Earnings Call: Q2 2020

Jul 15, 2020

Ladies and gentlemen, welcome to the HMS Network ABQ2 Report 2020. Today, I'm pleased to present Stephan Delphom, CEO. For the 1st part of this call, all participants will be in a listen only mode. Afterwards, there will be a question and answer session. HMS Q2 report, myself and Alstrom will start this and then Joakim Needable will take over and give you some more details about the numbers. Next, please, Joakim. So let's talk with a summary and we'll go into the numbers. And, I suppose somewhere you have seen the report already, where we have a weak development on the net sales and order intake minus 15 and minus 19 mainly due to Corona and Joaquin will talk a little bit more about this. However, we've been working quite hard to mitigate the reductions in revenue, and we've been working quite well on, maintain the EBIT margins So on EBIT, we are more or less on our long term goal of 20%. We are 19.4% on EBIT margin, and we also work very hard on the cash flow. So we feel that we have been managing things well, the things we can control during this, kind of, during this, quite weak market development due to Corona. And we have a good EPS of 124. So week on the top and better further down in the, P and L. Okay. Just a few words about HMS. For you who are not so familiar with our business or business to connect devices, mainly industrial applications, high reliability applications. We have 4 brands, any bus, X at E1 indices. And last year, we also bought 75% of a German software company, Web Factory, and this is our step into more of a software and visualization of data. Our customers, next week, our customers are divided into 2 groups. We have a main business with makers of industrial equipment, This is a company who make, industrial machines, like packaging machines, and medical machines, windmills, AGDs, and these kind of things. And we also have companies doing industrial devices such as drives, robot controllers, circuit breakers, etcetera. This majority of business. We also work with users of this equipment, in industrial automation, where our 4 main areas is manufacturing, energy and infrastructure, buildings, and HVAC And Transportation Logistics And here, we provide these customers with communication solution that integrate different, things, normally they're manufacturing or industrial process side. So users and makers are important to know. If we then look on our revenue in quarter 2, 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 major products. This is half of our revenue to makers. We also do, routers, gateways, this kind of communication products that, integrate different systems and products on the industrial processes. And here, we have a mix of users and makers. And 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 time 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. So this is where we see them the big impact, U. S. Was quite okay quarter 1, but now been impacting more on the order intake due to the situation we see in U. S. At the moment. However, we are, almost surprised, but happily surprised that both Japan and China are holding up well, and we show growth on order intake there. So it's a mixed picture. But the decline we are seeing in general affects all our brands. We are seeing double digit decline in all order intake. So it's not only one business. It's all over our brands. We've also been very focused on, converting into more digital events during this days of the limited traveling accommodations. We have done 180 events last month, generating over 5000 leads and registered attendees. So we have over 5000, engagement hours with customers and leads at the moment. So 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. And of course, our customers, they are also grounded at their homes. So they also have time to attend these digital events. If you just look on our Corona update, we are, very happy that our teams are okay and healthy. So from a health point of view, and our organization is okay. We've been implementing a 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 bar Barcelona areas. But I must say that, we are impressed about our supply team, how well they've been working during these difficult times. And I can't recall any customers complaining about lead times or, lack of pigments. So it's been, working out very well. Looking forward, we expect that this will continue for, quarter 3 and a couple of quarters going forward. We see a soft market and, We will also continue to work with, short time work in Germany. However, in Sweden, we grew up to a 100% work time now since we see that We have a lot of projects in the pipeline, and we wanna focus on some R and D project, and we need our staff to back at 100%. But we are monitoring this and, we can also go back to short time work in supply chain, I think it's like this if needed going forward. But right now, we focus on full time work, except in Germany where we have limited time work still. We also canceled most of our fares for rest of 2020, and we continue the successful path on digital events. So, 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 focused on gross margins, cash flow, OpEx reduction, but also long term investments in R&D And Innovations. Because 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 option of the systems at our customers. So all in all, from my side, it's been an eventful, a quarter weak on the top line, but better further down in the P and L. But Joachim, please take over and talk more about the numbers. Thank you, Safran. I'll do that. And I'm gonna start with order intake summary as we normally do. I mean, as you know, 302,000,000, that is not where we want to be. But given the situation, it is a tough, tough market out there. So, I think we saw this already when we released the Q1 report. We guided that we for 20% down in April, and that we basically saw it at the same pace should continue in the short term. So that's what we've been seeing. And on top of that, we can also say that, I mean, for the first quarter, I think in a few years, we are actually having some headwind from the currencies. So 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. But then we have the main thing that we have the Continental Europe market that's been slowing down rapidly. And our 3 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. Also U. S. Is now coming on to that 20% decline. Compared to a decent Q1. So they have the big things impacting. It doesn't help us that much that we have in Japan and China, which is very positive that they are growing actually more than 20% both in Q2 and year to date. So we're very happy with that development, but when the bigger markets as, as Continental Europe is down, it's tough for us. And as Stephan said, also that all of the brands are down more than 10%. Any buses feeding the decline on the brand side, I think we're down 18% in any bus. And then the other ones are between 10% 18%. So It is a wide decline on all markets across our customer segments. Currently, we expect about this situation will continue on the similar past. We don't see any anything getting worse, but we don't really see any improvement either. I think July has has started in the same pace as we've seen now for Q2 on the order side. Okay. Let's let's have a look at the sales. I think we had a decent backlog going into Q2, so I think the sales is not that badly affected. $355,000,000, 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 biggest customers there. But comparing to that, I think we were down to 15% organically 14%. So of course, that's a big decline. And here, it's a little bit of a different picture. It's still EMEA that is, is responsible for the majority in this decline. And America is actually plus 4 with a good backlog from previously. And then HS is minus 8% compared to the strong comparable. Asia is actually not that bad in absolute numbers. It's just that the comparison is, it's really, really tough for us. I think now with the order intake we've seen in Q1, for 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. So looking at the sales per 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. America is on 24 and Asia is now on 20%. So maybe the the now go over to the better part of the of the report when we go down to the P and L looking at our EBIT level. We are quite satisfied being able to deliver $69,000,000 or 19.4% margin given the weak development of the top line. So we're actually almost at the same level as last year, even if we had a decline of 15% in sales. So a couple of things that are helping us here. First is the gross margin that is, that is a bit better, 62%. I think we've been doing some good things on the cost side. Also on selected price increases that has been helping. And we have a good product mix, especially within any bus where we have less embedded sales to our bigger customers. Normally will have a bit of a lower margin that is helping a bit on the mix side as well. So despite the lower volumes, we managed to improve the gross margins and we were with that work. And so also the OpEx decrease is, of course, helping to impact. And we say here that we have a decrease of 21,000,000 organically, it's down 25. We have to help you understand those 25,000,000 what that consists of. Basically 2 things. One is the fact that we made this restructuring program in 2019. That is helping with about 11,000,000 And then we also see some some Corona effects of about 15,000,000. So about 5,000,000 per month, where we have less traveling, less customer events, Instead, we do in the digital activities and stuff I've talked about before. So I think this is something we can definitely learn a bit from the future as well to be better on the digital side. But we see this decline with the 5,000,000 per month, and we expect that to continue for the coming time as well. On top of this, you have 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 time work we've implemented. That's helped us with the 8,000,000 OpEx reduction. And as we said before, we have now stopped 1st July, we stopped the short term work in Sweden to focus more on the future developments for, for the brighter times after the corona crisis. So it means that we will have a slightly lower, lower governmental support for the coming time. Also, we made a write down of a satisfactory goodwill of CHF 40,000,000, which is also impacting, of course, negatively then on the result side. So this burst the situation a bit. But organically, we're down 5% and the other two items, I think we will not see that much of going forward. So also, year to date, I think we're, we've been doing quite well protecting our EBIT actually up 4,000,000 compared to previous year despite the substantially lower top line. So I think we're happy with that work. And also the gross margin is has been good, as you know, in Q1 as well. So we're happy to see an improvement here to date of about 2% on the gross margin side. And currently, we don't really see why that should decline if the volumes will be on the current levels. So EPS I don't have a lot of comments here. I think it's pretty clear, pretty clean from the, from EBITDA to EPS. Good to see that we can actually do 1 or better quarters with 124 on the earnings per share. So we're happy with that. And then over to the cash flow situation, which is very strong in the quarter with 1,000,000. I think it's our best cash flow, however, in the quarter. And, I think 1st of all, we have a good underlying EBITDA that is, is is helping this. And then, of course, we're doing some things on the inventory side, gain down inventory with 12,000,000, and then we also have some other positive working capital improvements that helps by in total $18,000,000 on the cash flow side. On top of that, you might remember that in Q4, we got, at tax return or we got a decision that we will get a tax benefit in Belgium. So now we've also gotten this tax return of 10,000,000, which is helping the cash flow. But the impact from the taxes is very low on the cash flow side. Also, 1st 6 months, we're doing good with $170,000,000 cash flow compared to $103,000,000. So So it's good to see that we're managing to convert. Also in these tough times, we're managing to convert to either receivables in a good way and, and deliver this nice cash flow for us. Which then has also helped us to take down our leverage substantially. We're down at 263,000,000 in net debt So you see we've taken down the net debt by 50% compared to a year ago. Of course, the fact that we decided to, to cancel the dividend helped a little bit on this side. But still the nice cash flow is really helping us. And I think we have now with, net debt, I think net debt to EBITDA were 0.73 That's right. That's actually a circa 0.73. So I think we have a very good situation when comes to go in after further acquisitions and invest in, you know, R&D. And I think that is why we're now going back to 100% work in Sweden. And we're also looking for as we always do for some interesting candidates for further acquisitions. We also, on top of this, we have possibility to issue new shares, up to 5% of the market cap. So we have the firepower that we need. Now we ask you to find the right targets and be able to execute. So thank you for that. I think let's hand over to the operator for potential questions. Thank We have a question from the line of Joakim Gunen from DNB Markets. Please go ahead. Margins and cash flow, I must say, but can you give us a sense here of what portion you would say is permanent and carries into 2021 I mean, you provided here a split on the, let's say, short term work as well as government support. How should we think about the OpEx levels going into 2021. Okay. So maybe I'll take that one quick Stefan. I think what we've been doing, of course, we've been do being quite careful on on taking on new costs for for the full year when we saw this situation approaching. So we're 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 and d parts, We're doing $146,000,000 in in OpEx in in the second quarter. I think for now, that is a pretty fair run rate that we have. And, at the short term until we see any major market improvements, I think we're gonna try to be running at this this pace, basically. And we have, of course, the, as I said, the 8,000,000 governmental support. We're now counseling that in Sweden, so that will maybe impact them with some let's say that's half of the, of the state 1,000,000 benefit. So with everything's in the same way in Q3, we would be running with 150,000,000. Then we also know in Q2, we also have some vacation effects and stuff like that. But I think a fair run rate would be about 150 at the moment. And and currently, that's where we're gonna and I'll stay. Very clear, Joakim. And as I think about demand in your end markets and how how it has, I mean, how you have experienced this in previous downturns? What is different? Perhaps, I mean, now that, I mean, how some visibility returned or how do you expect, I mean, end markets to rebound now? I mean, once again, you 2019 was already weak. So I mean, we have some easier comparables, etcetera. So, how do you think about that? I can take this to your camera. I think it's a bit too early to to say if we look back on, for example, 2009, it was a quick downturn, but then a quite quick ramp up again. I'm not sure how this will develop this time. I think we're just in the situation there. People really don't know how the rest of the year will look, and the people are also concerned about 2021, I think, depending what customers talk about, Then 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. But on the other hand, we have a lot of customers making a new paper or beer or things like that in food and beverage. So we have quite many traditional customers, and they are still quite successful. But of course, there's a little bit of wait and see at the moment. So we expect that the next maybe 1, 2 quarters, this weak market will continue. But we, we are expecting that 2021 will pick up again, but maybe a little bit different when it comes to, adoption of decalization, things like this. And we believe this could be beneficial for us, but it's too early to tell, I think. Alright. And I just, I mean, assume that with, I mean, limited visibility in into H2 2020, I guess that is holding back industry consolidation. But can you comment a bit mean, 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, 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, E1 and Intelisys was very typical applications, acquisitions where we, we bought the company from the founders, but the founders saw the opportunity to work with HMS 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 do something. So we, we are actively looking, but it's very long cycles with this entrepreneurial led companies. It's very difficult to say when we get results of this efforts we are having out in the market. All right. But 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 in our around our core markets more or less. So it's, we are still in the same playing field when we look for acquisitions. Very clear. And just a final more, I'd say, longer term questions. When you think about, say, the impact of COVID-nineteen, you mentioned this some extent in the CEO letter, Stefan, but, as you think about the impact on industrial automation longer term, where are HMS, say, best precision 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. This plans is not, you know, rip and replace, where it suddenly changed everything. So we see a lot of moving to new technologies. That's a lot of interest in 5G and IoT. But this will not take over quickly. So you need to integrate the existing, machines you have into this new technology. There we see a quite good opportunity to provide sounds that bridge the legacy with the new technology. And so there we have a good position and this is something customer needs in the near future. Thank you. Thanks. And the next question comes from the line of Victor Herbert from Danske Bank. Please go ahead. Yes, hi, good morning. So while I was part of this, maybe this question was asked, but just have a question on the web factory, 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 pay in terms of orders. So could you just elaborate a bit on, on that specific acquisition and how it's performing? Yes, sure. We can do that. I think, you're right, Victor, Q1 was good. And then Q2 has been very, very slow for web factory. So there's a lot of parties that have been postponed. And, well, we don't know if they will be brought up again. So QT was very weak. And we had a pretty aggressive plan for the company. So Q2 was Q1 was good, but it was also in line with the plan, you could say. Now Q2 was pretty far from the plan, which made our earnouts became pretty much impossible to, for the sellers to obtain. So we felt we need to take and reverse that one. And then we also since we're deviating quite a bit from the plan, And we were actually a bit shorter to plan also in, in, last year, we made an impairment test, and they realized that, okay, we need to, to do something on the goodwill side here as well. So I think the aggressive plan is pretty much what's behind. And with the aggressive plan, we could also protect the goodwill, but given that that hasn't materialized, we needed to, to take the consequence of that. Okay. Fair enough. That was actually all for me at moment. Thanks. And the next question comes from the line of Johan Hilde from Intafinder. Please go ahead. Yes. Super. And so on on your orders that you 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 decision taking maybe 6 months back, or can you see that some of your customers are daring to take bigger decisions to expand factories move forward in their capacity decisions, etcetera. I hope that a question was, understandable. Stefan, do you wanna take social Okay, but sorry for the delay here. We are sitting on 2 different lines, and therefore, it's not clear who will answer, but let me take this. When we look on the orders, I think quarter 1, we saw, quite many orders from large existing customers who want to build up inventory know, it was a bit, insecure when it comes to supply chain and things like this. So order intake was really good in, Q1. What we've seen in Q2, I would say, less orders from a large established customers, but then a quite broad mix, and you saw this on my slide when we look at the user maker that the mix between different type of customers and applications are pretty much the same. So we can't really see a trend change in orders the only trend change we have changed we've seen is that this kind of, buffer stocking that we saw in quarter 1 that's passed us now and they are shipping out in Q2. But otherwise, I don't really see any big, big new trends in the ordering thing. Okay. And it's a bit of a debate in the industry right now. If this crisis will perhaps lead to to companies moving their production, and sourcing closer to home and not being too dependent on, sourcing from Asia or other faraway countries. Can you see anything of that in, in your dialogue with your customers or, are everyone still in a crisis handling mode and not really thinking further ahead at this moment? No, I think we see this, if you started with U S, there we've seen this for a couple of years as a discussion topic. We haven't seen too much manufacturing and moving back from China to US yet. But we see that a lot of new manufacturing, is not moved from US to China anymore. It's moved either to Mexico. That's the start up in Mexico instead of expanding China. And we also see 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, in Europe, we are, seeing trend 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, but it's too early to see this materialize in orders, but 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. So also in China, I think the investors will continue, but much more of a domestic nature compared to just manufacturing outsourcing. Okay. Our next question comes from the line of Ramu Korea from SEB. Please go ahead. Just one pretty high level question from my side on the nature of the digital events that you've had which you foresee will continue and then you've canceled your fiscal trade first. What are you seeing with customers in terms of response rates And perhaps at the end of the day, it's a question of demand. So it doesn't really matter, but are you coming through in the same way that you did in a fiscal environment? Yes, I would say that it's more efficient. We get a longer, I would say, we have 2 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 don't, we get the 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 can you take better benefit of these products? And they will see better engagement, I would say, than traditional trade fairs. We are sitting with them for 1 hour, And, I would say that this is even more efficient than traditional trade fairs and, you know, this kind of walking around in a physical place and maybe bump into somebody that have interest in your product. So 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 this relationship to the next level. But we are positive about it, but we need to change a little bit our selling, our sales process when we have this kind of new leads, I think. And 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 interesting, 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 quarter. But we can work more on our gross margin or OpEx and cash flow and keeping our eyes on the long term ball. That's our strategy. And we'll keep on doing this for the, the rest of the year. This is our feeling right now. So now let's take a couple of weeks of vacation. I hope you same opportunity to relax a couple of weeks, and then we were back in August ready for more business. So have a nice summer. Thank you. This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.