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

Welcome to the conference call. [Operator Instructions] Now I will hand the conference over to the speakers. Please go ahead.

Thank you. Good morning. Staffan Dahlström. And Joakim Nideborn is sitting here on this recording, talking about our quarter 4 that we published early this morning. So we have an agenda today with an update of the business, quarter 4, some words about the new organization, and then Joakim will deep dive into the financial summary, and we end with an open Q&A. All right. Let's move into Q4. Mixed bag of results. On one hand, organic minus 33%. Not so good, of course. But this is an effect of a weak market, combined with the destocking from customers. So this is a double negative effect, and we've seen this on our order intake on the previous quarters. But we compensate this with 2 things. We compensate this with good M&As. We've made 2 M&As -- 2 acquisitions during 2024: Red Lion and PEAK-System. We'll talk more about them. But of course, this helps. And we are seeing some actually positive organic growth -- positive total growth as a result of this. Quite good order intake, surprisingly good. We didn't expect this to be as good as it was in Red Lion. Red Lion have some project business with quite high swings, up and down. And this quarter was a high swing up with some great orders. We see that also, the organic order intake is recovering a bit. But of course, plus 2% organic is too weak, but we are seeing continuous some destocking, quite weak marketing. We think this will improve going forward, but also in Q4, it's been a quite weak market. From a profit level point of view, on one hand, we see that we are declining our profits. But I must say we are quite proud that we can drive good profit levels even if our organic growth is minus 33%. So we worked hard to improve or maintain our gross margins despite lower volumes. And we made a lot of changes in the company to make sure we are more agile and ready for the future. Good cash flow. Cash flow is a combination of that we have a business that is CapEx lean, but also we are reducing our too-high level of inventory since some quarters, and this helps in combination. So good cash flow, and as you see, adjusted EPS, SEK 2.6. If you look in the full year, just a few words. The only thing I would like to mention is that the trend here with negative organic growth. Of course, that's something we know, and we are working. We think this will help. But it's notable that we -- despite this weak market, we -- due to the good acquisitions we made, we are, on total, at plus 1%, but it's good to have a growth year behind us here. But let's move into some of the trends we're seeing. Order intake, as I mentioned, good level, but it's mainly driven out of the acquired Red Lion that was surprisingly good in Q4, but we're also seeing some stabilization of the organic growth there. But it's a challenging market. Germany is still challenging. Japan, we see some more destocking to be executing in Japan in the next couple of 2 quarters, I think. But we also worked a lot internally. It's been good timing to do a lot of internal changes now when we have a weaker market demand. It's easier to do changes when you have some headwinds. So we launched a new division structure. I'll talk more about this in a moment. And combination of -- we need to be ready for new growth, but also the integration of the 2 large acquisitions needed to -- need an organization that is a little bit updated to the new organization. And we've also been busy with new product development. We just, end of quarter 4, released a completely new Ewon product with Ewon Edge and Ewon Cloud, where we think we can penetrate more customers in -- especially in this medium, large machine builder segment that we try to focus on here. And within one acquisition, PEAK-System was acquired in 1st of November, fantastic German company, and we talk more about this in a few moments. And we look at full year, challenging year, as I said, destocking effect and weak market on almost all geographical areas. It's been U.S. that is having a little bit more steam than the other markets. But we took the opportunity to execute M&As. It's been -- we worked this for a long time, and 2024 was a year of delivery on M&A plans. And as I said, we've been busy with product development. We launched our 5G products and, as I said, the new Ewon offer that we believe is something for the future. So this is new divisions, a lot of internal work, restructuring program, as a combination of the weak market demand, but especially building for the future to be ready for this. Every year in quarter 4, we always talk about our Design-Wins. This is related to the Anybus business we have. And this is -- the reason why we do this is that it's a very long term and very sticky model where customers integrate our technology inside their devices. It takes some time for them to do that. But when we are in there, we see a reoccurring revenue. Every time they need communication in their products, we get an order. And they have product life cycles from 7 to 8 to 10, 12 years. So this is very sticky. It's interesting to note this over the years that 2012, this business was 76% of our business. Now it's 32%. It doesn't mean that it's been bad. It's been great. But it also shows that as a company strategy, we said that we are -- we cannot only stand on one leg. We need to do more acquisition. We need to do other things in the company. And over the last 10 years, we've done quite many acquisitions of small entrepreneurial companies and now also this large acquisition of especially PEAK and Red Lion. But back to the Design-Wins. We see here in 2024 that we are successfully winning more new customers. So last year, we had 139 new Design-Wins. Now we have 152. This means that we have an attractive product offer. We are out there winning new business for the future. But we also see that some of these customers that we have in the Design-Win portfolio is getting older. And we see that this year, we retire 173. So the net effect here is minus 1, but this is quite natural after product. We have -- we released the first product for this in the '90s. So of course, it's been plus 20 years of a good success for this product. We talk about the new acquisition, PEAK-System, just a very few words about this. German-based technology company, working with software and hardware for communication around cars, around utility vehicles, in some medical machines and the intralogistics and have some similarities to our business with Ixxat in Germany. But together with Ixxat and also our business in Spain, Owasys, we form now a vehicle communication subdivision that focus on these kind of tools and connectivity. And there are 2 applications. One is working around passenger cars in the R&D cycle and also the aftermarket, how to get data out from the car and how to do simulations and things like this. That's one part of the business. We are not inside the vehicles there. Then we work with low volume, like utility deals and special vehicles, whereas they use our technology on board the vehicle, but that's in the low volumes in special machines, et cetera. A very nice company, Darmstadt, south of Frankfurt, high profitability, almost -- a little bit better than HMS. We're impressed about that. So 30% EBITDA margin, around single-digit CAGR in growth and EUR 25 million revenue. So we think this is a mature, well-established company, very technology driven and have a good position in the market. So we believe that this is a good acquisition for the future, and this will add to our growth and our profitability. So we view this as more of a bolt-on acquisition where we, together with Ixxat and Owasys, formed this new vehicle communication group, where we think that PEAK gives complementing products and technology. They have quite strong classical distribution network where we've been a little bit weaker with Ixxat. We have quite good e-commerce around Ixxat. We can help PEAK here. We see that they have software things we can use to differentiate our offering. And we also see that their hardware and software is a good leverage on our hardware and software. So we also see that we can go with the future product and harmonize this going forward. And they are Darmstadt. We are Ravensburg, both in South Germany. So you'll see that the culture and the geographical closeness is also good for this combined business. So we are quite excited about this. All right. Let's spend a few words on this organization. We talked about this on previous calls, but I just want to highlight this since, I think, this is key for our future growth. We divide our business. We're going from a matrix organization into 3 divisions. The large division, 44% of our revenue, is called the Industrial Data Solutions. Here, we focus on industrial automation towards machine builders, system integrators and end users, very clear focus for who is the customer. Second division, Industrial Network Technology. This is very much where we started with our Anybus business and going back to the roots where we have dedicated salespeople only focusing on device manufacturers on this kind of Design-Wins and the longer sales process where we've seen that it's key to have a different type of sales structure and sales mentality to be successful here. And then we have this New Industries where we collect some of the new and more faster-growing business. We have our building automation division with brand Intesis that is growing well but is a quite small business, and we have this newly formed vehicle communication. Both need a bit of extra love. So we treat them in this kind of greenhouse environment to make sure we utilize their growth potential in the next coming years. So focusing on having focus on the customers and making sure that the R&D teams have one flow of technology towards these customers. And we try to achieve 3 things. Of course, a more customer-centric, focused organization from sales to R&D. We also need to reduce the complexity when we've been growing our previous organization with the matrix. We -- actually, we've grown out of that organization. And we think the next step is much going to give full accountability to the divisions regarding strategies, resources, financial performance. So it's also a way for us to build the organization for the next coming 5 years. Combined with 3 divisions, we have some shared services. We have a common supply chain, but we still see a good potential for synergies between different products we make here. And then we have a small group function with guys like me and Joakim and a few more. So we believe that this is a good step for the future, and we are implementing this now, and it looks very good. So Joakim, with that, should we move into some financials?

Yes. Let's do that. And for the first time in a while, I'm going to start with the most positive. That's been a bit of a negative before the order intake that we can report SEK 893 million. And as you've seen, 110% growth, out of which 2% is organic. And even if 2% organic is not much, it's really good to see that the trend is broken. And for the first time since 2022, we can report growing organic order intake. The big positive is, of course, in Red Lion and the North American market where we have been reporting a couple of quarters with slightly lower than what we have expected, and what's been missing out is the project business in Red Lion where the pipeline has been a bit weak. And now we can report this really strong order intake in Red Lion where we see several good product orders and especially a nice order that we got just before Christmas for data centers for the power supply monitoring of data centers. So that's very good to see that we have this tick up in Red Lion. Then we still see a bit of destocking, especially in Japan where we have -- during '22, '23, we got a lot of customers that placed a lot of orders, building a lot of safety stocks. We've been talking about this several times before. And here, we still see a bit of destocking in -- especially in Japan. So that's impacted by SEK 50 million negatively in the quarter. We also have PEAK in. PEAK is starting up the first 2 months, November and December, on -- just as expected. So a good start for PEAK in the group. And I'm going to show now the slide that you've seen for a couple of years with the destocking and boost orders. And here you see the SEK 50 million that is destocked. And I think this is probably the last time we're going to show this slide because with this, we will more or less see that destocking is over. And we've been seeing the declining pace on destocking for the -- yes, well, since Q1. And this is, again, we think this is the last time we need to talk about this. So that's positive. Going into the sales, SEK 807 million, a 6% growth and organically, minus 33%, pretty much in line with our expectations. And while we're super happy that the Red Lion order intake is improving, we still think that the market is rather challenging, especially in Europe and around Germany. We don't really see the lift in the German market. And we're tracking about sideways compared to previous quarter. And as we write in the report, we believe that we need to wait until the second half of the year until we're going to see a better improvement than what we currently see. Also good, of course, when order intake is doing well. Book-to-bill is, here, 1.07, in -- if I exclude the currency effects. And this is also the first time since, I think, 2022 when we've had a book-to-bill greater than 1. So that's very positive to see that demand is slightly coming back. The main thing that is challenging is still the embedded business, where we don't have the same pace that we want to have. But we hope that this will pick up again in the second half of 2025. And again, PEAK coming in, delivering as expected for the first 2 months, so that's good to see. If I take a few words on Red Lion, you see in the net sales, we have a small tick up, not a huge change to previous pace, SEK 260 million in sales and 1% growth over previous year. And then as you see, the big improvement is on the order intake side, with a 37% improvement to SEK 348 million. And this is, of course, a pace that we're super happy with, with the SEK 348 million. Even if we don't think that we will see that full pace going forward, these orders that we got for the N-Trons switches, for instance, that is not something that will come back in the same pace in the coming quarters. But we think we are on a positive trend. So that's because we see several of these project orders, but we had some really good ones that we will not get all the time. And we can also say that the integration for Red Lion is now completed, at least the first phase. And Red Lion will, going forward, be a part of the IDS division, and supply chain is now integrated in the global supply chain in HMS Group. The backlog is increasing, SEK 97 million up, and now we have the SEK 703 million in backlog, corresponding to about 20% of rolling 12-month sales, which, I think, is a good number. And we would expect to be somewhere between 15% and 20% in backlog. So we prefer to be on the higher, of course, then we have a better situation for the coming quarters. Looking at sales per region, not a big surprise here. We have 41% in North America; 44% in Europe, which is still the main market; and APAC is about 15%. And the reason why APAC is falling a bit behind is because we have the new acquisitions in PEAK, is stronger in Europe and Red Lion obviously, a lot stronger in North America. A few words on profitability. All in all, I think we're quite happy with the result of SEK 163 million or 20% EBIT. We have, as you saw, a 33% decline in organic sales. And then to still be able to make 20% margin, we believe, is quite strong. In the Q4, that is quite often a bit higher for us in terms of cost. One of the main contributors to this is the gross margin. And when you just look at the reported figure of 62.6% in relation to 65.3%, you can see that that's gone down. And organically, we're down 0.5% in gross margin. And I think that is one of the strongest points in this report that with a 33% decline in sales, the gross margin is only suffering by 0.5% organically. The rest of the reason that we're down is that we have the acquisitions, PEAK and Red Lion, that are slightly below 60%. And of course, that's -- that dilutes the overall group gross margin. The gross margin of 62.6% is the same figure for the whole year, and they will meet the comparable 65%. So it's pretty much the same story. Again, we're quite happy that we can maintain the gross margin with that volume drop. Talking a bit about the OpEx as well. So we have a SEK 402 million in OpEx, which is organically 18% down. And we continue to be quite cautious on the cost side. And we also did a bit of a restructuring going into the new organization, seeing what roles we need and how we can become more efficient. And then we'll talk about that in a second, how that turned out. And also for the full year, you can see that we are saving back some 20% organically. So it's -- I mean that has been the key in order to protect the margins. And you also see that we do almost 22% margin for the year with this pretty big drop in sales. So I think when we conclude, we were happy with this that we managed to have this cost control and still deliver decent margin with the weak top line. A few words also on the restructuring program. So we communicated when we -- just before the Q3 report that we will make a bit of a restructuring going into the new structure. And we said that we would be looking over to reduce some 40 positions and save SEK 40 million with that. We -- and the restructuring cost should be SEK 25 million, I think, we said. Now when we're done, we've taken out 32 positions and saved SEK 44 million in yearly run rate saving. We should -- a little bit of that is actually impacting Q4 because we managed to conclude this quite quickly. So we have a few million positive impact in Q4 from this as well. And then we had restructuring cost of SEK 16 million that is reported in Q4. If I then just summarize, since we made a restructuring in Q2 as well, if I summarize the year in terms of this, we can see that we have reduced 76 position in these programs and saved with that SEK 85 million in yearly run rate savings. Of course, a big part of that is also hitting 2024, given that the first part was done in the second quarter. And then we have a restructuring of total of SEK 42 million (sic) [ SEK 43 million ] related to these programs. And on top of this, we have about 25 positions that have left the company as a normal turnover that we have not replaced, and we can sort of save back that efficiency gain with the new organization as well. So all in all, we've produced about 100 positions and saved more than SEK 100 million in the year. So I think we go well into 2025 with this new organization. And this has worked out pretty much as planned, I think, we have to conclude. At the earnings per share, we do SEK 2.6 and a small decline compared to last year. And of course, one contributor to that is the higher financial cost now with a higher leverage and more debt, of course. So that's impacting. Then you have probably already seen that we -- or the Board is proposing no dividend for the year. We don't think there's any drama in that. I think we did 2 major acquisitions last year and spent more than SEK 4.5 billion on acquiring those companies, which is a lot in relation to the size of HMS. And we had this discussion in the Board already before we made the PEAK acquisition that this probably will lead to that dividend will be difficult in -- for 2024, and that's what was concluded on the Board meeting here. So no -- nothing strange with that. We just need to delever the balance sheet a little bit. Earnings per share for the year, SEK 9.65, a small decline as well, again, from previous year that was extremely good. And talking about the cash flow. Here, we have, again, a good cash flow for the quarter, SEK 177 million, which is an improvement by 49% compared to the same period last year. The big difference compared to a year ago was that a year ago, we're building inventory. Now we're releasing inventory. So we have a SEK 35 million positive effect on the cash flow from the release in inventory in the quarter. And we believe that we can continue to lower the inventory throughout 2025 as well. And this will help us to have a good cash flow for 2025 also. For the year, we did SEK 592 million in comparison to SEK 519 million. So again, even if the profits were a bit lower, the cash flow was stronger due to the release of inventory primarily. We also want to comment a bit on the net debt situation, where we have in total of SEK 3.3 billion in net debt, and you see that is ticking up from Q3 related to the acquisition of PEAK-System. That explains more or less the increase in total. Maybe from our perspective, what's most interesting is to look at the dark blue part of the bar, which shows more or less the interest-bearing net debt. And here, you see that we are just about SEK 2.8 billion. This gives us a net debt, if I exclude IFRS 16 effects, divided by EBITDA of 3.37 if I take the pro forma from acquisitions included. And with this situation, the focus for 2025 will be for us to delever the balance sheet and come down. We know that -- we knew that we would be above 3 when we made this last acquisition of PEAK, and that's not the situation that we want to be in long term. We're not worried short term. We have good discussions with our bank, and they were also in on these plans. But for 2025, we're going to work down towards 2. Might not get all the way, but that's the plan for 2025. So if we summarize 2024 before we hand over to operator for questions. So first thing that you should take away, 2 really good acquisitions made with Red Lion, a new platform in -- for the North American market, which grows the North American business from about 20% to more than 40% of our business, getting more even distribution and also value-adding sales offering that we can cross-sell. And then we recently did the PEAK-System acquisition that will go into the New Industries division, and we see a lot of synergies together with our Ixxat brand on that side. The second thing we believe you should take away is the profitability in the changing market. I think we managed to protect the gross margins and also the EBIT margin, at least decently. We're suffering from this destocking. We have been suffering from that, and the market has been challenging, especially in Europe. And as we said, Europe will probably continue to be a bit challenging for another 2 or 3 quarters. We also expect to see this improvement then in the second half of 2025, as we said. And then the third thing, the new organization, to enable us to focus more on similar type of customers and do cross-selling where it matters, where it will have a good impact. And it also give a full accountability to our divisions to run the strategy and to run the business in the best possible way. So with that, let's hand over for operator and open up for questions.

[Operator Instructions] The next question comes from Simon Granath from ABG.

Congrats on the robust results here. I'd like to start on Red Lion. It's clearly doing well after lukewarm performance in recent quarters. You did mention that project sales were better than expected. So I'm wondering if you think this was driven by pent-up demand. Or is it just a case of good and strong performance also with some tailwinds from a better market? And as a follow-up, you also mentioned some project wins around data centers. Will we hear you talk more about these types of revenues going forward?

Yes, we see with Red Lion that do quite much project business with distributors and system integrators that take our product and it becomes part of some kind of system that is used in certain applications. So we see that as a quite lumpy, up and down kind of the business. Some quarters good, some quarters bad. There is a stable flow of base business every quarter, and then there comes some speaks -- spikes. And this quarter, we got quite a few of this kind of surprising large order. One of them was to Microsoft data centers. We are not involved in the data center in the compute. But with our products, they do some kind of power monitoring of the incoming power into the buildings. So that's where some of our Red Lion products are used. Good project. We expect more orders in this. But that's just one example of this kind of orders we see. And we see data centers is, of course, big in U.S., but we also see areas in process industry, oil and gas and others where Red Lion is also active that we also see some pent-up demand and good investment going forward. So we are quite positive about this. But keep in mind, quarter-by-quarter, it's a bit lumpy business if you get these projects.

And you did mention in the report China is one of the outperforming regions in Q4. What is your mid- and long-term view about China? We've read about some market share losses from non-Chinese robot OEM vendors in recent quarters. And although this dynamic does not necessarily entail a negative impact to your business, the country still makes up a relatively low share of your direct sales. So I'm wondering if you would like to enhance it further potentially through increased investments.

Yes. Thanks, Simon. I think this is a good question, and it's an interesting topic. I think when we started in China with our sales offer there, most of our business was related to European and American companies investing there, and they want to have Western technology inside their factories. I think that trend has changed now. We see most of our customers in China, it's more domestic players in certain infrastructure product and automotive product. But we're also seeing a big trend in China that Chinese, both government and customers, there's a push for buy Chinese. So we see that in areas where we have unique products such as our Ixxat brand or our Anybus brand, there, we have quite good business, and that will continue. Some other businesses, both in our building automation, there's Ewon thing we are doing. There, we have -- always have a bigger challenge because the internal competition is much larger in China. So we see that the unique products with high technical value, we are successful in selling to this application in China, and that's where we see the growth. But we're not trying to -- try to sell a lot of Red Lion products there. For example, we have a very little market there. It's difficult to sell this kind of American-made products in China, so -- with local competition. So the strategy going forward is to be more focused on the products where we have a unique position and provide a unique value in China. But keep in mind, that's a small portion of our business.

And as a final question for me on OpEx. You managed to hold these at very low levels, even if we exclude the recent cost-saving program. Is it fair to assume that bonus accruals remain depressed here in Q4 and that these might normalize going into 2025, all else equal? And is there anything else to point out on costs in 2025? Or are current levels relatively representative for the near term?

So I think -- I'll try to answer like this, Simon. In Q3, as you know, we released some bonus provisions to reflect the fact that we didn't really perform as we should in total over the year. Q4 has been normal in that sense. But it's also -- this year has been a bit lower, of course, with that organic drop. It means not a big payout on bonuses. So a lot of people are not getting big bonuses this year. If we perform according to what we believe we should in next year, we will, of course, have high bonus payouts. So then you will see an increase in OpEx from that part. But there's nothing that stands out in Q4 as it did in Q3. I hope that was -- that answer your question.

Yes, very much so. And could you also say something about OpEx, excluding bonuses in 2025? Is the current level also relatively representative?

Yes. I think what we've done now is we set the organization that we believe we should have going forward with the change of organization. So of course, there will be a bit of salary inflation, and that will always be there. But other than that, I think we shouldn't see any big impact to the OpEx. So we've set what we should have now, and we're going to roll that forward more or less. That's what we see in the short term, at least.

Just a little bit extra flavor on that. I think that right now, we have been holding back quite much on cost and done these changes. We need to spend more time to make sure the current change is working. But if we see a pickup later in the second half of the year, I think then we probably will do some more investments in future growth. But I think, first, we need to see the growth and the increased profit level. And then we can release a little bit of this OpEx cost savings we have been doing. But we keep cost saving mode here until we see a clear market trend that we are taking another step into our growth.

The next question comes from Joachim Gunell from DNB Markets.

So touching a bit on how to bridge the fact that orders are apparently starting to pick up Q4 versus Q3 partly, of course, aided by Red Lion. Despite this, you talk about incremental softness for 2025, pushing the recovery you envision towards H2 versus H1. Help us just dissect if you can quantify to start with, how much was the project, call it, the positive Microsoft surprise there before Christmas. If you can just quantify the one-off elements that you think was in the Q4 orders? And then also, I mean, sequentially, HMS excluding Red Lion was also up quite substantially quarter-over-quarter here in Q4 on the order side. So is this mainly HMS excluding embedded? Or is this also embedded starting to pick up slightly?

Okay. So that was a long question. We'll try to sort it out for you, Joachim. So if we first start with -- I exclude this question with the projects first. We see a small pickup more or less everywhere. So that's very positive. It's not super quick. It's a couple of percent improvement that we see in run rate. And then we don't want to quantify single orders. We don't normally do that. But let's say that in total project orders for Red Lion in the quarter has been maybe SEK 100 million. And then we should have -- we should always have something but maybe not everything. So it's somewhere in that range, and then you have to do the math yourself. But it's -- what we're trying to get across is that we are slightly positive, that we're seeing a bit of a pickup, but we don't really think that you should take the SEK 893 million and say that this is the level we are at right now because that's not what we think it is. There are a couple of one-offs in the quarter. But we're -- I mean we're still positive but not in that pace. I hope that makes sense in terms of sorting out.

Perfect. And also, if you can, on the HMS excluding Red Lion side, just talk about embedded trajectory here in Q4 and basically, if you saw a pickup here as well.