Earnings Call: Q4 2019

Feb 3, 2020

Welcome to the HMS Q4 twenty nineteen Results Presentation. Throughout the conference, all participants will be in listen only mode, so there's no need to meet you on individual lines. And afterwards, we'll have a question and answer session. Just to remind you, the conference is being recorded. Today, I'm pleased to present Stephan Dahlstrom, CEO, and Joaquin Nightborn, CFO. Please begin your meeting. Thank you. Good afternoon, everybody. Welcome to this call where we present our Q4. And the agenda for today is that I will do a short summary, a business update Joaquin 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 the 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 market, and I'll come back to that a little bit year. We are talking quite much in the report about both adjusted EBIT and adjusted EPS. And I will let Joachim explain this a bit later in the financial presentation. Quarter 4, quite good cash flow. And we're close to 2019 to be, not the best year ever, but some 11% growth But keep in mind that, one part that is currency translations, one part that is the acquisitions we have made So organically, we are seeing a weak growth of 1% organically 2019, something we are not happy with. Order intake also a small growth, but according to what we would like to see. We talk about an EBIT that is adjusted level, slightly lower but to keep on running on a gross margin sorry, EBIT margin that is beyond below our targets, right now, we are seeing a 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, over the years, more than 7,000,000 products installed in the market. And our 4 brands, AnyBAST, E1 and the indices are well known in the market. What's new from 1st January 2020 is that indices have, but have and now been integrating HSs and we are using the full scale of HMSA Salesforce also for indices. And maybe a note, there's a slightly new logotype for indices, including the day of a full member of our family now. Last year, we also have a web factory. 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 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 do 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, 16 countries around the world. We also 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 you 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 users 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 newer business model even if they are right now not ready to move into that. I think we 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 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 the new design wins are increasing, but also a number of existing customers are also increasing. This today represents 49% of our business, keep on growing, but we also have other businesses that grow faster than this. We also see a quite small churn, 95 customers went out of the business for Normally, it's for reason because they have an older product that they discontinued to manufacture. So all in all, we see a good growth, continue growth and long term trend is still positive. I think it's important to emphasize this also means that we have attractive product offer that attract new customers to define in our technology. Okay. 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 checkbox on that. On the EBIT, we have a 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 talk about in Q3, continues here in Q4, We have business in building automation with our indices. That is quite solid. It goes quite well, but most of our business is in the Manufacturing industry. And that continues to be a difficult market with a limited growth and low demand from our customer and our customer's customer. Especially this is noted on any bus and XAT brands where we continue to see headwinds. And I think this is where we have the biggest in on a weak market in the manufacturing industry. E1 have a better quarter in quarter 4 and also indices continue to show good growth for the building automation. By geography, 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 mark in Japan for quite some time, but there we are seeing some somewhat better. It's not good, but I think we are starting to see turnaround in Japan. So we're seeing the best quarter since quarter 3 2018, but we're coming from 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 or 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 open 2 small offices today, offices today, this year, 1 in Dubai and 1 in South Korea. In Dubai, we started some good traction in Korea. We still have a quite difficult situation with geopolitical situation in that part of the world. We've been investing quite much time and technology development into 5G. We have done some early adopter installations and we are around on 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 adopter and show these new technologies to our customers. We made 2 acquisitions. This spring, we acquired the German Web Factory Software company, And, we also acquired our Dutch distributor Rasa 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, Duakim will give a little bit more details on this. And we also finalized the integration of Bex where we take their technology and fully integrate to our IoT offer. And as I mentioned, we also integrate indices as a field full business unit within HMS group. All right. So Joakim, financial results. Yes. Thank you, Stefan. And as always, let's start with the order intake. As Stefan already mentioned, not the best quarter for us, $337,000,000 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 the Americas having a downward 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 to last quarters as well. And then going forward, we expect maybe this to be on these levels for some time. The positive sign would be in 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 courses in Q3 2018. And the decline we see is pretty much across all industrial segments. To build an automation part with instances is going much better. And then we have growth of 30% looking for the full year. But the in the industrial world, it's a tough market, for sure. Looking at some full year numbers, we're doing $14.70 1,000,000 in order intake. This is an increase of 3%, but organically a decline of 5%. The most of the gap, if you look, we have a book to bill of 0.97 The main reason for this, this big 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 moves where we build up on these customers. This in combination with a tough market in China for the Japanese exports has 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 a lot of 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 Annabasanixa, which are most cyclic of the businesses. And here, we also see a rather big decline. Ewan is, holding off a bit better, plus 6% organic order intake and instances, as we mentioned, is more than 30% of that organic fleet. 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 $346,000,000 reported sales in Q4, which means a decrease of 5% reported 10% organically. And as you can see, we're down on all markets, the smallest decline in EMEA, but that's also where we had 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 1,500,000,000 with SEK 590,000,000 which means growth reported 11% organically only by 1%. And also here, you have quite 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% on that market and almost 30% of group sales. Then we have Americas with, of course, USA being the biggest market with almost 20% of the group sales. And then we'll have Asia representing 16% of the overall sales. I think we'll 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 it shows to present to the adjusted EBIT first, which is $33,000,000 and corresponding to margin of about 10%. And the reported EBIT is $55,000,000. So what are the main things impacting this? We made a deal with previous owners of Beck ITC to make an earnout settlement already this year. That was expected to be done next year according to the contract. For various reasons, we decided to have this discussion already this year and to try to fix this. The maximum potential earn out was 1,000,000. And now we've paid out 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, had a provision of 25,000,000 for that for the program. We only needed to use 22,000,000. So there's not a positive effect of 3,000,000 from that. So the interesting number to look at is the EUR 33,000,000 in adjusted EBIT. Just mentioning the gross margins, we normally talk a little bit about that. We see a 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 indeed in the area that we expect the gross margins to be with the mix we currently have. We have some positive effects from WebFactory, but we also have some negative effects from Beck IPC going back before that acquisition. So somewhere around 61% is probably where we are with the business. And this is all in level with the line, the margins that we have for the full year and last year. Talking about the OpEx development, we have reported increase of SEK 12,000,000. If we adjust for acquisition in currency, we're actually saving CHF3 1,000,000, and this is an effect on this restructuring program that we initiated. And I'll talk a little bit more about that in a second. For the full year, we're reporting a 3 143,000,000 reported EBIT compared to 261,000,000 a year ago, corresponding to margins of 15%. And if we look for the full year, I think the adjusted EBIT number is very similar to the report. And so no need to talk too much about that. And as I said, the gross margin is 61.1 now in the year, similarly level as the year before. So This is where we expect to be going forward. It looks like the OpEx number for the full year. We have an reported increase of SEK 121,000,000 but organic is only $32,000,000 increase. And then we adjusted for FX impact acquisitions and also some currency hedging we will 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 we came into 2019. And then as always, we had ambitious plans for for the year, staffing up with both sales and R and D people. That's what we started doing over the year. And then early Q2, we made the acquisitions of the website in a rough products that has bumped up the OpEx level a little bit more and continue to expand from that. During mid year, sometime during the summer, we saw the market is not really there in the same pace as we're expanding OpEx. So we hope we have to do something. And that's when we initiated this cost improvement program that was then executed in October. That's where we see the downturn. So now to conclude everything, 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 cost ended up to SEK 22,000,000 And as well as communicated earlier, we expect still to have the savings of SEK 45,000,000 in relation to the run rate when we executed the program. And 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 the big changes to the current level. Okay. So if you look at the earnings asset 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 1.46 and adjusted this is 0.68. Now what's a bit, understanding out a bit is that we have a positive tax So plus CHF 20,000,000 in tax in Q4. And just several reasons behind this. If you look at the overall result, we have the CHF 19,000,000 from the Beck earnout 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 is 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 Texas of Houston Belgium, giving us a tax deduction of 19,000,000 for 2019. And just to understand that, the EUR 19,000,000 is actually accumulated for returns for 2018 2019. So 10 of these million actually relates to profits made in 2018 and the other 9 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. After that we need to reapply if this regime is still in place after that. We also have some other earn off related transactions that will give us a positive effect on tax of $5,000,000. This is quite complicated, so I'm not going to go into that in detail. But all in all, this all hits Q4, and that's why we have this very positive effect in Q4. Looking for the full year, of course, we have the same, the same things in place that led to Q4, but also we have this restructuring program going in the other direction with $22,000,000 that is impacting a negative way. So for the year, we report $4.43 earnings per share, but adjusted it's 4.06. And, with this in mind, the board has decided to propose a dividend of 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 61,000,000 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 EUR 50,000,000 lower inventory now in Q4 compared to Q3. We expect that to continue with maybe another SEK 10,000,000 in the first quarter. As a result of the lower sales, we have some low receivables of SEK 20,000,000 and all in all, this is to a decent cash flow in Q4. Looking for the year, we have a cash flow, and this is after then working capital changes, of 2 54 to compared to 193 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 are just going to talk about the debt situation and leverage a little bit. We have reported net debt of $402,000,000 And then you should know the EUR 93,000,000 of this comes from the IFRS 16 leasing standard. So underlying it's EUR 93,000,000 lower than that. And looking at net debt through EBITDA, we report 1.2 to be compared to 1.13 1 year ago, If we adjust this $493,000,000 of IFRS 16, that we have a comparable 1.03 to compare it to the 21.13. So I think all in all, the main messages that we with this 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 a decent earning level as it is. And we think that we have a very good position to go after more acquisitions with this, with this leverage that we have. So with that, we would like to open up for any potential questions there is in the audience. Thank Once your name is announced, you can ask your question. If you find it's answered before it's your time to speak, you can dial 2 to cancel. So once again, that's Our first question comes from the line of Joachim Ganor of BNB. Please go ahead. Your line is open. Thank you. So maybe you can start with diving into the order book trend. Perhaps you can provide some more detail 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? 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 seasonal effect as well. We are not really sure. But in general, almost the industrial markets with quite weak demands. People are hesitant to make investments and a little bit of wait and see. Of course, we see quite a 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 that's a hesitation in general. So I think this is what we can say about the order situation in general. Understood. So if we see, let's say, flat volumes for at best for 2020. Could you elaborate a bit on your ability to perhaps then expand the margins with the cost reduction programming in place despite the tougher industry backdrop? I think for now, what we've done on the cost side, we think is what we would like to do in the 1st phase. And as long as it doesn't get 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 margin and see if there's something we can do there. So let's report back on that maybe in Q1, Q2, when we know a bit more what we can can see on that side. Great. One more question for me then, perhaps, and I will get back in line. I know it's early days. We don't have a lot information yet. But with regards to the potential of a pandemic, how do you see potential trends spillover to your supply chain in China as of today? 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. We have a few two people working at the office. The other 10 are in 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, one in Beijing and 1 in Ningboo. And there, they are close an extra 9th February. At the moment, we are expecting a 2 week delay on our supplier, on sub supplier from sub suppliers in China, that will have a limited effect on our capability to make shipments to our customers. If this it will be longer than these 2 weeks, we need to make a new calculation, 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 mid term how this effect our business. Great. Thank you, Safran. You're welcome. I'll get back in line if there aren't any more questions. Thank you. Thank you. The next person in the queue is Victor Hubei from Danske Bank. Please go ahead. Your line is open. 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, revenues in Q4 came in quite substantially below that. Did you see any canceled orders or something like Not really. It's we don't really see it's been that bad. It's just that we have a slow flow in fuel of new orders. Okay. So it didn't fill up that year on the quarter? Yes. Okay. And looking at one of your large clients, EBT, the CEO, of which was in the double 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 or beginning of February? Do you see any signs of improvement or because Automotive is quite a large exposure for you. That's right. I think when we look at the macro that are coming more and more signs that, from a macro perspective, we are, at the bottom, I think for HNS as we wrote in the report, we expect that the next couple of quarters will probably be tough from 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 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. 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, what we 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? I think right now we are looking into, keep things as they are until we see a in market conditions, hopefully upwards. So we can be more cautiously 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 are a little bit wait and see when it comes to new things. Okay. So in terms of M and A, targets, discussions, pipeline, what are you looking at? What would you like to do? Or are you seeing in terms of prices? Yes, we, of course, we keep on talking with some customers on our potential targets on our shortlist. As we informed earlier, this is normally very long processes. These are, in many cases, lead companies and for them to sell their their baby. It's not so easy. However, we see 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. Markets have not been tough enough to bring them forward. I think we're working long term with our M and A. And what we've seen, I think, on the last couple of years, look back, on average, we have down between 01 and 2 acquisitions per year. And I think this is what we see going forward as well. I understand that it's 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 And A. That's clear. Okay. And just to make clear here on current trading, you have not seen a regardless of geography or product line any signs of improvement going into or here in Q1? Or is it just as hesitant that's in Q4? Or do you see any? Yes, we don't talk about this is the 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 waterside. I think that's one message we are, we are conveying here. But otherwise, we need to give it a little bit more time and come back in the next report to talk about your, quarter 1. Okay. Well, thank you. Thank you. And we've just had a further question coming from your Kim Gunnar of DMD. Please go ahead. Your line is open. Thank you. 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, yes, say in the past the 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 Annabas in 2019, we, I mean, the growth was still continued solids, I'd say. So if you can perhaps elaborate a bit on that. I think the conversion we are seeing between OT and IT is normally taking place on a higher level than the T level or the TLC level as we call it. So on the wheel, what is controlled centric on the factory floor, where all these industrial Ethernet and these networks are we don't see a lot of conversion from that level to IT. It's much more of this, from north of the PLC to SCADA systems. There, we see much more of a conversion starting into more IT. So I think our traditional Anybus and IXA 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 Thank Okay. There are no further questions coming through at this time. I'll hand back to our speakers for the closing comments. Thank you. Thank you all for participating in this call. As I said on the beginning, we are happy with quarter 4 And we keep on 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. We remain with our long term ambition to be a growth company, both organically and through acquisitions. So stay tuned and we hope 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.