Earnings Call: Q3 2021

Oct 22, 2021

Quarterly report

Ladies and gentlemen, welcome to the HMS Networks Audiocast for Teleconference Q3 2021. Today, I'm pleased to present CEO, Stefan Delskomm Joachim Nilleborn, CFO. For the first part of this call, all participants will be in listen only mode. And afterwards, there will be a question and answer session. Stefan, please begin. Thank you. Good afternoon, everybody, for this Beautiful Friday afternoon. So I'm Stefan D'Alstrom. I'll start this and then Joakim will come in halfway and talk more about the numbers. But we do as we normally do. We start with a small quick summary and introduction to our business, and I do a small business update. Then Joao can dive more into the Q3 results and a bit of the analysis, and we finish up with a Q and A at the end. When I will go, we published the Q3. A few headlines from that. Good net sales, Good growth from last year, but if you compare to Q2, quite flat. But it was also a bit of Challenges to deliver old orders due to component charges. We'll talk about this later. But what is fantastic to see is a continued order intake that is Very, very good. Last quarter, we were up 100%. We are slightly below that, only 99% up, That 99% is fantastic growth orders. There's also partly a boosting element, and Joakim will talk more about these Going forward. EBIT, slightly over 100,000,000 good growth from last year. We are a few points on the EBIT margin down due to I would say mainly due to a little Lower gross margin than usual due to some of the component challenges. We'll talk more about this later. Very strong cash flow, fantastic cash flow, and this very good. 148. And this results in a good growth of our earnings per share. That's quarter 3 in a nutshell. For the 1st 9 months, this just concludes the strong growth continues. Order intake is super strong. Profitability So everything goes in the right direction here. So far this year have been good, and we actually think it's the remainder of this year and going forward is also quite strong. And we'll just make a little bit of a dive into our business. Several of you already know it. We have our 4 main brands with Anybus, Yvonne, this is Nixon. And some acquired business the last couple of years, Web Factory, Procentec and also Last quarter, Spanish OBS is for wireless communication. So this is what we do. HMS is hardware mid software. So it's a combination of Hardware products with embedded software, but also cloud communication, visualization software and that kind of thing. As a company, we are having more than 7,000,000 installed devices around the world for our mainly for our Anybus brand. Our Evon brand is about remote access of machines, and we have over 300,000 machines connected to our IoT systems called Talk2M. And our field is really industrial ICT, information and communication technology. And we are a tech company. We focus quite much on 5 gs, IoT, wireless and these new technologies, but most of our customers are industrial customers where end users like AT and T is a steel plant. We have a very long term view on technology. So we also see that we see a mix of new technology, but also very long life cycle in our products. And that's Part of the capacity we have in this company to make a good mix of new technology, but also maintain technology for over 20, 15 years 2015, 2020 years, sorry. We are slightly more than 700 M3s around the world, and we operate with subsidiaries in 16 countries, And we work with partners and distributors in over 50 countries. And we are here actually, I'm here today in our head office in West Coast of Sweden, Hamstaedt. So if we move into more of the business, we have 2 types of customers. We have users of automation systems. This can be System integrators at the automotive plant, for example, this is 25%, 30% of our business. The majority of our business is towards machine builders, device makers who makes industrial equipment, and they embed our Communication technology of software and hardware into their machines and have this as a part of their offer to their customers. Last year, we communicated our 2025 ambitions, and it's 3 things. We talk about the environment. Secondly, we talk about staff and customers, We'll talk about sustainable growth and profitability. And then we put ambitious targets for sustainability. We're really focused on Our CO2 impact, and we would like to become net positive, both from the internal perspective, what we do ourselves, but also from the external perspective, Downstream and upstream in our value chain. And there we do quite many activities, and this looks good. Secondly, we believe that happy and high performing employees generate loyal customers, and our business is really about loyal customers. We measure net promoter score within our employee groups, but also with our customers. And we have targets of Beyond 25% above this. And at the moment, we are good over these levels. We are safe there and doing the right things. And then we have financial targets To continue growing and maintain a good profitability, we would like to have a revenue in 2025 of more than CHF 5,000,000,000 more than SEK 3,400,000,000 maintain a healthy EBIT margin, 20 percent and keep our dividend policy of 30% to 50%. So all in all, this is things you have heard before, just a short recap. Then we move into what you really would like to hear today. It's the business update for the 3rd quarter. And we feel we deliver a strong report. We see a very strong demand across the line, both in geographies And in different automations, automation sectors, we see drivers from increased automation and robotization. We see digitalization. We see energy monitoring, but also remote access of machines. Now in the post pandemic view, of A lot of customers realize that it's been difficult to access remote sites at customers. So our technology is very See a very good acceptance of customers today. And we think that a lot of the good developments here right now It's mainly from our existing customer base, machine builders, device manufacturers and users of these technologies. And We see that many of our machine builders have very good business in all our different geographies. We see a good order intake, but we estimate there's a Stocking effect where we have, we call it, boosting order by €140,000,000 Joao, can we talk more about the details to help you understand how our order book looks like? But we see also that the continued challenging on especially semiconductor market makes our customer place more and more long term orders. So we get orders for 2022 to some quite big extent today. We are seeing a gross margin push Almost 2% down. The reason why is that we are hit by increased component cost from our suppliers, And this is coming quite quick to us. And we are increasing our prices, but we don't change The prices on the existing accepted orders, it's for new orders. And of course, we have a big order book. So we expect that we'll see effect on our price increases From mid next year fully. So it's over the year, up to mid next year, then we have the full effect. So we will mitigate this and we'll be back on higher The traditional higher margins beyond 63%, probably from the middle of next year. So the current level of 61 something It's temporary due to the component shortages. I think already last call In July, we talked about this company, Obasis, we acquired them 1st July. Spanish company, small company where we acquired 60% of the shares. The 4 founders are having 10% each and keep around the business. We see a very nice business in Cellular applications for 4 gs, in the future 5 gs, another wireless technology where they use this in mobile machines. Mobile machines could be Anything from excavators, but also for AGVs and this kind of moving machines in factories. It's a good company, and we are very happy about this Timing Bilbao, and we also see that we can use our technology that we have in other sectors in HMS and make sure that Oasis can take this to grow faster. And the outlook is positive for remainder of the year. We see that the good investment climate for our customers continues. Of course, there's a boost effect on the orders, but the underlying demand is high. We see a lot of investments. A lot of our customers are very successful in their business, and we think this good outlook will continue. We see that the current challenging component situation will continue to be a challenge for us the couple of More quarters. It will be balancing out during 2022. It's not that we are seeing that we need to stop our supply chains and stop our We have a broad range of different products, but we have seen some of our products have long lead times. So this is a problem for us and our customers, But we also see that many of our customers understand that this is the situation, and they also have other suppliers with long lead times. So we feel that we have a quite good acceptance for this difficult situation among our customers. All right. So with that, I would like to hand over to Joakim and talk more about the financial results in Q3. All right. Thank you, Stefan. I think we're going to start with the order intake, which is also the highlight of the report. So starting looking at the graph up to the left, you can see that we've had a pretty good development. We reached a new all time high of €669,000,000 which corresponds 2% to 99% growth, out of which 80% is organic. So it's a very good number for us. And then I'll try to explain to you now a little bit with The boost effect, how that is impacting what's actually more underlying business going in the right way. But first, we can say that if we were to take away this boost effect, We still see about 43% underlying organic growth. So we still have a very strong business behind these numbers. And it's almost unfair to point out something since everything is going well. All our markets are delivering. All our brands are delivering in a good way. But we should also mention an Airbus, which is the main driver of this, with more than 100% organic growth in the quarter. And then obviously, here is also where we have the strongest boosting effect in the end of mass embedded segments. We see a lot of customers placing our orders into also second half of 2022 to make sure that they will get deliveries. We have some small headwinds On currencies, you see we have minus 5% in the FX effects in the quarter and minus 9% year to date, which we believe will even out a little bit as we go forward and leaving the kind of strange comparison numbers from the first half of 2020 behind us in a larger extent. So with that, let's go over to look at the net sales as well. Here you see, starting looking at the graph again, up to the left, you see a bit of a more slower development on the curve. And we moved up 37% in comparison to Q3 in 2020, out of which 18% is organic and roughly flat Expect to be able to get out in maybe the coming 1 or 2 quarters as well due to the component situation. So we see also that we had we could probably have achieved around €50,000,000 more if we didn't have to push out orders in the quarter. That would have taken us a bit above the €500,000,000 mark, which would have been a nice milestone. But I'm sure we'll get there soon. What I also want to like to point out is the Prosemtic business that we acquired a year ago quite exactly, which has been developing in a very positive way. And we started to see this already in the Q1 that we're moving in the right direction. And then it's just been Getting almost better and better, and it's quite clear that we've been taking a step in that business with some U1 accounts that will be very Positive for us going forward as well. So I think this is a level where we believe we should be able to stay at them and also continue to grow from. So very positive development of that acquisition for sure. Also here, we see that small headwind from the currencies Not impacting a lot actually now in the quarter, only minus 2%, but still. So then I've included this time a couple of extra slides to try to explain to you How we see the underlying market, I think that should be interesting to understand and also how the backlog has developed in relation to that. So here we have, first looking at the left side of this graph, I'm trying to show you the order intake. So the full bar would represent what we have actually reported and the dark blue bar would be showing then what we say is the Underlying demand and the delightful bar would then be the boosted order intake. So what you can see here is throughout the year From Q1 to Q3, we've been seeing a larger impact from the boosted orders. And this is simply what we believe is an effect from The component situation, our customers are seeing this as a bigger and bigger problem, and they want to be more and more careful and place orders further out in the future. I'll show you in the next slide also the effects of this. But it's quite clear that the underlying market is improving quarter by quarter Even if we see the 9% improvement quarter by quarter that you see in total, it's maybe a bit overrepresentative of the actually underlying demand. We've been trying to do the same things looking at the net sales. And here, you have the dark blue bar would be representing the reported net sales. And then the total of the dark blue and the light blue bar would then be representing what we believe is the underlying demand. So also here, you see that we have an up ramping demand throughout the year, a little bit better each quarter. You also see that we have The largest share that we are not managing to deliver given the sourcing situation. But still, we think this is a very positive trend that we're seeing. And As Stefan commented in the beginning, it's pretty much across all markets and all geographies that we see this improvement. And it's we believe it's very positive for the future. And we have I mean, all our customers are having a very strong business on their side, which is spilling over to us. Then just to also put in perspective, I think this is quite interesting looking at the backlog. As you can see, if we now compare the closing Balance of Q3 of €746,000,000 is an improvement with more than 200% compared to a year ago. And you also see the ramp up throughout the year here with every quarter being significantly better than the previous one. And also to put that in perspective, on the right hand side, we have orders for delivery further out in time than 3 months. This is normally quite small part for us. We have the vast majority of our order book normally within the coming 2 months. We see normally between 15% to 20%, that would be more than 3 months out. And you see here in January February, We are on normal levels with 16% and 17%. And then you just see a pretty steep ramp up. Now we're up Almost at 40% of our backlog, which is for delivery for the coming yes, actually for the coming year, it will mean since we're now at the end of September. So this means that we're going to have a super strong backlog going into 2022, already with almost €750,000,000 and we That had to build out also during Q4 to be even higher. It also means that, as Stefan commented on the price increases, we are not Changing the confirmed orders. We have long term relationships with our customers. They understand that we need to make price increases, which we're doing now. So I think that Discussions have gone well, and we expect to make up the margin drop, but we will have a limited impact Over the coming 2 or maybe 3 quarters before this will get an effect due to, of course, the big order backlog. Sales per region. Here you see that Europe is or the major region, I should say, is at 63% of Our net sales in the group, which is slightly higher than what we normally have, the main reason for that is that we have the strong development within percent, again, the new acquisition with Oasis With almost 100% of the business in Europe. But as I said, we're happy with the development across the line. So It's simply the nature of the business that we have more. This is in the EMEA with acquired entities that is making this sort of change. We can also note that China is almost as big as Japan in terms of market. And That's quite interesting because we've been having a big gap there. Japan has been the main part of our APAC region. But now we have 2 strong markets, which would be great for the growth going forward that we have 2 good markets to work with. Then having a look at the profitability level, We are delivering them CHF101 1,000,000 equal to a margin of 21.5%, slightly down in margin compared to last year. And as you already understood, there are 2 drivers for this. One is that we are losing out a little bit in the gross margin. We're down about 2 percentage points comparison to Q1 and Q2 this year. And that is, To almost to the extent, driven by the price increases we are seeing in order to get sourced components. This varies a lot from component to component. In some cases, we pay 10x and even more than the normal price to make sure that we get that last piece that will make us been able to complete the product that we're going to ship. This is a continued fighting for our supply team, which has been doing a good job to keep the delivery performance as good as we've managed To perform so far. And we already covered the price increases that we are now working with. And again, the effects will start to show, we believe, Mid-twenty 22, given the strong order book. The other thing that's impacting the margin is the OpEx ramp up. We've been I think we've been transparent with this throughout the year. We made some new investments in Q2, Which we are now starting to see the effect of. We have €189,000,000 in OpEx, which is organically up €33,000,000 or 25% In comparison to Q3 last year. So it's a big change. Then you should also keep in mind that 2020 was not a Fair comparison in that sense since we have had a very low activity, now traveling and so on. Now we see the traveling is starting again. There is a built demand for meeting customers, for meeting the organization. And we see this as also some key activities to get things started again and To move on with our growth initiatives. So we believe it's quite positive that we do these things. But of course, it's going to impact the margin. And the 21.5 Could maybe be a bit better with better gross margins, but otherwise, we believe it's a fair level to be And we said this before, I'm just going to say it again. We are continuing to see this OpEx ramp up will also hit Q4, of course. We don't have the vacation effects that we have in July August, making OpEx come down a little bit in Q3. So we believe that we'll be roughly 10% up in OpEx in comparison to the levels that you see in Q3. Looking at the earnings per share then, also here good development, 36% up. There's not a lot Interesting happening. We are pretty much debt free in terms of interest bearing debt, so that is not impacting the financials. So a solid conversion to SEK 1.81 in earnings per share in the quarter and SEK 5 point SEK 75 for year to date number. Looking at the cash flow, also one of, I think, the highlights in the report. We are quite happy To be able to perform in the quarter, a cash flow of €148,000,000 which corresponds to cash conversion of 117%. And if you take the year to date number, we're very close to a cash conversion of 100%, which we believe is very positive given that we have pretty high growth Going on. The reasons for being able to convert this good in cash conversion is, I mean, first of all, we have the inventory. Despite the high increase in net sales, we are we basically don't have any finished goods. Everything is going out as fast as it's produced due to the high demand. The other thing is that we see our customers are paying us better than ever. So we have a pretty big gap between the DPO and our DSO Given that nobody wants to pay late because they know they won't be getting stuff and everybody is desperate to get goods in time. So we have a very well behaving A bunch of customers in terms of paying on time, which is, of course, very good for our cash flow as well. So we're quite happy to be able To keep the working capital low, we're at 7.4% in relation to sales and compared to 10.7% a year ago. So it's a good improvement. It might not be sustainable over time, but it's good to see that we can be in these levels also when we're growing the business. Also for the full year, we have a very strong cash flow of €405,000,000 And even if we have a big growth, Only minus €5,000,000 in terms of the working capital changes impacting the cash flow. So final slide, which I think is maybe more important to Right now than most times and looking at our net debt situation because we have a big thing impacting a lot now. Yes. We acquired, as you know, percentic last year. We acquired Oasis this year. In both cases, we have both put and call option, which means that the probability that someone would acquire or that the deal will happen that will acquire the rest is very high. And looking at IFRS, this means that if that is the case, you should be reporting the most likely purchase price And sorry, the effect of the purchase price into the increasing debt level. So you take away the consolidated minority And then you report the expected purchase price as a net debt. And in total, this will add €390,000,000 to our net debt. So you see, if you look at the dark blue bar, without this €390,000,000 which is, of course, not interest bearing, in terms of interest bearing debt, we would be Debt free, so I'm not cash. So I think with that, we have a very good position. We have big room still for continued M and A and a very solid balance sheet to work with. So quite satisfied with that situation. With that, I think we have said what we had to say. And operator, why don't you see if we have any questions? Our first question comes from the line of Joakim Gunnell from DNB Markets. Please go ahead. Thank you. Good afternoon, Saffen and Joakim. So really helpful with this, I mean, more colorful order Short there. But can you help us just get a sense here on how much of this very strong order intake excluding the stocking effects you highlighted That's really, I mean, call it catch up effects after years of low investment activity that Can be, so to say, sustainable? And how much of this upturn is green versus brownfield? Maybe I can start with the general picture here, Georgi. I think we've seen that now for the 1st quarters, we what is more and more like a pent demand? But this is coming quarter by quarter. So we believe now that there's a strong new investment cycle coming. And I think especially for groundfield that we see a lot of activities, a lot of more capacity built out. So I think a lot of our customers' customers are Investing in their supply chains and building more capacity. So we believe that this is not only a pent up demand from the pandemic, it's Even more, a new demand that is coming. And maybe Joakim Niedebo, maybe you can put more Label on that? I think you're right, Safran. It's, of course, very difficult to start to dig into how much could be 1 or the other. But we think what we said In Q1, we were thinking it's more about an effect of building up that inventory that had been taken down for some time. And the last 2 quarters, it's more about securing delivery capacity for the coming quarters. So we believe that what we see is It's a quite fair representation and of course excluding this boost effect of where the market is. And it's we hear that from all Our business managers that the customers are having a very strong demand on their side as well from them. As we sell mostly to the makers, so from the user side, There is a strong demand and new investments going on. Thank you. And with the book to bill at this, I mean, at very high levels, can you talk a bit about how the order backlog margin, I mean, is evolving? What I'm trying to get there is that is it fair to expect that the The operational leverage here, which was obviously slightly down now in Q3 versus the past quarters, is a good representation for what we can expect Till mid-twenty 22 when you expect to see the price increase initiatives? Yes. I think that's a fair assumption. The margins that we'll have on the order book will obviously be a bit squeezed since, I mean, we are getting the price increases now. And from the component suppliers, they are pretty clear. I mean, if you want to have the goods, then you have to pay, and it's now. We try to we are very cautious with the relationships with our customers. And we could, of course, be a bit harder than what we are, but we believe that, that Might hinder some of the relationships. So we're trying to be a bit cautious as to how we handle it. We've had good discussions. They're accepting the changes. But I mean, as you also commented yourself, Joakim, it will take until mid-twenty 22 because we start to see the big improvements. There might be some exceptions, of course. So we'll probably start to see maybe a small improvement in the beginning of next year, but it'll take up until mid Mid-twenty 22 until we are back recruit for these 2 margin percentage points in a drop that we've seen. That's helpful. And just finally, if you can talk a bit about with Evonal Intesis being hit hard despite the delivery disruptions here, why is that? And how do you see that develop into the coming Why is that and how do you see that develop into the coming quarters? I think that is You want to go start on July? Yes. I think it's a coincidence. The things that we're having problems with, it varies from quarter We solved one problem. We have another one that's coming up. Right now, it's memories to a large extent. And it's just been the components that we have in these products. So when it comes to E1, we expect to have that situation stalled, I think, in mid November. So We hope to be able to recoup a little bit in Q4. With Intesis, it's a bit tougher, and we're doing some redesigns to try to solve the problem. But I think it will be an ongoing struggle for the coming months to try to get this solved. But it's not a lot of That is just even an indices. I think that's just a coincidence. Understood. And just fill in there. I can only fill in there from we also see that we have a quite big mix of different products. We have 500, 700 different part numbers. So I think We don't have supply problem on everything, but on some of them, there are problems. So I think this is maybe also one benefit of having a broad range of products that Some have problems, but some keeps on running. And for this quarter, it was happened to be EVON and Entities. I'm quite sure that next quarter, it's something else. That's clear. Thanks. Okay. Thank you, Hakim. And we have one more question from the line of Victor Hooper from Danske Bank. Please go ahead. Yes. Hi. So just a couple of questions. First one on Procentec. It seems like impressive growth of the 2019 level of €120,000,000 when you acquired it, up to €200,000,000 now. Did you say that you think that level is sustainable? Yes, I think we are very doing Joachim, please go ahead. We're in 2 different locations, so we don't see each other. So I'll start off and then you can Please start. Yes. So we believe that think we managed to or I can't say, Austin, I think the Procentec management team has done a great job in driving the business up To this SEK200 1,000,000 level, and that's been through some really good new customers coming in, plus I mean a strong underlying demand as well for them. And we think that is business that will be here to stay. So we think that we'll have a good base. It is €20,000,000 or SEK200,000,000 And then we'll be able to grow from that level going forward. So we're quite happy with that. I can only echo that. And we're also saying that We see also even more business opportunities in this market. So I think this is a very nice company, well run for the management team and the potential is keep on growing there, have a high potential. Okay. Well, sounds good. And on the delivery capacity, you said short term to Expect it to be at these levels to improve slowly into 2022 or during 2022. What does slowly mean in this context In terms of timing, Q1 at these levels as well and potentially Q2? Or would that be to stretch it too far? Yes. So I think the reason why we're not being super sharp in that comment is because it's so difficult to say. We know that in Q2, we have Some things that will settle itself. I mean, if something wouldn't be very changed compared to what we know today. And then we see that we have a slightly better situation For various stuff in the beginning of the year. So we believe that we might have a similar situation in Q4, Q1 and then We will start to be able to deliver out in Q2. And I mean, obviously, we have a big backlog. So if we just get components, we will be able to see a pretty big Uptick in the sales to get the orders out. What we will end up in that case is, of course, then the capacity strange because everybody if this situation is resolved and everybody is going to get the components and everybody want to have their deliveries at the same time. But I mean, I think we're going to be pretty careful to guide too much now. We'll have to come back, I think, in Q4 and Q1 to give more flavor on that. Okay. Fair enough. And in the slide on the orders that have a duration longer than 3 months, 40% of the current backlog. Did you say anything about how much of that were For the second half of twenty twenty two? I did not say that. It's a part of it, but most of it is for the first half. Okay. And in terms of price increases, What kind of magnitudes are we talking here to mitigate? It's different on different customers. But I would say, on average, High single digits in percentage. So that's what we are negotiating at that level. And we think our customers understand that this is that we have increased costs. I think we are getting acceptance for that. That is not Well, that is dramatic, but it's not more dramatic than that. But is that in the same magnitude that you have been hit Yes. So we've only seen a part of it in our central part. We expect to get more also going forward. So our expectation is that with what we are doing towards our customers with the price increase we are pushing out, we should be able to recoup on the full price increase that we will also see Okay. And final one on M and A. We still have a decent headroom in the balance sheet to do further acquisitions. You changed the targets a year ago to include more Maybe not focus from you guys, but maybe the potential or the willingness from others to meet with you and to speed up the potential M and A talks. Should I go Stefan? Yes, please. Yes. So I think I wouldn't say that, that has had an impact. The current situation, we have not seen that. We've had some good discussions going on. And as you know, we're picking. We work with the same ambitions As we talked about last year, and it's long processes in some of these cases, and we ask hope It will be able to have some good things to present going forward. I think the meeting targets in Europe is now back on normal level. I think that's a challenge still in U. S, But especially in Asia, where there's a lot of restrictions still. So of course, this is delaying some of the processes, some of the But we have local teams working in Japan and China, so we can meet them locally, but our global management team It's not able to meet face to face with these targets. And as there are no further audio questions, I'll hand it back to the speakers. Okay. Thanks, operator. So thanks a lot for joining this quarter 3 presentation, and thanks for good questions to Victor and You're welcome here. So thank you for participating, and please stay tuned. We have some interesting quarters coming up here. Have a nice weekend. Thank you. This concludes the conference call. Thank you all for attending. You may now disconnect your lines.