Earnings Call: Q2 2020

Jul 15, 2020

Ladies and gentlemen, welcome to the HMS Networks AB Q2 Report 2020. Today, I'm pleased to present Staffan Dahlström, CEO. For the first part of this call, all participants will be in a listen-only mode. Afterwards, there will be a question and answer session. Speaker, please begin. Thank you. Good morning, everybody. Welcome to this HMS Q2 report. Myself, Staffan Dahlström, will start this, and then Joakim Nideborn will take over and give you some more details about the numbers. Next, please, Joakim. Let's start with a summary, and we go into the numbers, and I suppose some of you have seen the report already, where we have a weak development on the net sales and order intake, -15% and -19%, mainly due to Corona, and Joakim will talk a little bit more about this. However, we've been working quite hard to mitigate these reductions in revenue, and we've been working quite well on to maintain the EBIT margins. On EBIT, we are more or less on a long-term goal of 20%. We are 19.4% on the EBIT margin, and we also work very hard on the cash flow. We feel that we have been managing things well, the things we can control during this quite weak market development due to Corona. We have a good EPS of 124. Weak on the top and better further down in the P&L. Okay. Just a few words about HMS. For you who are not so familiar with our business, our business is to connect devices, mainly in industrial applications, high reliability applications. We have four brands, Anybus, Ixxat, Ewon, Intesis, and last year we also bought 75% of a German software company, WEBfactory, and this is our step into more of a software and visualization of data. Next, please. Our customers are divided into two groups. We have a main business with makers of industrial equipment. This is company who make industrial machines like packaging machines, medical machines, windmills, AGVs, and these kind of things. We also have companies doing industrial devices such as drives, robot controllers, circuit breakers, et cetera. This is majority of business. We also work with users of this equipment in industrial automation, where our four main areas is manufacturing, energy and infrastructure, buildings and HVAC, and transportation logistics. In here, we provide these customers with communication solution that integrate different things, normally their manufacturing or industrial process side. Users and makers are important to know. If we look on our revenue in quarter two between users and makers, we see this looks more or less, in general, quite much the same as previous quarters. The major business we have is with makers. We have our business with embedded products that is integrated deeply into makers products. This is half our revenue to makers. We also do routers, gateways, this kind of communication products that integrate different systems and products on the industrial processes. Here we have a mix of users and makers. We have a small but growing part of software and subscriptions and services. This is only 5% of our business today, and it's divided more or less 50/50 by users and makers. Okay, let's move into a business update in this difficult Corona times. It's been a challenging macro situation, especially, I would say, on our European markets, Germany, France, and Italy, where we've seen big impacts on lockdown and also customers are waiting to make decisions. This is where we see the big impact. U.S. was quite okay quarter one, but now been impacting more on the order intake due to the situation we see in U.S. at the moment. We are almost surprised, but happily surprised that both Japan and China are holding up well, and we show growth on order intake there. It's a mixed picture. The decline we are seeing in general affects all our brands. We are seeing double-digit decline in all order intake. It's not only one business, it's all over our brands. We also been very focused on converting into more digital events during these days of limited traveling and customer interactions. We have done 180 digital events last month, generating over 5,000 leads and registered attendees. We have over 5,000 engagement hours with customers and leads at the moment. We are pretty happy that we've been able to move from traditional trade shows and customer seminars into digital events, and we see a quite good interest in this. Of course, our customers, they are also grounded at their homes, so they also have time to attend these digital events. If we just look on our Corona update, we are very happy that our teams are okay and healthy. From a health point of view and our organization is okay. We've been implementing short-time work in Germany and in Sweden for part of the time in quarter 2, and we've been successfully mitigating any problems with supply chain. We have some issues in Spain, where we have our factory there closed for a couple of weeks due to regulations in the Barcelona areas. I must say that we are impressed about our supply team, how well they've been working during these difficult times. I can't recall any customers complaining about lead times or lack of equipment. It's been working out very well. Looking forward, we expect that this will continue for quarter three and a couple of quarters going forward. We see a soft market. We will also continue to work with short time work in Germany. However, in Sweden, we grew up to 100% work time now, since we see that we have a lot of projects in the pipeline, and we want to focus on some R&D projects, and we need our staff to back it 100%. We are monitoring this, and we can also go back to short time work in supply chain and things like this if needed going forward. Right now, we are focused on full-time work, except in Germany, where we have limited time work still. We also canceled most of our fairs for rest of 2020. We continue the successful path on digital events. The strategy we have is unchanged. We want to make sure that we keep our teams intact, and we do what we can now to focus on gross margins, cash flow, OpEx reduction, but also long-term investments in R&D and innovations. We believe that when this Corona time is behind us, we think that's a good market opportunity for automation and digitalization. We think that some of the things we have seen during Corona will probably increase the level of adoption of these systems at our customers. All in all, from my side, it's been an eventful quarter, weak on the top line, but better further down in the P&L. Joakim, please take over and talk more about the numbers. Thank you, Staffan. I'll do that. I'm going to start with order intake summary as we normally do. As you know, SEK 302 million, that is not where we want to be, but given the situation, it is a tough market out there. I think we saw this already when we released the Q1 report. We guided that we were 20% down in April, and that we basically saw it at the same pace should continue in the near term. That's what we've been seeing. On top of that, we can also say that for the first quarter, I think in a few years, we are actually having some headwind from the currency. Organically, we're only down 17%, but reported a 19% down. We had also, as you might recall, in Q1, a few stocking orders in March. That was extremely good order intake in March, which probably meant that some of those orders would normally come in Q2 otherwise. That also affects a little bit the big deviation from Q1 to Q2. We have the main thing that we have the Continental Europe market that's been slowing down rapidly, and our three biggest markets there, Germany, Italy, and France, are all down substantially. Italy and France actually down more than 50%. Germany a bit less, but still I think 20% down in Germany. U.S. is now coming on to that 20% decline compared to a decent Q1. There you have the big things impacting. It doesn't help us that much that we have Japan and China, which is very positive that they are growing now actually more than 20%, both in Q2 and year to date. We're very happy with that development. When the bigger markets as Continental Europe is down, it's tough for us. Staffan Dahlström said it also that all of the brands are down more than 10%. Anybus is leading the decline on the brand side. I think we're down 18% in Anybus, and then the other ones are between 10%-18%. It is a wide decline on all markets across our customer segments. Currently, we expect about this situation will continue on the similar path. We don't see anything getting worse, but we don't really see any improvement either. I think July has started in the same pace as we've seen now for Q2 on the order side. Let's have a look at the sales. I think we had a decent backlog going into Q2, I think the sales is not that badly affected. 355 million, even if when we compare to Q2 last year, which was a record quarter for us with a lot of backlog being delivered out in Asia to our bigger customers there. Comparing to that, I think we're down 15%, organically 14%. Of course, that's a big decline. Here it's a little bit of different picture. It's still EMEA that is responsible for the majority in this decline. America is actually +4% with a good backlog from previously. Asia is minus 8% compared to the strong comparable. Asia is actually not that bad in absolute numbers. It's just that the comparison is really tough for us. I think now with the order intake we've seen in Q1, sorry, Q2, obviously Q3 will be challenging on the sales side, and I think it will be tough for us to reach the same level as we did in Q2. Looking at the sales per region, this looks a little bit different compared to what we normally see in Q2. Since EMEA is down a lot, we're now actually on 56%, and normally we would be just over 60% of our total sales in EMEA. Americas is on 24%, and Asia is now on 20%. Maybe now over to the better part of the report. When we go down to the P&L, looking at our EBIT level, here we are quite satisfied being able to deliver SEK 69 million or 19.4% margin given the weak development of the top line. We're actually almost at the same level as last year, even if we have the decline of 15% in sales. A couple of things that are helping us here. First is the gross margin. That is a bit better, 62%. I think we've been doing some good things on the cost side, also on selective price increases that has been helping. We have a good product mix, especially within Anybus, where we have less embedded sales to our bigger customers, that normally will have a bit of a lower margin. That is helping a bit on the mix side as well. Despite the lower volumes, we managed to improve the gross margins, and we're happy with that work. Also, the OpEx decrease is of course, helping to impact. We say here that we have a decrease of SEK 21 million. Organically, it's down 25. Just to help you understand those SEK 25 million, what that consists of, it's basically two things. One is the fact that we made this restructuring program in 2019, that is helping with about SEK 11 million. We also see some Corona effects of about SEK 15 million. About SEK 5 million per month, where we have less traveling, less customer events. Instead, we're doing the digital activities that Staffan talked about before. I think this is something we can definitely learn a bit from the future as well, to be better on the digital side. We see this decline with the SEK 5 million per month, and we expect that to continue for the coming time as well. On top of this, just to make it a bit more complicated, we have some other things impacting the OpEx as well. We have received some governmental support in line with the short-term work we've implemented that's helped us with the SEK 8 million OpEx reduction. As we said before, we have now stopped. 1st of July, we stopped the short-term work in Sweden to focus more on the future developments for the brighter times after the Corona crisis. It means that we will have a slightly lower governmental support for the coming time. Also, we made a write-down of WEBfactory goodwill of SEK 40 million, which is also impacting, of course, negatively then on the result side. This bursts the situation a bit. Organically, we're down 25%, and the other two items, I think we will not see that much of going forward. Also, year to date, I think we've been doing quite well protecting our EBIT. We're actually up SEK 4 million compared to previous year, despite the substantially lower top line. I think we're happy with that work. Also the gross margin has been good, as you know, in Q1 as well. We're happy to see an improvement year-to-date of about 2% on the gross margin side. Currently, we don't really see why that should decline if the volumes will be on the current levels. EPS, I don't have a lot of comments here. I think it's pretty clear, pretty clean from EBIT down to EPS. Good to see that we can actually do one of our better quarters with SEK 124 on the earnings per share. We're happy with that. Then over to the cash flow situation, which is very strong in the quarter with SEK 150 million. I think it's our best cash flow ever in a quarter. I think first of all, we have a good underlying EBITDA that is helping this. Then, of course, we're doing some things on the inventory side, getting down inventory with SEK 12 million. Then we also have some other positive working capital improvements that helps by, in total, SEK 18 million on the cash flow side. On top of that, you might remember that in Q4, we got a tax return, or we got a decision that we will get a tax benefit in Belgium. Now we've also gotten this tax return of SEK 10 million, which is helping the cash flow. The impact from the tax is very low on the cash flow side. Also, first six months, we're doing good with SEK 170 million cash flow compared to SEK 103 million. It's good to see that we're managing to convert also in these tough times, managing to convert the receivables in a good way and deliver this nice cash flow for us. Which then has also helped us to take down our leverage substantially. We're down at SEK 263 million in net debt. You see we've taken down the net debt by 50% compared to a year ago. Of course, the fact that we decided to cancel the dividend helped a little bit on this side. Still, the nice cash flow is really helping us, and I think we have now with net debt, I think net debt EBITDA, we're 0.73. Yes, that's it, 0.73. I think we have a very good situation when it comes to going after further acquisitions and investing in R&D, and I think that is why we're now going back to 100% work in Sweden. We're also looking for, as we always do, for some interesting candidates for further acquisitions. We also, on top of this, we have the possibility to issue new shares up to 5% of the market cap. I think we have the firepower that we need. Now we have to find the right targets and be able to execute. Thank you for that. I think let's hand over to the operator for potential questions. Thank you. If you have a question for the speakers, please press 01 on your telephone keypad. We have a question from the line of Joakim Gjerlufsen from DNB Markets. Please go ahead. Thank you. Good morning, Staffan and Joakim. Obviously impressive margins on cash flow, I must say. Can you give us a sense here of what portion you would say is, say, permanent and carries into 2021? You provided here a split on the, so to say, short-term work as well as government support. How should we think about the OpEx levels going into 2021? Maybe I take that one, Staffan. I think what we've been doing, of course, we've been quite careful on taking on new costs for the full year when we saw this situation approaching. We're running a little bit skinny at the moment. I think if we look at the relevant parts with the sales admin and R&D parts. We're doing SEK 146 million in OpEx in the second quarter. I think for now, that is a pretty fair run rate that we have. At the short term, until we see any major market improvements, I think we're going to try to be running at this pace, basically. We have, of course, as I said, the SEK 8 million governmental support. We're now canceling that in Sweden, that will maybe impact them with some, let's say that's half of the state's SEK million benefit. With everything, and in the same way in Q3, we would be running with SEK 150 million. We also know in Q2, we also have some vacation effects and stuff like that. I think a fair run rate would be about SEK 150 at the moment. Currently, that's where we're going to stay. Very clear, Joakim. As I think about demand in your end markets and how you have experienced this in previous downturns, what is different, perhaps, now that have some visibility returned? How do you expect end markets to rebound now? Once again, 2019 was already weak. We have some easier comparables, et cetera. How do you think about that? I can take this, Joakim. I think a bit too early to say. If we look back on, for example, 2009, it was a quick downturn, a quite quick ramp up again. I'm not sure how this will develop this time. I think we're just in the situation where people really don't know how the rest of the year will look, people are also concerned about 2021, I think, depending what customers talk about. We have some customers in, for example, automotive, where we see quite big changes in the structure and how they build their cars and stuff like that. On the other hand, we have a lot of customers making paper or beer or things like that in food and beverage. We have quite many traditional customers, they are still quite successful. Of course, there's a little bit wait and see at the moment. We expect that the next maybe one, two quarters, this weak market will continue. We are expecting that 2021 will pick up again, but maybe a little bit different when it comes to adoption of digitalization and things like this. We believe this could be beneficial for us, but it's too early to tell, I think. All right. I just assume that with the limited visibility into H2 2020, I guess that is holding back industry consolidation. Can you comment a bit on, say, pipeline, how many potential targets you're tracking and perhaps what sort of acquisition candidates you're looking at? Well, I think we've been fairly successful last year or so doing bolt-on acquisitions on companies that are smaller than us and have very good products and want to take the next level in their development. For example, Ewon and Intesis was very typical acquisitions, where we bought the company from the founders, but the founders saw the opportunity to work with HMS Networks to create more value. I think there are more opportunities like that. I think also there might be openings now when markets are tougher, that some of these, especially German-led entrepreneurial companies, may feel that the market is tough and maybe it's time to do something. We are actively looking, but it's very long cycles with these entrepreneurial-led companies. It's very difficult to say when we get results of these efforts we are having out in the market. All right. It's roughly the same type of companies that you've been tracking for, say, the past year. Yes, that's right. Smaller than us, things that can bolt on to our organization in a good way and expand around our core markets, more or less. We are still in the same playing field when we look for acquisitions. Very clear. Just a final, more, say, long-term question. When you think about, say, the impact of COVID-19, you mentioned this to some extent in the CEO letter, Staffan. As you think about the impact on industrial automation longer term, where are HMS best positioned to capitalize on those bigger trends that could obviously potentially be accelerating from here? I think one of our biggest opportunities that may not be so sexy, but this is most of our customers or end users run industrial plants, industrial processes. These plants is not rip and replace, we suddenly change everything. We see a lot of moving to new technologies. There's a lot of interest in 5G and IoT, but this will not take over quickly. You need to integrate the existing machines you have into this new technology. There we see a quite good opportunity to provide something that bridge the legacy with the new technology. There we have a good position, and this is something customer needs in the near future. Very clear. That's all from me. I hope you have a great summer. Thank you. Thanks. The next question comes from the line of Viktor Högberg from DNB Bank. Please go ahead. Yeah. Hi, good morning. My line was partly disconnected, so maybe this question was asked, but just have a question on the WEBfactory acquisition and the reversal of the additional purchase price and the corresponding write-down in Q2. If I recall correctly, WEBfactory had a good Q1, didn't they, in terms of orders? Could you just elaborate a bit on that? specific acquisition and how it's performing. Yeah, sure. We can do that. I think you're right, Viktor, Q1 was good, Q2 has been very slow for WEBfactory, there's a lot of parties that have been postponed. Well, we don't know if they will be brought up again. Q2 was very weak. We had a pretty aggressive plan for the company, Q1 was good, it was also in line with the plan, you could say. Now Q2 was pretty far from the plan, which made our earn-out became pretty much impossible for the sellers to obtain. We felt we need to take and reverse that one. We also, since we're deviating quite a bit from the plan, and we were actually a bit short of the plan also in last year, we made an impairment test, and they realized that, okay, we need to do something on the goodwill side here as well. I think the aggressive plan is pretty much what's behind, and with the aggressive plan, we could also protect the goodwill. Given that that hasn't materialized, we needed to take the consequence of that. Okay, fair enough. That was actually all for me at the moment, thanks. The next question comes from the line of Jonas Hugene from Interfund. Please go ahead. Good morning. Can you hear me? Yes. Super. On your orders that you took in the quarter, is it possible to say anything in general what the nature of those were, if it's from existing customers building out a part of their factory or connecting up machines that they already have, or if you see more expansion, bigger expansions from your customers that's running into your order intake, perhaps from decisions taking maybe six months back. Can you see that some of your customers are daring to take bigger decisions to expand factories, move forward in their capacity, decisions, et cetera? I hope that question was understandable. Staffan, do you want to take that line? I'll do that. Sorry for the delay here. We are sitting on two different lines, and therefore it's not clear who will answer, but let me take this. When we look on the orders, I think in Q1, we saw quite many orders from large existing customers who want to build up inventory. It was a bit insecure when it comes to supply chain and things like this. Order intake was really good in Q1. What we've seen in Q2, I would say, less orders from large established customers, but then a quite broad mix. You saw this on my slide when we look on the user maker, that the mix between different type of customers and application are pretty much the same. We can't really see a trend change in orders. The only trend change we've seen is that this kind of buffer stocking that we saw in Q1, that's passed us now, and they are shipping out in Q2. Otherwise, I don't really see any big new trends in the order intake. Okay. It's a bit of a debate in the industry right now if this crisis will perhaps lead to companies moving their production and sourcing closer to home and not being too dependent on sourcing from Asia or other far away countries. Can you see anything of that in your dialogue with your customers, or everyone still in crisis handling mode and not really thinking further ahead at this moment? No, I think we see this. If you start with U.S., there we've seen this for a couple of years as a discussion topic. We haven't seen too much manufacturing moving back from China to U.S. yet, but we see that a lot of new manufacturing is not moved from U.S. to China anymore. It's moved either to Mexico. That's the start up in Mexico instead of expanding China. We also see a trend that both Japanese or many customers, I would say, American and Japanese, moved from China to Vietnam. That's a pretty clear trend. If you look in Japan, we see that the government, at least unofficially, is sponsoring Japanese manufacturers to move home manufacturing from China back to Japan again, and they get sponsoring for doing that. In Europe, we are seeing discussions about that people would like to be closer to their manufacturing. I think this will be a long-term trend, that people will not rely on global supply chains only. I think this can help investments in, I would say, especially in Japan, U.S., and continental Europe. It's too early to see this materialize in orders. The discussion is there for sure, and decisions are taking where to make these investments. Okay. Thank you. On the other hand, we also see in China that the government is also investing a lot in building their own capacity in semiconductors and others to make sure they get less dependent on other countries' technology. Also in China, I think the investments will continue, but much more domestic nature compared to just manufacturing outsourcing. Okay. That's clear. Thank you. Okay, thank you. Just as a reminder, if you do wish to ask a question, please press 01 on your telephone keypad now. Our next question comes from the line of Daniel Thorsson from SEB. Please go ahead. Thank you, operator. Morning, Staffan, Joakim. Hope all is well. Just one pretty high level question from my side on the nature of the digital events that you've had and which you foresee will continue and that you've canceled your physical trade fairs. What are you seeing with customers in terms of response rates? Perhaps at the end of the day, it's a question of demand, so it doesn't really matter. Are you coming through in the same way that you did in a physical environment? Yeah, I would say that it's more efficient. I would say we have two types of digital events. One is more future-oriented, talking about what's the benefit of 5G and more marketing us as a company in that area. There, of course, we get general interest, but we can track it back to real orders. That's one category. The other category is to learn more about our existing offer, more deeper, like technology, how does this product really works, how you can take better benefit of this product. There we see better engagement, I would say, than traditional trade fairs. We are sitting with them for one hour, and I would say that this is even more efficient than traditional trade fairs and this kind of walking around in a physical place and maybe bump into somebody that have interest in your product. I think it develops well. We need to work a little bit more in our marketing systems. How do we qualify these new types of leads, and how do we take these relationships to the next level? We are positive about it, but we need to change a little bit our sales process when we have these kind of new leads, I think. It's clear. Thank you so much. Thank you. As there are no further questions, I'll hand it back to the speakers. All right. Thank you very much for attending this morning session here. Thanks for interest in HMS. We are not happy with the top line and the orders. Unfortunately, we don't see a short-term fix we can do for the next quarters, but we can work more on our gross margin, our OpEx, and cash flow, and keeping our eyes on the long-term goal. That's our strategy, and we'll keep on doing this for the rest of the year. This is our feeling right now. Now let's take a couple weeks of vacation. I hope you get the same opportunity to relax a couple of weeks, and then we'll be back in August ready for more business. Have a nice summer. Thank you. This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.