weak. I think we're down with 35-plus percent this year. Estonia has had a very weak year, a lot of customers that have been dealing with stock reductions. Then we have Finland doing a new record year. Torsby doing a new record year. Lund will do a new record year. We had a record month in September. So very different depending on where you are in our world. So it's not only that between the segments it's very different, it's also where are you in implementing the new customer programs that we have been awarded.

So what we see, as we see it, is that we will gradually come out of the weak trend and then more and more of the sites will go from negative to positive. And when that happens, we will see more of a general recovery. We have predicted that to come in the second part of this year. We are no longer expecting that. So therefore, we have guided low for Q4, and we will get back to you how we see upon next year.

In our customers' view, we would -- if we would believe the customers, we would see a strong recovery in 2025. But we want to get closer to that before we start to give you more details in that guidance. So we believe that '24 will be a very weak year, and that '25 will be a growing year again. And we will, as I said, come back to more guidance around that.

But if I look at what the customers are expecting from the programs that we're producing, their view of the demand coming 12 to 18 months is significantly higher than what we're achieving right now. And therefore, we are investing to be able to cope with that demand, say, in the second half of next year, then we're expecting to be at a significantly higher level.

So therefore, we are continuing the plans. We are expecting the Torsby factory with 7,000 more square meters. We are moving out of the current premises in Lund, because we are simply -- currently, we are ramping more than 2,000 square meters in another building. So we have already outgrown the Lund facility. And we have others where we are expecting similar things. We will continue to invest heavily in automation and in new equipment also in Q4 and next year, because we believe that, that is going to be necessary. So it's very mixed emotions. We are presenting a quite weak quarter from a sales side and yet we are putting the gas pedal quite hard down in investment and preparing for the future. So very interesting.

If you like numbers, you can say, okay, the trend is very negative. But if you look at, say, a 5-year average, we're still with the guidance we have for 2024. We're still reaching 15% organic growth year-over-year if we start at either '18 or '19 as a starting year, it doesn't matter. So still, the growth for a longer period has been very strong, and we don't see any signs in the market that will indicate that this has come to a stop. So therefore, we are preparing for higher numbers in the coming quarters and years, even though we don't get support for increasing our guidance in Q4 more than we have been guiding in our guidance in September.

Okay. Long story short, here are our numbers. I think most of you have seen them, but sales, SEK 809 million, down 22%. OP came in at 8%. We have some positive one-offs in this, which is the currency and the currency translations. And we had some negative with one-offs where we are continuing to adjust our cost level. I will come back to you a little bit how that has worked for the last year. Underlying, 8.3% compared to 9% last year. I mean, as you know, we're always talking about what I call fall-through on increased sales.

If you look at the negative fall-through on reduced sales, we are hitting much better numbers than we are expecting for increased sales. We're expecting 15% of growth to end up at bottom line. The reduction here of SEK 200 million has resulted in the reduced OP of SEK 27 million. So we are below the 15% or the negative fall-through, which I think is very strong. It's much easier to increase profit when you grow than to keep profits when you are declining. So I'm very impressed with how we have done this. So this is telling me that what we have done from an automation point of view, from a cost mitigation point of view has been efficient. So this is one thing that we're very proud of.

Cash flow, I've talked about it, SEK 157 million in the quarter, almost SEK 400 million year-to-date, very strong numbers. If we then exclude the investments that we have done, or the acquisitions, we are, yes, SEK 340 million in free cash flow. Very, very positive.

Going into the segments. If you look at Western Europe, we are declining less than we do in the rest of the world. I've talked about it before, China is significantly weak. If you look at this, we are also hitting quite good numbers in operating profit. So Western Europe is not affected as much as the rest of the world. We are only declining [ 1.1% ], but that's also related to that we are not losing as much sales in Western Europe. So the link is very clear.

If you look at the rest of the world, we are declining from 8.9% to 5.4%. That is something that we are working on and one part of the one-offs that we were presenting is another cost saving initiatives in China that we will do in the coming quarter. But if you look at the number of employees, and we are counting number of employees in the year-to-date number, and then we see an increase in total. But if we look at where we were 1 year ago when we ended Q3, we were 972 in Western Europe. Now we are 922. So we're down with more in headcount and our sales is dropping. So we're seeing an efficiency there. The same goes also for the rest of the world. We're down with 24% in sales, and we're down with 14% in headcount. Here we have some more work to do. So we will continue with that. But to me, this is showing that we are continuing to prepare ourselves for being efficient also in the lower sales that we're having. So this is something that we will continue with.

What will happen when the growth comes back is that we have reduced our overhead costs. So when the sales is coming, we're going to hit the 10% mark, that I already see as our target, much earlier than we would have last year. Say that last year we were reaching 10% at maybe SEK 1.1 billion. This year I think that level is down to maybe SEK 1 billion, SEK 1.25 billion or something. So very important to keep in mind that we are adjusting our cost base to hit better operating profit at the lower sales. It's very easy to add capacity when needed, and it's better to adjust to where you are and then you add resources where you need them. Otherwise, you would have a bucket full of and not fully utilized resources, and we don't like that. So that's how we think.

But if you look at the numbers, you see China, minus 35%. And as I see China, we are not seeing a quick recovery. We are preparing for a lower speed in China. We are preparing for growth in Estonia. We are preparing for growth in Sweden and so on. But China will continue to be at a quite low level as we see it in the near future. We don't see a recovery there as of now.

Looking at the segments. And here we're seeing that Industrial is the only growing segment. We were declining in Q3, but year-to-date, it's a growing segment. And in this segment, we have defense. Defense has grown maybe, I don't have a number, SEK 150 million plus. It's probably SEK 200 million this year, but I don't have the number in back of my head. But if we exclude that also, Industrial is negative. But what happened in the third quarter was that we were expecting Communication to be at a higher pace. And in this segment, we had a few customers coming in with quite high expectations and the conversion from forecast to orders were not happening.

So one of our biggest customer in this segment were expecting sales of SEK 30-plus million and we ended up at SEK 9 million. We didn't know that when we entered this quarter. And therefore, we were a little bit caught by surprise. I had a meeting with the CEO of that company just before the summer, and they were very optimistic and they did not get orders as expected. And this is a customer where we're doing only -- all the installations that we do is a bit of custom design. So they cannot buy to inventory, because they don't know which customer that will order. So there is a late configuration. So that was converted to pushed out orders or pushed out forecast as we see it. So this segment had a problem with converting quotes and tenders into orders and we hope that, that will change.

The guidance in Q4 is that we keep these customers at a similar level as Q3, just to be clear. So we don't have any high expectations of communication in the fourth quarter either. We will see -- if the conversion comes in, we will exceed what we expect in this segment. Greentech took also one hit in this quarter, where our biggest customer on the EV chargers, we were doing a refurbishment program with them instead of building new units. So we lost maybe SEK 15 million in new sales of that. We were helping them to upgrade all the revisions into the latest revision. We're changing the communication cards in the units. And therefore, that had an impact on our sales. That one-off is not expected to happen in the fourth quarter. We're expecting them to be back on a normalized level. So Greentech were affected by kind of one-off.

Medtech is running at a slightly lower level than last year. We're expecting fourth quarter to be in line with the third quarter. We haven't made any big adjustments to that in the guidance and we haven't increased that. So our guidance is feeling very, how should I say, modest rather than that we expect growth in it.

So what do we expect for the future? I mean, Communication, very low level. Medtech, we also see some of the customers there have been doing less compared to what they have forecasted in. We had very high growth in '23 in Medtech. And we are probably expecting to get back on the '23 level in '25. Greentech, yes, I hope that, that will recover. We have much higher expectations from the customers, then they're not converting expectations into orders. So I would say that Greentech as a segment is a lot of wait and see, not so much conversion to orders. So that is where we're sitting.

Industrial, we have a lot of big industrial companies outside of the defense area that are also pushing some orders out. We're doing fairly good volumes, but we know that there is a lot more to come. We have also quite a few new customers that are on the way, especially in the Industrial segment, that we expect quite high sales from in the coming 12 months. So we have some growth enablers that we will see some effect of in the coming, yes, year or so.

Challenging market. If you look at this in a broader perspective, what do we see? If you look at -- there is not only in the contract electronic manufacturing industry where I've seen reduced guidance for the third quarter. If you look at the car industry, we're not really selling into the automotive industry, but we're selling to the suppliers to the automotive industry. So when those are reducing, we're seeing a decline for us as well. So I would say, automotive industry, if that takes a big hit in the coming year, that will affect most of the industrial companies supplying into them, and that could be a challenge for us.

We're not that much directly involved in all those businesses, but it will have spreading effects that can be stronger than what we see. I would say that is the biggest challenge for us if that industry is not bouncing back a little bit. But overall, I think that we are pushed down, where there is a lot of this inventory reductions going on among several of our customers. And when that rounds out, we'll see higher sales going forward. We can talk a lot about this, but I'd rather come back in the presentation of Q4 and see where the quarter has landed.

Some highlights. Despite all this, we still keep operational excellence as part of our offering and our quality, and delivery performance is still world-class as we see it. Yes, we're adapting our businesses. We're continuing doing restructuring. We take a cost for that for SEK 7 million in the quarter. The most important thing is that we're trying to adjust our cost base even lower than where we are to be able to hit higher profitability numbers on the lower sales.

Order stock. We have the lowest decline in the last, say, 5 quarters now. We are declining with 3% in the quarter. That would indicate that there will be -- and we're guiding down with 8%. So maybe the order coverage is better now when we enter fourth quarter related to the guidance compared to where we ended Q4 last year. That is a positive signal as I see it. We're also seeing that this shortening of the order cycle that we have been talking about, I would say that, that has more or less ended. The availability on the market for components is good. There's no allocation as the suppliers is talking about. That means that we will not see any more reductions of the order backlog going forward related to the component shortages. So I would say that we can say that this is normalized after Q3.

As I said, CapEx is going to continue to increase. We are moving -- or we have just decided to move Lund into new premises. That will happen in the middle of '26. There's going to be a new building that is starting to be built this fall. And I think that is very important. Lund is one of the sites that have been showing the highest growth in the last, say, 4, 5 years. So that's very important for us. Lund is also -- our current building is in an area that will be restructured into housing, that industrial field will be turned into housing.

Return on operating capital, 23%. We're still keeping that number high up. This is in line with our long-term objective. And I think we are quite higher than many of our peers on this number. Our equity ratio is up to 49%. Our liquidity situation is very strong and solid. So we believe that our balance sheet looks very good. If we find the right acquisition targets, we have plenty of room for those. So we just need to find the targets and agree on the price. That's easier said than done. But we have a good pipeline, and we have some good dialogues in this area as always.

Outlook. As I said, our guidance is around SEK 1 billion for the fourth quarter. That means negative 8% from last year, in the middle of the guidance. Profitability, we expect to have a higher underlying profitability in Q4 than we had last year. And we believe that, that is a solid number. We don't believe -- our performance as of now is indicating that, that is fully reachable. We also believe that the market is strong in the long time period. So our guidance for 2028 remains as is. We moved it 1 year ahead. And I would say the outlook for the industry has not changed. The '24 has become a lot worse than when we set this number. So we basically say that 2024 will be what I call a lost year in sales.

It's not lost in any other activities, because we have, in our mind, built NOTE to be a stronger company during this period. So we're better prepared for growth and better prepared for the future today than we were 1 year ago. So we look very positively on the future.

So, with that said, I will open the floor for questions. If there's any questions in the room, I'll take them first. Yes.

[Lucas Mattsson, analyst]

Thank you for the presentation. Lucas Mattsson, equity analyst at Inderes. I have 2 questions, maybe 3 if we have time. First, do you believe that the expected sales in Q4 is primarily due to timing factors or seasonal patterns or increase in end consumer demand?

[Johannes Lind-Widestam, executive]

I would say that our guidance is fairly flat to our run rate if you look at the month. So we're not expecting any deviation from what we have seen in Q2 and Q3 if we exclude July that is lower. So we don't expect a recovery. We are expecting Q4 to have the similar market conditions. We are expecting that destocking will be less and less going forward for every quarter. We have expected that for some time. So that is due to happen sometime.

[Lucas Mattsson, analyst]

And in your opinion, besides lower interest rates, what other factors would encourage customers to shift from, let's say, a relatively defensive approach to a more active one?

[Johannes Lind-Widestam, executive]

Yes, that's a very good question. I think that will be one enabler. I think that just for or us to get our sales up to where the customers' consumption of the product is that, that would be a step up. But I would say that the general economic climate is a limiting factor now. All the private persons and a lot of the companies are not investing in so much at the moment. So there's a lot of wait-and-see as I see it as of now. Yes, so that would be my biggest, how should I say, the biggest upside. If the economy bounces back, we will see a good growth, especially if the construction industry is recovering, that will have a good impact for our business.

[Lucas Mattsson, analyst]

Great. And do you still see that the 7% estimated market growth is a realistic outcome until 2030, as the global economy has faced like quite notable challenges during the recent years, for example, geopolitical risks, China slowdown and trade wars, et cetera?

[Johannes Lind-Widestam, executive]

We believe that, that number is valid for Europe. And I think the European production is going to benefit from the geopolitical disturbances. There will be more production done here than that have historically been made in China. So we believe that the European part of the manufacturing will increase. But the world economy, I see quite negatively on that. I don't think that, that will grow more than maybe 2% to 3% a year, but the production in Europe will grow faster. That is what the indication is showing.

Any other questions? Otherwise, I'll start with some questions from the web. Yes, I have one from Karl Norén here. I have a few from him, so I'll take them one by one. Karl is not here today.

New customer wins year-to-date. Is it possible to comment on this or how you are tracking versus previous years?

Very good question. We have seen a decline. This has been weaker than the last few years. We have seen that the time from quote to decision has increased. So we're working with a similar number of quotes and a similar number of bids, but we see that the time from we submit the quote until the customer makes a decision is significantly longer. So this has been a bit weaker this year than last year.

Second question from Karl, is it possible to tell us a bit more on the development within Industrial in Q3? It is some SEK 90 million lower from Q2 in Western Europe. Which segments are seeing lower demand? I understand there's some company specific, but can you share some more info on this?

I would say that Q3 is a quarter where we closed the factories a bit longer, and that has a negative effect. We had less working days this year than last year. And so it's more of a general decline rather than a company-specific decline. Greentech continues to slow further. We know you have Plejd, which is developing very strong, but the rest of the portfolio must be really weak. Are you seeing Greentech being worse going forward or stable? Or what is the trend?

I think that Greentech is at the lower end where it will be. Yes, Plejd is one part there, and there is also a listed company, so I will not comment on them specifically. But in general terms, I would expect that Greentech is at the lower end of where it will be. So if any, I would expect increases.

One more from Karl. Can you comment anything on price pressure and pricing in the market? Are some companies wanting lower prices from you? And have you lowered prices, but rather customers wanting lower prices?

Yes, this is a very good question. I would say that customers are always wanting lower pricing. We will see that we are in an inflation economy. Many of the economies out there are still pushing up salaries and so on. So there's a cost increase pressure as well that is offsetting, as I see, the price reduction activities.

I would say that we have not reduced prices more this year than any other year. We have mechanisms where the material cost is constantly adjusted to the price that we pay for it. So we're not negotiating that because the agreements are stipulating how to deal with that. But outside of that, I don't see that the price pressure is higher this year. But this is a good question.

And as long as we and the peers are maintaining a healthy profitability, there is unlikely that there will be a price competition among our peers here in our part of the world. But as soon as we will be -- if we see companies making negative profits, then I would expect the price pressure to be higher, because then some companies will start to underbid to get more volumes to fill up the factories. That has not happened yet. So I hope that everyone else is doing similar activities that we are doing to avoid that. But that could happen. That was all from Karl.

Then I go over to [ Harold ]. You explained how the current pace is quite stable and that low turnover in Q3 is largely explained by adaptation in July with prolonged holiday. Given the picture, why did you wait until September 19 with the warning for a weak second half of 2024? What was the additional negative from July to September?

The big negative was that we agreed with one customer in the EV segment to rework on products instead of building new. And that the conversion within the Communication segment from forecast to orders did not happen. So these were factors that we did not see in the second quarter. Second quarter was fairly strong in the Communication segment. So that was the reason.

Then we have one from Tommy -- or we have 2 from Tommy. We start with the first. You keep presenting forecast for the next quarter despite the fact that some of the last forecasts have had to be revised. Has there been any discussion about pros and cons about this forecast?

Very good question, and I can assure you that there has been a lot of questions or discussions internally about this. But why have we continued to do it when we are not meeting what we are saying, that can be argued. But we feel that we should be the best one to give forecasts. We want to give you, as owners and followers of NOTE, the best possible information to make your decisions on how do you sleep on NOTE.

And even if we know that the climate has been very hard to predict, we have still continued to do this because we believe that it adds value. If we would feel that the analysts and others that are following us are seeing that this is the wrong thing to do, we will cease to do it. But so far, we have been encouraged to continue with it even if we have missed it. But I know that this has been a bit problematic, and we can only say that we are doing our utmost to do as best guidance as we can.

One other from, Tommy. You list the figure of SEK 7 million of provisions for restructuring expenses in Q3. Can you tell us a little more about this? Have you explicitly listed restructuring expense in recent history? If not, why not?

We have not done it lately. We have made adjustments as we have taken them. This quarter, we took some initiatives to change some in the management and therefore, we made them as one-offs. And at the same time, we did a quite big reduction in China, and therefore, we decided to present it as some kind of one-off. So that's the reason why we did it. But in the last year -- or the last years, we have not presented this in this way. We might have done it in way past, but I don't know that. I'm looking at our CFO and she's nodding our heads, so we have probably done it in the past.

And the last question I have is from Thomas. Thank you for the presentation. Do you see any risk of customers, especially in Greentech and Communication going away, i.e., going out of business because of the market conditions?

Yes, there is always a risk. We have what we feel provisions that are covering for that in our report. We have an open dialogue with our auditors and presenting where these are standing. We see some risks in our customer portfolio. I think that we are well covered in this area, but there is a risk. I would say that I hope that the economy, especially for the Greentech customers are bouncing back a little bit. There's a lot of companies that are struggling at the moment. One of them is, of course, Northvolt. We're not exposed to Northvolt. I would like to say that here. We don't have them as a customer.

This is rather interesting because we have tried to get them as a customer for many years and we have not been successful there. And currently, we're quite happy with that we were not successful. But if we would have won them 3 years ago, we would have been very proud at that time. So time is changing very fast.

Okay. That was the last question I have. Then I will close the questions and I will summarize.

I think if you look at -- we think Q3, as I said, it's weak from sales. We're proud of the profitability. We think that, that's a good position for the future. Q4 is slightly, if you call it, bounce back from the current run rate, we will be back on, say, the Q2 run rate. We have a lower cost base today than we had in the second quarter. So our expectations for profitability is good. We continue to be optimistic about our cash flow. We expect that to continue to be strong.

I mean, Q3 was really strong, SEK 157 million. If it's that strong in Q4, it's very hard to say when this is time, but if I say that we will have another maybe SEK 100 million positive cash flow compared to where we stand and go. If that comes in Q4 or Q1, it's hard to say, but it will come in the near future coming from continued inventory reductions and so on. So that is what we see.

And we still invest in the future. We still believe that we need to be better positioned and better covered for the growth that we are expecting to come. And therefore, we are continuing to invest in this.

Automation, I talked about it a lot. We are continuing to invest in automation and making our factories more efficient. That is something that we will benefit from the future. We have benefited from it in the last couple of years, and that is something that we remain very focused on. So we're still building for the future even if this is a quarter that is quite weak.

So with that said, I thank you all for listening.