HMS Networks AB (publ) (HMS) Earnings Call Transcript & Summary

All right. It's 2 p.m. in Sweden. Welcome to this Investor Update from HMS Networks. And my name is Joakim Nideborn, I'm the CFO of HMS. And just to put some context to the session, we've done these investor updates for maybe a year or 2. We have a pretty high demand of one-to-one meetings, which we don't really have time to take all of them. So then we said instead, we'll try to collect some people who want to get an introduction and chance to ask questions around the company. We did that bimonthly roughly, and this is the -- actually the first one we do in a while. We had a bit of a break. So good to have people on board. And the way we do it is, I will go maybe some 20 minutes or so to give an introduction to HMS. And some topics that I think could be of interest for the moment. And then we will do a Q&A. And then I ask you to be muted for the first 20 minutes and then raise your hand when you have a question and I try to take you one by one. So everybody will get the chance to ask the questions, I'm sure. All right. So let's get going. If we start with HMS, stands for hardware meet software. What we try to do is very, very simply explained, we'll go deeper later, is to allow different machines to communicate both on the shop floor, exchanging information, but also to give users the intel about their operations and their machines, what the data means and try to connect remotely and then be able to control some of those processes as well. Some short facts about the company. We're approaching 10 million devices connected and about 0.5 million of machines that are connected to our cloud systems and monitored 24/7 in that. We are in the business of industrial ICT. That's how we label the context we're working in. And I think you can say that we are, at least in our space, working in the forefront of technology with a lot of new technologies we're testing. And right now for the last few years, I think 5G has been one of the main things that everybody talks about and that's about to break through. We are 11 -- somewhere between 1,100 and 1,200 employees with a large share of those in R&D. You can say that roughly we have 1/3 in R&D, 1/3 in sales and 1/3 in operations and supporting functions for that. We have different offices in -- I think, it's now 19 countries actually and partners in additional over 50 countries to sell our products. We're headquartered still in the, where it all started, in Halmstad, the West Coast of Sweden, a small town by the ocean. That's quite nice. And last year, we did SEK 3 billion of sales and 25% EBIT margin, which is also the target we have for our profitability, and we managed to accomplish some 20% growth over the last 10 years. You can more or less pick any base you want to see a similar growth number. So it's been a good growth journey. I wanted to cover 4 main topics today. And the first one is talking about our new organization, where I'm also going to talk about our different offerings and how we have grouped those to be as efficient as possible. And then I'm going to talk a little bit about the business climate that I think a lot of people are interested in. And then I'll give a short introduction to or an update of the status in Red Lion, the big acquisition we made in -- that was finalized in April this year. And I'll also touch on PEAK-System that we closed, an acquisition that we closed a month ago and that might be new to some people. So I'll try to cover these topics with a few minutes on each, and then we go into Q&A. First, about the new organization. We have for 7, 8 years, been in a matrix organization. And with the rapid growth we had over the last couple of years, we've seen that, that will not be -- it's been very good so far, but it will not be what's going to take us to the next level, and we need to get more focus on how we go to market and make it easier for especially our salespeople to navigate what they're going to focus on. So the conclusion was that we need 3 different divisions, and I'll try to explain why. The first division we call Industrial Data Solutions, IDS, which is also the biggest division with 44% of our sales where we are targeting machine builders and system integrators and end users. So it's the same offering that goes to all 3 customer groups. And what we're trying to do here is also what I mentioned here in the beginning to the main thing is to visualize data, gaining insights in the production processes. And with the acquisition of Red Lion, we're doing that by operator panels. So it's actually on the site, but we're also doing it with our remote access and remote data offering. You're allowing the user to actually monitor the processes from everywhere -- anywhere you want by connecting remotely to your machines. We also have an offering for diagnosing your networks and making sure that they are working as they should. And of course, in all of this, the security aspect is a very important that the connections are safe, which is included, of course, in our products, but also something that is a big topic for the future and how this will work when more merchant machines are being connected. We're having some direct sales, but the main go-to-market here is through distribution, partly through e-commerce and partly to value-added distributors. And I think that's what characterizes this business. If we then go to the next one, the Industrial Networks Technology or INT. Here, we have where HMS started the communication and control of various devices on the shop floor. And here, we enable the communication between those machines and connecting those to the local networks. We have a big range of different standards all around the world, where U.S. device manufacturer do not want to be able to keep everything up to standard, so instead it's much easier to source these products from someone who maintains the whole portfolio to enable you to connect to any network at any time. The difference from the IDS division in terms of going to market is that here we go direct to the device manufacturing in all the cases. So we don't go through distribution. Of course, this builds a bit of a sales infrastructure that we need to have. That's also why we have our own business in 19 markets. And it's also a process that takes some time to sell the products, and you normally start with getting a design win, then you spec'd in? And then maybe 1 or 2 years later, start seeing the volumes. So it's a bit of a different business compared to this IDS business, where instead of working with design wins, you basically get the order and ship it a bit quicker. And this is one of the main difference, one of the main reasons why we choose to go into divisions to separate those go-to-market approaches and also different type of customers. This will be easier for our salespeople to navigate and it will also help our R&D teams and product management teams to get a bit closer to the customers. Then we have the third division, a smaller one that we call New Industries, which is more or less 2 different businesses that we have in this division, where one is building automation where we have a quite similar offer to what we also show in this Industrial Networks Technology part. We are allowing primarily air conditioning devices, but also other parts in commercial buildings to connect to the building management system. And in that, by that, be more efficient in using energy, controlling all the devices and so on. Then the second part is what we call vehicle communication. This is also where we made the last acquisition of PEAK-System, which is a business that's to a large extent, working with communication protocol called, CAN, that is used to a large extent in the vehicle business in different commercial vehicles and cars and so on. This is not the full scope, but this is the main part of this division. So that's why we have called it vehicle communication. We'll get back to that later as well when we talk about the PEAK acquisition. So we wanted to -- the main reason for changing the organization was to go from the -- this matrix to divisions to be more focused -- better focused on the customers and get our product management and R&D people closer to the market. If I then go over to talk a little bit about the current business climate. Just to put things a bit in context, you will see it also on the next slide. We've had a very bumpy ride since after COVID with -- looking at the order intake. And, of course, the component shortage is a big explanation to why we see this development. So we had a huge order buildup -- huge backlog build up with a very strong order intake during 2021 and '22. You saw in 2021, we had a 66% organic growth, which is, of course, not in correspondence to the underlying demand in the market; and the same for 2022, where we had a 21% growth. And of course, that has been -- this huge buildup in inventory at our customers have then had to be reduced while the order intake has now been kind of weak for almost 2 years, and I'll talk more to that on the next slide and try to explain what it is we think we're seeing. Some words on what we saw in the third quarter. And by market, if we start with North America, we have this INT business, which is an embedded system that we're selling that has been struggling for some time, and that's also where we've been seeing the most of this order buildup, and then now the order reduction and then the inventories have been normalized out. This had a bit of a challenging time in North America also. I think before we've seen bigger impact in Europe and Asia, but in the third quarter, we saw continued challenges in that business in North America. And then with the new acquisition of Red Lion, where I think the base pace is quite okay, but we are lacking a bit of a project pipeline where I think that the -- during the year, this business was for sale. It seems like management did not have the full pressure on having that pipeline up to date, and we've been seeing some impact on that for the first couple of months when we've been owning the business. But we're working to build that up, and we think that we'll see a slightly better future ahead on those project orders, which will support the Red Lion business somewhat. Europe, I think, is what's probably most challenging for us at the moment, where Germany is very slow. It was in the third quarter, and we don't see a big change in that at the present time. And a lot is related to the automotive market, which is maybe somewhere -- yes, maybe 20% of our total business, of course, a larger part in Germany for us. And here, we've said and we still think that, that makes sense that we're going to have a bit of a challenge for probably 2 more quarters. And then at the second half of 2025, we hope to be able to see a pickup from where we are now, probably a small improvement from where we are until the half of 2025, and then second half should be significantly better. And then if we talk about Asia, our biggest market in Asia is Japan. And even if a lot of that business goes in export to China, here, we've seen a quite okay development in the third quarter, and we've been seeing some growth in that market also after a bit of a challenging 2023. So I think this goes in the right direction, and we expect that market to continue to be okay, probably not a big growth from where we are, but to keep tracking maybe with a small improvement. In Japan, we're still struggling a little bit with very big inventories at some of our key customers. And this is where we saw the biggest impact of these early placed orders during 2021 and '22. Japanese customers tend to be a bit careful there, and they took on a lot of inventory, which we know for a fact that we will not have any huge orders until probably second half of 2025 from many of these customers. On a good note, we had a pretty positive development of design wins, both in the third quarter, and I think we had more or less the full year. And design wins is something that we track to see the adoption of our revenue or our products, not necessarily connected directly to revenue, but it shows you something how many customers are adapting our designs in their products and shows you something what we can expect from the future. So this is, of course, positive that this is developing on a good pace. I talked a bit about this order buildup, and we put it into -- try to put it into context in a slide where we look at what we see as the underlying market demand and also for 2021 and '22, you see this brighter blue, which is the -- what we call boost orders, so orders that we should normally not have received in that period. And then you see also for the last few quarters, you see the green one, that is the destocking at our customer site. That is actually our reported order intake shows to be worse than what it actually is. And here, I'm showing you only the numbers for HMS pre the Red Lion acquisition, so to make all the things comparable. So you see that the underlying market has been developing quite well during '22, '23. And then during the last few quarters, it's been a little bit slow and actually coming down a bit. And in Q3, you see a pretty big reduction from where we have been, which we think is reflecting pretty well what we see in the marketplace. And again, we expect to see a gradual improvement from here, but maybe not something that is much better than what we see until the second half of 2025. I think I'm going to skip this slide to move on. And then Red Lion, the biggest acquisition we've done in HMS. We paid almost SEK 3.8 billion in April this year to get our hands on this nice company. And the purpose with this acquisition was a couple of things. First, to get a platform in the U.S., also expand the product offering a little bit within switches and HMIs. And then also to be able to cross-sell a lot of products in the American market to find those synergies and realize synergies on the sales side, get a big market access for our own products, but also open up more channels for the Red Lion products. And if we look first on just a few notes on this on the offering, 3 different parts in the offering. The first part is called Access, which is very similar to what HMS has been doing before with various gateways and protocol converters, quite similar to the Anybus offering in this INT division, but also adding some access points and remote access products to the offering. So this is well-known domain for HMS, about 20% of the Red Lion business. Then on the second part, the Connect part is more or less Ethernet switches, which is an offer that HMS has not fully had before and that's what we've been after for some time. And this will -- this is pretty much an extra sell when we sell the rest of the things because you will need those switches to connect your different points, your different machines to 1 access point in the factory. So this is something where we see some potential synergies in selling when we have too similar customer base that we already have in this IDS division, the Industrial Data Solutions division. And then the third part of the offering, which is almost half the business, the Visualize part with Human Machine Interfaces or HMIs. So we already do a lot of visualization from taking the data from machines, send it to your connectivity wherever you want to be, and then you can visualize the data from your machines remotely. And now we also add this capability on site for the operators to be able to both see and control the different processes. And yes, the company is founded in 1972. So it's been around for some time, about 370 employees, 3 development centers, both in -- 2 in the U.S. and 1 in India. And what was particularly of interest for us, a very strong distributor network in North America. For this size of company, about $100 million -- sorry, yes, $100 million. It's not easy to be present in all different states with own personnel. So we do a lot of the business through distribution in the American market, both with HMS before, but also with Red Lion. So here, we get now a much stronger distributor network that we can push some and cross-sell some products after this. For the last 12 months, we've seen, yes, about $100 million in revenue, a bit more and 56% gross margin that we managed to improve. So it's now almost closing into 60% after some changes to discounted salespeople. So we have taken away some discount possibilities and also some early investments in the manufacturing space, which we're going to continue to do. The EBIT margin has been around 17%, which is, of course, not where we should be. And the volumes have been a little bit on the slow side and where that picks up and with continued improvement of the gross margins, we should see the EBIT margin to climb above 20% and towards the 25% that is the group target. A few words on the integration. I think we've had a good progress on the back-office functions, all the finance, HR, IT parts are more or less done. We've done some investment in supply chain, and we're waiting to do some additional ones that should, as I said, continue to build gross margins a few percentage points. And right now we're merging the sales organization for HMS and Red Lion, which is a pretty big job. And we need some small back-office support to get that fully finalized, but we will -- we think that will be done somewhere mid next year. Outside the U.S., we've integrated the sales organization from Red Lion into HMS to rest of the sales organizations around the world since the HMS infrastructure has been much bigger. And I mean, right now, the focus is to get back and get this product sales pipeline to where it should be and to have those projects kicking in and with that also enable the top line to improve a little bit. We come also from a situation, if you look on the graph to the left, where we had -- you see it on the top graph where you see the sales, where that's been a bit boosted in 2023, same reason as for HMS with component shortage. And from next quarter on, we're going to have, I think, fair comps. So you can actually say something about the development. But then we're through this boost in the sales, and we hope that we will be able to grow. The reason it's flattish since then is I think the market in the U.S. has not been as strong as we might have hoped for, and you can see that a lot when you look at big players like Rockwell Automation, the biggest player in the U.S. in our field that's having to revise their forecast downwards every quarter this year. And next year, we will also look into what we can do on the R&D side within this IDS division where Red Lion will reside. Just a few words on PEAK. I'll go maybe 3, 4 more minutes, and then we open up for Q&A. So we made this nice acquisition of PEAK-System in November. It's a company we've been having on our target list for quite some time, and Staffan, our CEO, actually met them, I think, in 1999. So it's been quite some time since then. And what PEAK-System is doing, they are a big leader within CAN communication, where we are strong with one of our brands as well in this vehicle communication division. And what we see the possibility to do here is to add -- there are some overlapping products, but also some complementing products, especially on software and the diagnostics of these networks, which we have not had before. And be able to take those new products, selling our channels and at the same time, also open up for PEAK to be present in more places in the world by using our offices. So we're getting a strengthened offering. We're getting a new customer base. PEAK has had a slightly different focus than HMS, stronger in automotive than HMS, where we can take and sell HMS parts into that space and vice versa. The company is founded in '99, about 50 employees and 2 development centers: one in Germany and one in France. And a pretty strong global presence, I would say, with 25% of sales in the U.S., 25% in Asia and 50% in Europe with, of course, Germany being the main market. Yearly revenue is about EUR 25 million, adjusted EBITDA margin of about 30%. So a very well-performing company and around 8% CAGR since 2021. So I think with that introduction to not take more time, I will stop sharing and I open up for questions from the crowd. So if you want to ask a question, please raise your hand, and I will try to take you one by one and make sure that everybody gets a chance to ask questions.

All right. Gustav, please.

Yes. I was just wondering if you could start maybe with the Red Lion and sort of the Ethernet switch here. And can you just help us understand the importance of owning this part exactly? And also who are the competitors within this space?

I think for us, it's something you will need in your factory infrastructure to connect all your devices. You don't want to have access points on everything that becomes kind of expensive. So you tend to take a couple of units and connect them to a switch and then you'll have the switch being connected to the Internet, if that's how you want to do it or to just the local network. And the importance for us is, I think, it's a key part of this offering. If you're going to be into selling infrastructure, if you're going to be able to connect all devices, it's one thing that everybody will need, right? And I don't necessarily think that this is the key device. It's not the most intelligent device. But if you sell like the remote access things that we do, which is a bigger -- it's a bigger choice, I think, how you -- what you want to put into your factory, then it's pretty much free business to also be able to say, "Hey, we'll hook you up with the switches as well. So you can buy everything from us. We have a complete offering." And I think we become a more serious player with having this complete offering. So that's been why we've been looking for this for some time. And I think this market was consolidated around 2010, 2012, somewhere around that time, where a handful of companies acquired a lot of these switch players. So it's a pretty consolidated market at this time and not so easy to get in as a new player, and that's why we've been trying to source this through M&A to get a foot into this market. Some of the main competitors would be a company called Hirschmann, a German company that is owned by American, Belden. They're probably the market leader. There is a Swedish company called Westermo that is owned by Ependion, which is in this market, specialized a lot into train and those kind of things, but also in -- we also see them in this business. And then you have like Siemens is having an offering as well. Cisco to some parts, but a very, very small part. I mean, Cisco is more in the office environment. They're trying to break ground in this -- in our space as well. And maybe not super successful, but still it's a known brand and some people will go for Cisco in certain cases and so on. Then you have some smaller local players, but those are probably the main names to investigate if you want to learn more. All right. Any other questions? All right. Gustav, please go ahead again.

I guess I can just keep shooting here. Can you just talk a little bit more about the aftermarket sales and service business? I mean it is not a very large part for you. And I mean, can you just recap why it's so hard to drive sales here and also if it has changed with the Red Lion and PEAK-System Technik?

Yes. Good question. It's -- I think it's not one answer for all of our offerings. But if we take the main offering first, this embedded offering in this INT division. So here, we sell this small module that you plug into your machine. And I mean there is not so much to do. There is no really aftermarket. If that, for some reason, which very rarely happens, if that breaks down, you sell a new one. It's not like you're going to repair it or something like that. And if you think about our value chain, we will sell to the device maker. And the main -- the biggest group is the robot manufacturers. And if you take -- let's take ABB, for instance, I mean, we will never do ABB's aftermarket. They will take care of their aftermarket. In fact, they are buying our remote access products to be able to utilize their own aftermarket offering. So it's -- we're kind of enabling them to have a good aftermarket business. It's not really for us to take that. But what I want to comment on what has changed a little bit, which is super interesting, and it's not directly aftermarket, but it's into services. And we have -- with the remote data, remote access business, we have a cloud solution called Talk2M where we allow customers to basically project their data from their machines in a cloud space. So you can have your dashboard on your PC and look what's happening in all your manufacturing processes. This has been something where we've been giving away the introduction product or like a freemium model before. So you can have a model which is for free. And you can also choose to upgrade to a Pro version. I think here, we have now stopped doing this free version. So we are now charging for everything. And we have segmented this so you can add on different features, the more features you want to have. This has had a pretty good upswing on recurring revenue the last couple of -- yes, the last couple of months, actually, the second half of 2025 -- sorry, 2024 when we started with this. And this has gone from about EUR 2 million to recurring revenue to EUR 5 million in recurring revenue in a pretty short term -- short time. So this is quite interesting, and this is probably the closest we will get to aftermarket sales in this space going into these services. And this is something that we're going to work a lot more with for the coming years. And we also have, as we've been talking about throughout the year, a new offering in this space. So this is some big investments that we've been doing, and we just released this new offering now 2nd of December, I think it was. So we're quite optimistic for the future with this.

Does this imply or the EUR 2 million to EUR 5 million, is that a huge penetration of your current customer base? Or is it just in the early phases?

So I think it's a good penetration, but most customers have chosen to start with this -- the lowest level of services. They've been going from this free version to the minimum services. I think what we're trying to do is to show everybody that we have enough value to actually pay a bit more for those services. And I don't think that will happen overnight, but that's something that's going to be a big theme for 2025 onwards for us to get more customers to subscribe and sign up for these services. Any other questions?

Maybe I can shoot one more if there's time.

That's fine for me. I'm going to be here until 3:00 European time. So you go ahead.

That's great. Okay. I was just thinking about it, I mean, you commented on a solid amount of design wins. I mean, are you seeing this as you taking market share? Or is it more related to new products entering the market?

So I think what we've been seeing, we've been -- if you look at -- now I didn't bring the graph to this meeting, but for the last 2 years, we've been seeing a growing net design wins and active design wins with about 6 percentage points per year, which is also the number -- the average growth we've been having for the last decade or so. The way we've been getting to this growth in active design wins is that we've been seeing fewer new design wins, but also fewer expired design wins or retired design wins. So you can say that the inflow and the outflow has been lower than normal. And of course, our thinking around that has been that during 2022 -- '21, '22, maybe '23, since there's been such a big problem with component shortage, a lot of customers have been redesigning rather than maybe new designing. And I mean, the same goes a little bit for us. We've been trying to also redesign a lot of products to be able to ship. And so our thesis has been that that's the reason for the lower inflow of design wins and also lower retirement of the design wins. So we can expect that this year, when everybody is through this problem with component sourcing and maybe having the opposite problem that you sit with too much inventory at hand, then it's easier to redesign or to make new products. So I think that that's what we're seeing that a lot of customers are spending more money to actually do something new instead of just handling the current portfolio. And that also means that we are seeing more design wins. At least that's what we were hoping to see because then there would be some kind of proof that our offer is relevant, and that's what we have been seeing. So we're quite happy to see this development. And I think it just means that the offering that we have is still relevant and that customers have moved more resources from redesign to new design. And of course, this is also something that is positive for the coming years. So that's our main scenario, what we think we're seeing here.

Okay. That's clear.

Anyone else that would like to ask questions? Gustav, do you have anything else, while I take the time?

Maybe just one last then. I mean, just on the competitive landscape, I mean, it's obviously hard for you to see all that. But I mean, are you seeing any -- or noticing any signs of increased competition in this area or the areas you are entering?

I think we do see increased competition in the remote access space. There we see -- I think we've been seeing that for maybe 2 years or so with a few newer companies that are starting to break some ground that I think are doing a good job. And then also, I think there are a lot of new proof of concepts and stuff that has not yet really become a key player, but is trying to. So I think we see a lot of new entrants in that space that are trying to solve those problems in different ways. That's probably where we see more tangible change in the landscape. In this -- the INT division, where we have these embedded network cards, I think it's really -- it's a pretty narrow business, a pretty small market. There, we see very small changes in new entrants. It's the same old players and not necessarily a lot of movements around between suppliers either. So I'm not -- I don't think that we are taking a lot of market share. I don't see that we're losing market share. I think that we are just growing in line with the market and everybody is sort of keeping their position a little bit. That's how I see it.

But who are the competitors entering sort of the remote access, where are they coming from? Not geographically, but what kind of business?

Two players that I think have been doing a good job. One is IXON from the Netherlands and one is Secomea from Denmark that have been quite successful also outside Europe, which is, I think, is good, well done because it's not so easy to come from a smaller scale and break ground in the U.S. and Japan, China and so on. They are still fairly small, but I think they're growing and probably taking some market share on that market. All right. It seems like we don't have any more questions, and then I'm going to round off the call. I'll give a last chance if anyone else wishes to ask something. All right, then. Then let's close the meeting, and thank you all for listening. I hope you learned something about HMS and see you soon again. Thank you. Bye-bye.