Earnings Call: Q3 2020

Oct 23, 2020

Thank you very much. Hello, everybody. Welcome to this quarter 3 call. And it's myself, Stefan Holsturm and Joakim Niedeborn, our CFO, who will be joining you for this afternoon. And we have a couple of topics. I'll start with a short summary and a business update, and then Joachim will drill down into the details of our numbers, just presented an hour ago, and then we end up with a Q and A. But let me start with just short overview. For the quarter, we are continuing to see quite weak development on our net sales and also order intake, a little bit as expected. Keep also in mind that quarter 3 last year was a fairly good quarter for us. We have strong comparables. So we have a weak top line. It looks better further down. We are quite happy with good EBIT. We are up compared to last year. We are SEK 77,000,000 compared to SEK 56,000,000. But you also need to keep in mind that last quarter 3 2019, we made a CHF 25,000,000 provision for our restructuring program. So we are similar to the EBIT level we had before that provision. So we land on 22% EBIT margin, better than our long term target, which is 20%. So that's quite good. And I must say, we are very pleased with the continued good cash flow from operations, and landing at EUR 116,000,000, resulting in a quite good earnings per share as well. So that was the quarter, and this accumulates over to the 9 months with similar development. Weak order intake, weak net sales as expected, but we are on par with the last year's profit before that provision for restructuring, and we are landing last 9 months on 20% EBIT margin on our target. So we're quite happy with that. We've been maintaining good cost control. And of course, we've also done some savings from the restructuring program, but also COVID-nineteen situation helps us to also review some OpEx cost. We've spoken Joakim will talk more about that. So just a few words about our business. What we wake up every morning doing is to think about how we have our customers connecting their devices and machines to different networks. We have millions of critical applications, critical machines that are connected in power plants, in automotive plants, in breweries, in this kind of industrial automation applications. We have 4 brands. We have Anybus, we have IXSANT, we have Evol, we have Indusys, all with different functionality and a little bit different focus area. We also have our 5th area for software, web factory, and I'll talk more about web factory in a minute. We focus on 2 areas. We focus on makers, makers of industrial equipment and industrial devices, companies such as Rockwell Automation, Schneider Electric, Caterpillar, where we help them with their connectivity and dig into their device or into their machine, which allow them to connect to any type of system that their end user may have. We also work with these users. This could be companies that produce the beer or the car or the electricity that you use. And here, we have different products for interconnect different systems and machines in their plants or in their remote installations. So these are 2 very important areas for us. And if you look on the distribution of our sales, it actually looked quite much the same as previous quarters. So even if we see a downturn on our top line, the distribution is quite much the same. We have 47% of our quarter 3 revenue on the design model. This is a long term model where we embed our technology in the makers products and this is a long term business. But of course, we need to have makers that sells a lot of products that can buy a product as well. So really a bit depending on our customers' success and that we've seen some headwinds in this business the last quarters. We also work with our gateway routers and other products. There's a mix. We sell it both to users and to makers, and this comes together to 4% to 8%, quite much the same as we've seen before. And software subscriptions and services is an area we want to expand, but we are still on the low 5%. And we are we have long term targets to grow that, but it's still on a single digit percentage. What we and our Board of Directors have done in the last couple of months is to spend a lot of time thinking about the long term future. Of course, we need to have 2 things in our minds for the future: the short term activity we do in this kind of challenging market, but we also need to make sure that we focus on our long term activities. So we have now set a new goal, and our ambition is to for 2025, we should our revenue that year should exceed SEK 5,000,000,000 more than SEK 3,400,000,000. We are engineers, so we like this kind of easy to remember kind of numbers. So SEK 5,000,000,000 is very important for us, and that's our ambition to go there, both by organic growth and also by selective acquisitions. And maybe the mix will be approximately 5050 to go there. Profitability, we are around 20%, and we will maintain that target going forward. That's an ambitious target, but we've seen that we can deliver that. We would like to maintain this profit level over the business plan for these years. We are doing a slight change to our dividend policy. We used to have 50% of EPS should be in approximately 50% of EPS should be in dividend. We're now saying 30% to 50% to also allow for some more flexibility when it comes to preserving some cash in the company for acquisition, etcetera. But at the same time, we are saying that dividend is important for our shareholders. With the business update, let's move quickly in there. We have a couple of companies' acquisitions we have done. We bought 70%, the majority of the Dutch percentek group. The remaining 30% is owned by 3 senior executives in the management team there, and we work with them to develop this company. And what they do is hardware and software for surveillance and diagnostic open network traffic in industrial applications. This could be in a steel plant or in a paper plant where they attach their sensors and equipment to the network, we can then monitor potential problems in the network to have service they do the service. We can predict also that there are areas that might impact their network traffic going forward. So therefore, they can also do proactive services on these things. Specialized company, and they are headquartered in Rotterdam in Netherlands and have old sales offices in Germany, UK and Italy. And they're around 70 employees. It's a small company, but a very nice technology, and it fits very good to our users and our ambition to do more business within software and services, which we think we can develop here. EUR 12,000,000 approximately going forward, we expect maybe single digit growth and double digit EBIT margins. And of course, our ambition is to improve the growth by helping them. But we also know that this is with users in this industry, it takes time to generate new business models, but the idea is also to develop their business with more from this kind of product they have today to explain why things doesn't work, tools have predictive maintenance and have more intelligence in these products to help our customers to have preventive maintenance. So preventive maintenance is something like that is more intelligent that predict future potential problems. We see a good market and a good fit with Placenta going forward. As you may remember, we bought 74.9% of the software company WebFactory last spring, And we now agreed with the founder who owns the remaining 25 0.1 percent to acquire his shares. And the idea now is to speed up the integration and use more of their products integrated with our other hardware offer. So far, the business with Traveler Germany and Central Europe has been quite challenging, and we have seen a lot of delays with customers in this kind of software and monitoring applications where we focus on. But we strongly believe that being 100% owned on WebFactory can help us accelerate how we use the product, how we sell the product, but also how we bundle the software together with other products making us to make a solution based on both hardware and software. We also see continued impact from COVID-nineteen. But it's a mixed picture. We see customers with exposure towards medtech and food and beverage. They are performing quite well. But we see continued challenging business related to Automotive. We've seen that for quite some time. This is still a challenge. In China, we see a quite big pickup in some verticals like wind power. We see that our ordering tech in China included free is up 50%, and this is quite good. But in general, we see a lower hesitant CapEx investments in the industrial applications in general. But what we know from other early downturns is that this lower CapEx investments normally doesn't take away CapEx long term. It's more a delay. So we believe that there's a good opportunity post COVID that these investments will come. So we are quite positive in the midterm. We see in general that Europe has been down both in sales and order, especially Germany, France, Italy, Spain, where we see a lot of effects from corona. Asia is down in our revenue, but a good pickup in orders, so that looks promising. And U. S. Is, I would say, sideways, low growth, but it's quite okay. But there's also big uncertainty in U. S. For the near future here. So we see Germany and Central Europe is down. We see that Anybus is down, but for other brands and other geographies, it's quite okay. So it's a mixed picture. We had stable gross margin despite lower volume and also despite a current situation that is a bit unusual for us. We have had years of positive FX, but now we see some headwinds on this, and this is also affecting some of our gross margins, but we've been fighting to really be more efficient here internally. And we are quite happy to maintain a good stable gross margin here. Finally, from my side, short COVID-nineteen update. We still have a team that is fully functional, fully healthy. So we have no direct impact in our teams for COVID-nineteen, but we are very careful. We have continued home office work for most of our staff. Now the policy is that we would like to have our different teams at least one day a week in the office and their manager decide what is the best day, and we try to organize it so we don't meet everybody at the same time. So we are finding new ways to work and new ways to meet to make sure we can do our business going forward. We continue some short time work in Germany, in smaller it's around 20%. In Sweden, we work full time. In most other countries, we work full time as well. We have full function in our supply functions in Sweden, in Spain, in Belgium. So we are fully up and running there. Looking forward for quarter 4, we can say that the quarter 4 so far has started to be in line with quarter 3. We don't see a big change upwards or downwards. So it's more sideways, keep on rolling here. We see challenges in Germany, so we maintain short term work until further notice. We continue COVID-nineteen very much. And of course, like we all, we are quite concerned about this second wave coming up here in many of our markets. So we need to be careful. But our customers are also learning how to deal with this and taking countermeasures. So most of our customers are up and running and have a business that is working quite well. But we are canceling all these traditional fares and face to face meeting with customers. So we see a lot of digital events. And I must say I'm quite both surprised and sometimes also impressed how well this works and customer interactions that it goes on. And we see a lot of digital meetings with our customers, and customers appreciate this as well for their safety, but also for their efficiency. As we said last quarter, we believe that even if we have a little bit of headwind right now, we see good market conditions for automation and digitalization going forward, and we are quite optimistic for medium term of our business when we have corona behind us. So we focus on our long term business for the time here. Year. With that, I would like to shift over to Joakim to give us a little bit more details on numbers. Okay. Thank you, Stefan. So we're going to start out as normal with our order intake situation, which is maybe the softest point in the report. Even so, I mean, we see a bit of an uptick from the weak Q2, and things are definitely moving in the right direction even if that is pretty slowly so. So we are showing now SEK 336,000,000 in comparison to the SEK 372,000,000 organically, a decrease of 7%. And it's really isolated to a couple of countries where we see the big drop. And it's Germany, Italy and France that is representing this challenging development. Otherwise, we had a small decline in the U. S. And the positive, as Stefan also mentioned, is Asia. Both Japan and China is doing well. China is doing extremely well and we're winning a lot of new interesting projects in China that is probably going to help us a lot in the future. So very good order intake there. Ultimately, the 1st 9 months, we're down pretty much SEK 100,000,000 organically 9%. And as Stefan said, for the first time now in some years, we're actually seeing some headwind from the currencies, which you will see throughout the report is affecting us on many lines here. The picture is pretty much the same as in the quarter for the 1st 9 years. We have Germany and Italy being the main reasons for the decline. U. S. Is pretty much flat and Asia is growing very nicely. So that's, of course, very positive. So a bit of a change, a different picture depending on what geography. And Stefan also commented on the customer mix. That is also quite different. We have some customers performing quite good. And the ones that are more into automotive and Industrial Investments are having more challenging time. So let's have a look at the sales, which is a slightly different view than on the order side. As you see, we're now pretty stable around the SEK350,000,000 level. If you look at the last couple of quarters. We had SEK 345,000,000 in the quarter to compare with SEK377,000,000 for Q2 1 year ago. Organically, we're down 6%. It's the German market and Polyde is behind mostly this decline. And the difference compared to the order intake is that we have also Asia being down on the sales. But obviously, this is going to change in the future given the strong order intake that we see now. Also, in the 1st 9 months, pretty much the same view here. We're down SEK 111,000,000 in sales. Organically, that means 9%. And as you see, it's pretty much the same view on different markets as in the quarter. So I think for the coming, I think we wrote in the report for Q4 that what we've seen is that order intake is continuing pretty much in line with the pace that we see in Q3. So I think we believe that there will be pretty slow recovery from this situation, but we are a little bit positive and hope that we will see at least as good numbers as we see now for the coming quarter as well. Then the sales split per region in percent, maybe not that interesting. We have 60% of the business in EMEA, which is quite normal. We have a bit more in America with 23% and 17% in Asia. This will probably change a little bit in the coming quarters where Asia will have a bigger percentage given the strong order intake. Otherwise, it's pretty much what we normally see here. Then maybe what needs a bit more explanation is to understand the result and the gross margins because you might get a bit of the wrong view just looking at the numbers without understanding the underlying reasons. If we just start with the EBIT level as such, it's actually a record quarter for us, SEK 77,000,000 even if we had adjusted SEK 81,000,000 in Q3 last year, adjusted for this restructuring provision that we had. But it's also good to see that we have margins of 22.3%, which I think is the best we'll be seeing in many, many years and also above our target. And the reason is, of course, the low OpEx, there's still a quite solid gross margin that makes us achieve this good number. And just to understand the gross margin, 61.9%, you might also see that this is actually down compared to Q3 last year. But we think, if anything, we're quite satisfied with that number in the report actually. And we have negative impact from the fact that we have lower volume, euros 32,000,000 lower sales, which gives an under absorption of our manufacturing overhead. And that is impacting with about 1 percentage point negatively. We also have currency headwind, which is also giving about 1 percentage point negative effect compared to the number 1 year ago. So I think all in all, we managed to do some good things internally. We've done some good things in supply. We managed to get through some price increases. So to achieve the SEK61.9 billion with this low volume, we think it's actually quite good. Then looking at the OpEx is, of course, dramatically down SEK 44,000,000, but then you also should remember that SEK 25,000,000 of that is related to this provision that we had for the restructuring program. And the organic number is SEK 13,000,000 down, so 8%. Also just wanted to mention the short term work impact, which might be interesting to also know. In total, that's SEK 4,000,000, where SEK 1,000,000 comes from governmental support related to this. That same number for the full year is SEK 7,000,000 in sorry, SEK 5,000,000 in governmental support and SEK 7,000,000 for the other impact. Some other comments on the 1st 9 months. It just happened to be so that the EBIT level is exactly on the same number as for the 1st 9 months last year, So SEK 230,000,000, which, given the lower sales, takes us to precisely our target, 20%. And here, you can actually see that the margins are up 1 percentage point, so 62.1% compared to 61.1 percent. And this is due to the reasons I mentioned before. And also quite positive to see that we can actually increase this margin even if the volume is working against us. OpEx is, of course, dramatically down, SEK 70,000,000 organically and adjusted for this SEK 25,000,000 restructuring provision, it's SEK 53,000,000. And out of that SEK 53,000,000, we have about SEK 33,000,000 related to the restructuring program. And the rest is just basically lower run rate in terms of lower activities with less traveling and less customer events and so on due to macro situation. So we're also now, when we're pretty much through the effects of the restructuring program, happy to see that we will get the SEK 20 5,000,000 sorry, the SEK 45,000,000 yearly effects that we had planned when we did this last year. Yes, some comments on earnings per share. There's not a lot of interesting things happening here. We have a good underlying result, which is basically a falling through, strange things happening within that financials or tax in the quarter. So happy to be able to present SEK 1.33 in the quarter and SEK 3.58 year to date on the earnings per share. Looking at the cash flow. We have also record cash flow, NOK 160,000,000. Of course, we do get some help from some working capital adjustments. So we have a positive effect on the cash flow by SEK 20,000,000 due to this. The two main items is we have some inventory reductions compared to last quarter and also we have substantially lower receivables by SEK 28,000,000. With that said, I just also wanted to say that it's we still have pretty much the normal level. We're actually up a few million compared to year end in receivables. It's not that we empty out this. I think we managed to get some help and maybe we'll not have the same effect in the coming quarters. But we're very happy with the 16,000,000. And yes, even if we get the help from the working capital, we still think that's quite healthy. So in relation to sales, we're at 10.7 percent working capital, which is where we normally expect to be around this 10%, so nothing strange there. Year to date, also very strong number, EUR 286,000,000 compared to EUR193,000,000. We get some help from working capital reductions, not so much for the 1st 9 months, only SEK 8,000,000. And here, we have the big changes, actually, the inventory that is down SEK 23,000,000 compared to year end. But we might see a bit of a buildup in inventory for the coming quarters since we will have to take on some components that we see the longer lead time due to some corona impact. One thing being common for us, but we need to have those components, so we'll take a bit more inventory of those that we normally keep. Also, what is behind the very strong cash flow and improvements is that we've got some tax returns that I think we talked about in also Q4, of course, related to the Belgian business. And overall, I think we have pretty low financing costs due to the fact that we have a low debt at the moment. And we also when we get the lower net debt to EBITDA, we also get better financing cost as such. So yes, to end up with the leverage and the debt situation here, we have, as you can see on the graph, a very positive trend. Of course, the fact that we didn't give a dividend this year helps a little bit. But still, we have been able to convert pretty well to our cash and to work down the debt level. So I think we have a very strong situation now going into Q4. And as you understand, we made the acquisition of Procentec in October and also the last 25% of WebFactory. So that will, of course, increase the net debt for in the quarter, but still, it will be on very low levels. And I mean going out to the quarter at 0.42 net debt to EBITDA. Even if that will be a little bit higher after Q4, it will still be on very comfortable levels and we will have a lot of firing power left for new investments and interesting acquisitions. And before I leave back to operator for questions, we just wanted to say also that we will have a Capital Markets Day. That will be digital. It will be in November 18 between 9 a. M. To 12 a. M. Central European Time. And we hope that you will want to listen in to see what we have to say about the coming time for HMS. So thank you for listening. Operator? Thank you. Our first question comes from the line of Victor Horijsvar from Danske Bank. Please go ahead. Hi. So I've got a couple of questions. First, on the new revised financial targets and the implications from them. It implies a slightly lower growth rate over time than the previous targets and a slightly lower organic growth rate that is at least my take. Is that due to the higher revenue base? Or do you see something shifting in the market or from the competition? Or could you just elaborate a bit on the organic part of the growth target up until 2025? Maybe let me start with that Joakim. Just want to say that me and Joakim are different locations here. We don't see each other. But let me start with this. I think this new target of exceeding SEK 5,000,000,000 in 2025 represents growth of what can be 18% a year, something like this, which is lower than our original, but it's still not that far away from it. I think this is a combination of bigger numbers and what we see as challenging but also realistic going forward. And our estimation is that this would probably be, let's say, fifty-fifty mix based on organic and M and As. So organic will be 8% to 10%, something like that, and the same for M and As going forward. Joakim, maybe you can give a more detailed picture on this? No, but I think it's it was a good description, Safran. And I think the fact that, as you if you do the math, you're probably not a little bit lower than 20% that we had said before. And our feeling is, yes, that we don't really have that. The market isn't really there. And maybe we've overestimated the potential before. If you look at the market reports and so on, we still think this is quite ambitious and in line with the high intervals on the industry reports. That's the reason behind. Okay. So turning to the M and A part half of this growth. Where do you see your pipeline? You just executed on a deal a couple of weeks ago. And so how's the pipeline looking? What are you looking at? I know software multiples are higher than hardware multiples, but you're still wanting to grow your software business? And also, how do you see your balance sheet over time? How much gearing would you be comfortable with? Joaquin, will you take this? Yes, sure. I can take it. I think it's a mix, what we're looking for. I think we'll probably see us doing some software acquisitions more than the Web Factory business. But I still think that the majority will be maybe a little bit closer to our more, what shall I say, base business, so to say. I think the business for remote access and remote data we have with the Multi 2 E1 is also an interesting area for us to see what more there can be done. So that's one area that we're going to look more to. And what else did you have with the gearing? Well, I think as you see now we're at very low levels. I think going up to like 2.5 or so will not be a problem at all, net debt to EBITDA. They were quite comfortable. I think it could go higher than that. It might happen from time to time, but that would probably be in a limited period if that happens. Okay. And just the last question on growth. Placentec, you said you expect single digit organic growth. Is that to be expected over time? Or is that near term expectations? Or what do you see for the Cosentyx business, maybe for 2021 in a recovery year with easier comparatives maybe above that? Or what do you see from Ozempic, short term and longer term? Maybe I can start. I would say single digit growth for that business. That is how they are standing and going today. So they have growth on their current business. I think the first maybe 2021, HMS will not be doing a lot of changes. We need to support them and help them. Going forward, I can see more engagement from us to help them find new markets like in North America, in Asia, where they are not really present today. So we hope that can also, over time, help them to grow faster than the single digit growth. But for 2021, I would expect HMS will not be having the time to accelerate that faster. But in the midterm, we will be able to grow that business more than single digits, I think. Okay. And on the gross margins, you had some headwinds here, both in volumes and in FX. You quantified it to around 2 percentage points. And you still manage at 62% gross margin, slightly below 62. What does that imply when we will see volumes coming back, presumably next year? Would 64% be a relevant target of 63% on the gross margin? Or what do you see over time? Or will that be will you meet another headwind in gross margins besides this? Well, maybe I should talk to Grafon. I think what we also should remember that I think I mentioned quickly is that we also given all those headwinds, we have the help from a good product mix. As you saw when Stefan presented, we have the embedded business, the timing business was only 47% of revenues. That is normally around 50%, percent, maybe 51%. So that is actually helping us a little bit, but we have less of these low margin custom products. So I think on one hand, when the volumes come back, it will also probably coming back on those offerings with a bit lower margin. So that might be working a little bit in our disadvantage. With the currency situation, it's very difficult to say. But I think when volume comes back to be slightly north of 62% shouldn't be impossible. We want to be a bit careful guiding since we still think that 62% is we've been improving from like 60% to 62% in the last couple of years. But somewhere 62%, maybe a slightly north of 62% should be achievable, we think, for the coming year. Okay. And just last comment or a question on the gross margin. In Procentec, we got the EBIT expectations. What about their gross margin? Is it in line with your business or slightly below? I would assume it to be closer to 50% than 60% given the EBIT margin? Yes. I think you would think maybe, but actually, it's very much in line with our gross margin. So we don't really see that, that will have an impact in any direction from that point of view. I think where there might be some potential is that it's still a relatively small company starting to set up a bit of a group structure with some sales offices. So I think that's why maybe you see the OpEx being a bit higher in percentage compared to, for instance, us. So that's what we think we can work a little bit on to maybe get the EBIT margins up slightly. But the gross margins are very healthy, so that we're happy with. Okay. Last question. ABB comments a robotic surprise positively for them. But their comments were that we're going to see on orders. This is going to be seen in the numbers in 2021, not in Q4. So could you what do you see for Q4? We have a very much easier comparative when it comes to growth from Q4 'nineteen than we had in Q3 'nineteen. But is the market there for returning to growth slight growth already in Q4? Or what do you see? Do you have the comment on positive data points, but still uncertain markets? On a net basis, what does that translate to? Yes. That's a very good question. And to be honest, we don't fully know. We look on the macro data, and the PMI indexes are looking quite good actually going forward. When we talk to customers, we still see some they are nervous and a bit hesitant. So it's we get mixed feelings. So I think our conclusion is that it will continue to be sideways for a couple of quarters. We don't see a strong momentum yet. Even if the macro data seems to be better, we can't really see that we see this own orders and in the comments of our customers yet. Okay. That's it for me. Thank you. Thanks, Victor. And as there are no further questions, I will hand it back to the speakers for closing remarks. Okay. Thank you very much, and thanks for taking time on this Friday afternoon to join HMS here. And I just want to highlight again, Capital Markets Day, digital format, November 9 Central European Time. You're very welcome to join, and we talk more about the strategy. We'll have some other team members, our management team as well joining, and we hope to take this time to give you a little bit more detailed information about our business and our view of the future here. So thanks a lot for this meeting and look forward to seeing you soon again. Thank you. Have a nice weekend.