Kitron ASA (KIT) Earnings Call Transcript & Summary

So I'd like to welcome you to Kitron's Capital Markets Presentation for 2023. I'm Peter Nilsson. I'm the CEO and President of the Kitron Group. Today, I brought with me some additional members from the Kitron team to help me with -- to cover some of the topics. We plan to be done with the presentation in 40 minutes leaving us 20 minutes to half an hour for Q&A. I think that will cover the things you wonder about. That said, let's kick off this show, and let's start with a brief introduction to the Kitron Group. So let's start with our core business and operations. With Kitron, we have our roots in the company founded in 1962 in Arendal, Norway. Today, we're an industrial partner to many companies. You know and that you use products from. Our core business is building electronic assemblies. As an industrial partner, we take care of the manufacturing of electronics that reside inside our customers' products. Sometimes we build the complete assemblies also. These customers, they design, they own the design and they sell these products. We sell the service of manufacturing. Our business is known as EMS, electronics manufacturing services. In addition, we provide services upstream through design and development and downstream through end of life, redesign, overhaul of products and field services. This allows many of our customers to focus on product design, market development and introduction. To enable our growth, we continuously invest 2% to 3% of our sales in capacity and capability upgrades. Today, you'll find more than 3,000 Kitron employees who are spread over 12 different countries. With more than 105,000 square meters of manufacturing footprint. However, our corporate headquarters is still just outside of Oslo, in Billingstad. So taking a look at some of the long-term growth we've had and value creation. We've been listed on the Oslo Stock Exchange since 1997. Over the past 5 years, revenue has more than doubled. Profit, EBIT profits have more than tripled. A strong commitment to dividends and year-on-year profit improvements have resulted in more than 300% shareholder return. As you noticed, we maintain our outlook for 2023 with revenues between EUR 750 million and EUR 800 million with profits between EUR 65 million and EUR 75 million, with the midpoint at [ EUR 75 million ] and EUR 70 million EBIT profits. Before we talk about our future ambitions, let's review some hard facts about our proven track record. On revenue, we have demonstrated an annual growth of 10% per year on average. We've developed existing customers and added new customers and products to keep up with technology and market dynamics. We've gone from 4 to 10 factories globally to support our growth. We have proven the economy of scale concepts, sites running at capacity delivered double-digit margin consistently. Over the years, OpEx has been reduced from 35% of sales to just over 20%. And payroll has gone from 27% to 16%. So those are some of the explanations when you guys look at, why is gross margin dropping. Well, it's not really dropping. It's the percentage of the material sales grow part material in our product going up. But since we're reducing our operating expenditures and our salary as a -- payroll as a percentage of sales, we actually improve margins. Over time, we've also done 2 international acquisitions. One carve-out competitor and 1 competitor, adding facilities in the U.S., Czech, China and Denmark. 2 greenfield operations have been started. In Poland, in 2019; in Malaysia, in 2023. We've also completed multiple site upgrades with new plants in Norway and Sweden and doubling of facilities in China and Lithuania. More than EUR 50 million has been invested in new equipment and capabilities. Now as we move forward, we carry with us this experience and these learnings from past performance. So let's take a look at our ambition for 2027. As we look to the future, we set our ambitions to achieve EUR 1 billion by 2027, at a 9% margin. We're confident that the megatrends for connectivity, electrification and defense will continue in the coming years as we move past next year. We're also well positioned to continue the outsourcing opportunities from the European market as well as regionalization trends in both Europe, North America and China. We continuously review acquisition opportunities, but we're quite selective. And when we move on an acquisition, I expect it will be sizable. We believe a 9% margin over time is sustainable. There will be periods of struggle and challenging efficiency scenarios. So we're content that 9% should be our target. Let's move on to market positioning and growth strategy. So who are the customers? Well, we prefer market leaders, companies that are innovative, companies that come with new solutions, companies that are fast growers. Often, our business is long-term and repeat business. We have just over 100 customers with substantial sales. The top 5 account for less than 20% of our sales. The top 20 just about 60% of our sales and the top 30, about 75% of our sales. Let's discuss our positioning in the market. Our tradition is to manage complex, high-margin products with special requirements. Within several market sectors, Kitron is recognized as a strategic and critical supplier. Over the years, we've evolved to become a leader known for delivering agility and flexibility in many different market conditions and market sectors. In the terms of volume, I'd say we are in the medium volume range from a few thousand to several hundred thousand units. And in the recent years, we've moved more to the right on the graph here, both when it comes to units delivered and as the size of customer accounts. Kitron has defined the market in 5 market sectors: connectivity, industry, electrification, medical devices and defense aerospace. These market sectors can be viewed through several layers as we see on the upper part of the chart. For this Capital Markets presentation, I think it's important to discuss what we know about the near future. Regarding the uncertainties in the market for 2024 we feel confident that the markets that cater to public investment with larger contracts over longer periods of time are extra important when there are many unknowns regarding products that are directly dependent on consumer demand. Viewed through this lens, we see the defense, aerospace and other security products should show strong growth for 2024 and beyond. This is confirmed by the customer demand where we see that there's -- where we see that it's up some 50% over 2023. We also see a similar situation with fixed grid infrastructure and chip design, automation and verification products. We'll review the outlook by sector and region a little bit later. Let's talk about what kind of growth we see in these market sectors. Overall, as we've said many times, our ambition is to grow faster than the average market. Over the past 3 years, we've won projects with significant growth potential in connectivity, electrification and the industry sectors. We expect these customers and products to grow some 7% to 15% over the medium term, which is 2025 through 2027. It will vary a little bit by sectors and by years. But on average, those are the kind of growth rates we'll see in those sectors. Products in these sectors range from IoT, sensors, a lot of asset tracking equipment, low earth orbit satellite communication, e-mobility, energy storage, power grid solutions, industrial automation. Finally, 2 of our traditional areas of growth, defense/aerospace and medical devices, both sectors have extremely high requirements, high entry barriers to do business with and long product life cycles. We will continue to grow in these sectors with existing customers as well as adding a select few new. We don't expect any significant growth in the medical sector. However, we're extremely bullish in defense aerospace where demand is expected to exceed some 30% per year over the strategic period. Let's take a look at the 2024 market sentiment when it comes to EMS and start by regions. Over the medium to long term, global EMS growth will continue. Digital transformation is driving growth with high inventory levels with customers and distribution chains, may likely suppress some of the immediate demand, early demand. The Asian manufacturing dominance will continue. However, export and local demand is tempered by Chinese domestic challenges. For our Asia sites, we see some 25% slowdown in 2024 compared to 2023. However, the Asia region is also our smallest region. In Europe, IoT and green tech demand will continue to grow, but again, dampened by slow stock turnover due to economic caution. We see some 15% decline in our CEE sites over 2023. However, compared to 2022, there's still 20% growth. That just shows how strong growth '23 has shown for these sites. In the Nordics and U.S. defense and aerospace sector surge, bolstered by security needs. Multiple production transfers are required to solve the short-term capacity restrictions. Our facility in Norway with Hans Petter, who will come up here later, should deliver over EUR 200 million of revenue in 2024, up from EUR 150 million this year and EUR 100 million last year. Pretty significant growth for 1 factory way out in the [indiscernible] In Norway. Sweden should continue to grow 10% year-over-year during this time frame with over EUR 100 million in sales in 2024, and the U.S. is expected to grow 50% in 2024. Denmark will also benefit from overflow from the Norway factory. When we look at market sectors, IoT and 5G continue to fuel growth in connectivity. There's probably some inventory induced delays in the immediate uptake. For industry, CEE will see a gradual industrial automation growth. But again, there are some short-term revaluations of capital expenditures. In electrification, we see strong growth in fixed infrastructure for grids. However, EV and energy storage solutions and other green tech solutions with solar and others, they will continue to grow. But currently, they're paced by some very low consumer spending and a lot of inventory in both distribution and customer lines. Defense, well, increased spending because of the geopolitical concerns. That takes us to the outlook for 2024. Growth is expected to continue strong in sectors electrification, power grid solutions, 100% up within those products. Defense, Aerospace and security, 50% up for next year. These sectors show solid growth for the whole year. Tepid demand for the first half of the year in Europe and China, with significant stock rebalancing contributing to a conservative outlook for 2024. Customers have noted a cautious approach to demand in the first quarter with more optimistic outlook for steady improvement towards the end of the second quarter. We have chosen a conservative approach to conserve cash and flexibility to be able to act on short lead time. Kitron expects revenues between EUR 700 million and EUR 800 million for 2024 with an operating profit between EUR 60 million and EUR 74 million. And with that, I'd like to turn the podium over to my friend, Mindy, who heads up the Central European region now.

Good morning. My name is Mindaugas Sestokas. I'm Kitron's VP for Central Eastern Europe. I'm about 14 years already in Kitron and [ Lithuania ]. So before talking about our plans, let me shortly summarize the European EMS market. So European EMS market is driven by fast technological advancements and a notable trend towards regionalization. We all see that geopolitical situation and sustainability concerns, prompting governments and companies to focus on reducing carbon emissions and addressing such issues like trade, cybersecurity and intellectual property. Just for illustration, we have quite many cases from our customers of business transfer from China back to Europe again during the last few years. Furthermore, still there is potential in outsourcing from original device manufacturers to professional of electronic production EMS companies. The example could be Germany, where outsourcing levels are considerably low. Additionally, rising defense budgets, especially in countries like Poland contributes for our belief into future demand growth. So all in all, analysts project that European EMS market to reach about EUR 45 billion total EMS market in Europe by 2026 presenting about EUR 10 billion increase from 2021, really significant increase rate number. So given that more than half of European EMS industries located in Central Eastern Europe, I think Kitron is well positioned to capitalize on these opportunities. Yes. So let me now review a little bit what is our setup in Kitron in CEE. So we are operating in 3 facilities in CEE. It's Lithuania, Poland and the Czech Republic. The larger site established in 2020 in Lithuania is heading to about EUR 160 million in 2023. It has around 700 employees and a proven track of performance, the diverse portfolio of approximately 40 customers in the various sectors. The Kitron site in Poland, which we started 4 years ago in quarter 4, 2019, has rapidly grown and reached over EUR 90 million revenue this year. Making it the fastest-growing site in the Kitron Group. At the moment, we have about 400 employees and developed a solid number of customer base in e-mobility and green battery applications. Kitron Czech, the third site, what we have in Europe -- in Central Eastern Europe, integrated into Kitron in 2022. And this year, we're forecasting over EUR 50 million of revenue. It comprises about 250 employees and excels in serving customers and smart home applications. Examples could be home controls, connectivity, heating pumps and other applications. In summary, strategically, Kitron will focus on electrification, connectivity and industry sectors in CEE. Another interesting opportunity is different sector in Poland, which is under our attention currently too. So also worth mentioning that by consolidating regionally, we want to get synergies and costs, resources, capacities, best practice sharing and enhanced flexibility, which, in many cases, very, very important for our customers starting new business or new projects. Okay. So what we have reached -- achieved this year in 2023 and what are our plans going forward? So this year, it has been a record year for Kitron in CEE with an anticipated revenue of about EUR 300 million and over 55% growth. Last year, we were slightly below EUR 200 million. I'm really proud that all sites, particularly in Poland, which have demonstrated remarkable progress. I think this really shows the company health. The electrification sector has proven to be a robust driver this year and is expected to continue shaping our future growth. So looking ahead, Kitron ambition in this region is to achieve a minimum of EUR 430 million by 2027. Key elements for that, I believe, is expanding our customer base and winning new business. So we aim for annual growth target of over 10% and winning over EUR 50 million in new business each year. It's nothing new for us. We experienced like that in previous years. So I believe it's really achievable. So important part to succeed also will be capacity availability. The platform for this has been laid during 2023. The overall capacity, what we have now in Central Eastern Europe in all of these 3 sites is nearing about EUR 400 million. What we did this year, we have expanded our facilities in the Czech by adding about 4,000 square meters, totaling about 10,000 square meters in total right now. And additionally, we have secured over 80,000 square meters of land plant in Poland, providing a strong foundation for future expansion needs. Now we have flexibility for our expansion of current facility in Poland, and then demand is in place. It's about 12 months lead time you have it. So summarizing all that, I believe that Kitron setup is well streamlined for growth, future opportunities and mitigating risks. So we said that, let me now pass the stage to my colleague, Hans Petter. Thank you.

Thank you, Mindaugas. I will give you an update -- first of all, my name is Hans Petter Thomassen. I'm in charge of the Nordic and North American region in Kitron, where we have the lion's share of defense activity in the Kitron Group. First of all, a little bit of context. What's happening in the defense sector now is driven by the tragic war in the Ukraine and the commitment of the NATO countries to support that war effort and to achieve the 2% GDP -- defense spend effort. This is creating a tremendous surge of demand in the sector. We've only started to see the beginning of it. We also see that the NATO membership change in our Nordic region is also changing somewhat the landscape. We are starting to see more cooperation in the Nordic region on armaments procurement efforts. We are seeing bilateral initiatives emerge from between Norway and Germany, we're seeing more EU initiatives emerging. These are all very, very, very strong drivers for the economy of scale and the volume of the contracts going forward. Last but not least, the U.S. foreign military sales program is, by far, the largest feed of armament into NATO countries and other allies and I will come back to the positioning for Kitron this one. But this will surely fasten growth of defense acquisitions that has been planned over years. So key transposition. First of all, we have been in this market for decades. It's not a -- it's a market with very, very tough entry barriers. So if you start today and think to enter the market tomorrow, you will have a tough time. We've been in this market for decades. We have built relations to OEMs, leading OEMs, both in Europe and in the U.S. over time. We focus very, very strongly on being a capable, competent, compliant provider of defense. The requirements into this from regulatory requirements, quality requirements, security requirements are tremendous to have robust processes supporting all of that is a pretty tough undertaking. And we have focused over time and we're able to deliver on those requirements being a qualified bidder into these programs. We have a strategic footprint very much capable of serving the OEMs that we have relations to. Okay, the lion's share of the businesses in Sweden, Norway and the U.S. for now. There are also initiatives ongoing where we might be doing defense activities in the Central Europe sites, but the lion's share will remain in the Nordic and North American region. We have, over the last year, scaling -- been scaling capacity both in terms of manpower, machinery and factory footprint. And we have further plans to scale capacity to the extent needed in the regions where we have the growth. It's extremely important to us to come across as being fully capable of supporting the growth our partners, our OEMs are having at this time. So lastly, what does this translate into? Well, first of all, we are committed to having our market share upheld in this segment. We are seeing a boost of revenue currently of about 50% in the factories that are defense-oriented. Norway, for instance, current year is about 70%. Looking forward, there is clear indications both in the order backlog and in the RFQ and pipeline for opportunities suggesting that we will see growth lasting for probably a decade. I was -- I read a summary of a NATO defense Industrial Conference just recently. And the end statement there was we need more, faster, everywhere. So with that, I will hand over to Kristoffer, who will take us through the next segment.

My name is Kristoffer Asklov. I'm the COO of Kitron Group. I'm Swedish, I've been here in Kitron for 2.5 years, been in the EMS business for close to 20 years. This year, Kitron has won new businesses from new and existing customers for over EUR 120 million, which is in line with our targets and a bit above our targets actually. As our sales cycles are rather long, it's crucial to have a well-filled and well-balanced sales funnel that will continue to deliver new businesses on a regular basis. In the first half of 2023, when the component situation was crucial nor when it's eased up, we focused all our resources to deliver to our existing customer demands. And we did that very successfully, resulting in a high capacity utilization with the increasing margins. Now we again have a full speed ahead of winning new customers as well as growing our existing ones with new business opportunities. We have a sales pipeline worth over EUR 400 million. makes us well positioned for our long-term growth, and we have a global sales team that are experienced to sell under all market conditions. In our business, there is always potential businesses to be acquired. In good times, new products are being developed and launched, and we expand in growth segments. In bad times, new products -- in bad times, customers are looking for strategic outsourcing to lower their costs and to tied up capital and focus on their core business. This has been proven over and over again, and our team is well prepared and positioned to win their businesses. When we talk about expansion, we mainly talk about 3 categories: manufacturing sites, our people that bring competence and capacity, and machines. Looking at footprint, Kitron is currently in 11 countries, Norway, Sweden, Denmark, Germany, Lithuania, Poland, Czech, India, Malaysia, China and U.S. And we have 10 manufacturing plants in 8 of these countries. This year, we have invested in increasing some of our existing facilities, and we will continue to do so in the coming years. We have also started to develop a new manufacturing site in Malaysia to increase our offer in Asia, but outside of China. In Poland, we have acquired land close to our existing manufacturing site to be able to expand when that's needed. On top of that, we are investigating new potential places where a greenfield expansion could be of strategic interest. And we focus on Eastern Europe, but India is also on our radar for future expansion. And after 2 years of -- close to 2 years of harmonization between Kitron and BB Electronics, which was our latest acquisition, we have recently taken the next step towards a fully integrated and efficient One Company organization. These steps include a new and updated corporate management team with focus on regionalization and organization and resilience. It also includes a rebranding adding all sites under the Kitron brand. Going forward, we aim to develop our shared service in India, we started a few years ago, adding more -- a wider range of functions into India. We have during the time up until now, shared best practices, making sure that we are bringing the best out of the 2 companies. But going forward, we will accelerate our digitalization and process automation to drive efficiency increase and capacity utilization. Over the next 4 years, we are planning to increase our organic capacity by over 50% and on top of that, we are looking at potential merger and acquisitions. Kitron has proven method of scaling up business in greenfield investments as well as a successful acquisition integration. Circling back to our expansion through greenfields, we aim to fit those into our CapEx budget of 2% to 3% of our yearly sales. The most important factor when we decide where to make our new investments is access to competitive labor pool that we can remain over time. The growth strategy for new facilities is to introduce existing growing customers and to do a carbon copy setup of the transferring site. This within in Poland with transfers and copy of Lithuania and this we are also doing the same now in Malaysia with the carbon copy of China. When it comes to acquisitions, we are interested in helping our growth by adding capabilities, regional presence, new customers and new capacity. We constantly evaluate projects to determine how well they fit into our overall growth strategy. And if the prospects provide customers, market sectors, geography that allows us to continue -- us to grow faster or to be used as a bridgehead to launch additional initiatives. In this picture, you can see our new site in Malaysia. This is in the final phase of the construction, and we soon see the first deliveries coming out of that factory. This is a very important and strategic expansion for Kitron, offering our customers -- Asia offer but outside of China. This will not only drive new businesses, but also secure many of our customers that we have in China today. So we have a backup solution if the geopolitical tension makes it hard for our customers in their businesses. Cathrin, talking about our targets.

Thank you, Kristoffer. So my name is Cathrin Nylander. I'm the CFO of Kitron. I have been so for 10 years now, and I am Swedish and also Norwegian now, as you can be. Go on the other way. I'll talk about the long-term ambition. So we have set a long-term ambition of EUR 1 billion in 2027. As always, this is funded in our -- each of our customers' ambitions and their own strategies, which we add up and get a number, and then we look into what is realistic to reach and basically, what we have done is we've taken the mid guiding for '24 and then a 10% growth after that. And these numbers are also secured by the acquisition of new customers. We have acquired several new customers where you don't actually see the revenues even so far due to the current market environment. But the underlying fundament for the megatrends in the EMS industries, they're still there, and they will help us to grow going forward. This year, we have changed our target going forward from 8% to 9%. We have demonstrated now in 2023 that we can deliver on an EBIT margin of 9%. And we see no reason why we shouldn't be able to continue to do so going forward. Of course, as Peter said, it might be slightly around 9%, but it will be a 9% that is the new target. And of course, any acquisition, we'll have to add on to these numbers. And again, the guidance for this year is EUR 700 million to EUR 800 million revenue, which you can see in that little box on the bar to the right for 2024. It shows the range from EUR 700 million to EUR 800 million. And we estimate an EBIT margin between -- our EBIT between EUR 60 million to EUR 74 million, giving a mid guiding of 9% for next year. Talking about those numbers, as was mentioned earlier, we have looked into the numbers that we have and the demand that we have, and we try to take air out of the demand so that we don't get inventory in because we want to be able to deliver on demand, not to get inventory. So it might be considered for some slightly conservative. So talking about what we have delivered to make sure that we can deliver on the future as well. We want to prove that to you by showing the numbers. So we have 5 main strategic targets. These targets are also flow down to each of the different sites. So we're measuring the company in many ways as we are explaining it to you. So first of all, CAGR, we talked about 10%. And as you can see, the 5 years rolling CAGR from the first bar to the left is from '14 to '19 is 10% and then '15 to '20 is also 10% and then '16 to '21 is 10%. And then we have the acquisition of BB in addition to strong growth on the, what you say, old Kitron as well, where the CAGR for those years are higher. So a reasonable growth rate of 10% over time. When it comes to EBIT margin, now as we said, this year, we estimate 9%. It was around 7.1% last year. We have shown that we can utilize on our economy of scale and deliver. We have good cost control and also good pricing control. So 9% over time is our new target. ROCE is the return on operating capital. It's a very important target for us. It is the return on net working capital plus fixed assets, all the machineries that we invest in, that should have return on 25%. And that goes into every bid calculation that we do with any customer. We shall have 25% ROCE. So if it's not ROCE, if it's too much inventory or whatnot, then we need to increase the price. So we get more than 25% return on operating capital. So we aim to have above 25%. And our ambition for this year, would seem to be at 30%, what we see currently. Cash flow in percent of EBITDA, this is the part that we see that we can improve the most. At the end of this year, we see strong cash flow. We're going to end out at 4% to 6% of EBITDA, we think, at the end of the year, and we will have a stronger year next year as well. But our target is to have 80% of EBITDA as a cash flow, and I'm talking now about operating cash flow. And our more of a group target is net interest-bearing debt over EBITDA, which is set at 2.5. It's 1 point lower than our covenant, which is 3.5. But coming into a situation where we are now when we're paying approximately 6% interest rates, we want to be well below 2.5 because it's quite expensive. So these are our main financial targets that we are working on. And then for some sustainability, when we only have 1 slide, I'm afraid. Our stakeholders very much depend or decide where we focus our sustainability efforts. We have very strict requirements, of course, from our own employees and our owners and whatnot, but the customers are actually the ones that are creating change. They have quite hard demands and it's normally a criterion to be able to bid for a new customer. But our main targets, it's environmental target, it says sustainable energy supplies. That means that we want to have renewable energy and supplies to our facilities. And currently, that is at 83%. There are some sites where it's more difficult to get the 100% like in the U.S., where it's not really easy. And we're growing in Malaysia, so that will change the number, but we are currently around 83% for this year. And then you have the EU Taxonomy target, which is based on our customers' end products. It's not the company as an EMS company, but what we are producing for them. So basically, qualifying products are the ones with electrification and some in connectivity. Defense are not qualified at all, not medical and part of connectivity not and industry for sure not. Social target to have 40% women at all levels. Currently, we're in total at 53%, but we have a lot of women in direct workplaces and not so many in management team. And you can see that here, I'm one and therefore, so gives you an indication. We need to work on it. And then you see a few of our certificates that we have. Important one is EcoVadis silver medal that we have because it's quite a common used method for qualifying. And with that, I will leave the word back to Peter. There you go.

Thank you, Cathrin. So increasing the number of women in the company is really important also in the management teams. And I think all of the people here can attest to my drive to increase the equality in our leadership teams. But it is a tough situation. Our business is not very attractive to women. And we have to work harder at it, obviously. So some key takeaways. Overall, the message is may be mixed here today with a conservative outlook for next year. Looking at the region that Hans Petter is responsible for the Nordics and the U.S., his challenge is extreme with extreme growth and product transfers and capacity utilization between the sites. So his job is all about growth, right? And then you have Mindaugas, who heads up Central Eastern Europe, all of the sites there, where it's more -- it's a bit down. The outlook right now, maybe 10%, 15%, maybe 17% at most. But at the same time, that's still 20% more than we did last year in that region. So it's still sort of growth when you look over a 2-year period. Where we have some real reduction right now is our Chinese operations, both due to regionalization, products moving back to Europe, but also because of the market sentiment really in China, where yesterday, they released what -- new CPI numbers out of China with minus 1.3 in CPI, right? So deflation really going on there and people holding on to their money what, $2.3 trillion or $3 trillion worth of savings with the Chinese people. Nobody spending money. So all that is sort of driving growth opportunities or lack of growth opportunities in China and pushing us down on -- because our focus is all -- over the last several years been China for China. So local production for local demand in China and getting away from this export business. Now of course, with the market really tempered or very -- not even lukewarm in China, at least for the next 6 months or so as far as we can see, that will be a challenge. But on the other hand, it's back on 2021 years levels for us in China, which those sites delivered double-digit margin in 2021 at those levels. So from that point of view, it's not too concerning. But overall, I'd say the management team is really optimistic about next year. We see some challenges. We love challenges. Some are a little bit more difficult than others because growth is really difficult. Contraction is not so difficult. So we have both things going on. One foot on the gas pedal, the other foot on the brake, which is normal in our business again. So in summary, on the growth, right? Strong growth in electrification, we've said, the fixed infrastructure products significant growth; defense/aerospace, significant growth next year and also over the longer period. Tempered demand for the first 6 -- first half in Europe and China contributes to our conservative outlook for 2024. Over the mid- to long term, Kitron's ambition is to achieve more than 10% organic growth each year from market sectors and product applications that are supported by megatrends. Our ambition for 2027 is EUR 1 billion of sales with 9% EBIT margin. We will continue to focus on capacity utilization and maximizing economies of scale, ensuring competitiveness and profitability. And as always, we will continue delivering superior performance to customers and shareholders. And with that, our presentation is over and we'll open up for some Q&A.

All right. So we have a lot of online questions, but we'll start off with the physical presence. So any questions there?

Maybe just to start with the 2024. What type of dialogues do you have with your customers regarding inventory levels and the timing of kind of when demand will come back? Is that where we -- and what kind of -- like the range of EUR 700 million to EUR 800 million, does that represent kind of the timing when demand will return or any comments on that?

As usual, when we have a range for bid like that, that means what we think is probably in the middle of that range. That's where we are. When it comes to discussions with customers, we've been very tough when it comes to discussions on inventory. And we've been running that way for the past 24 months, really where anything outside 4 months of inventory level, 4 months of production demand inventory level, we talk to the customers and say, this is not in our business model. Our business model is 25% return on operating capital. It's based on 4 months of inventory and then utilize some other resources and payment terms from the customers, if it's 90 days or 60 days or 30 days or whatever it may be. So we have those tough discussions. And when we move outside the range that's acceptable for the business model, the customer has to step in and finance that. And we've been very successful in those discussions because what's the alternative? Well, you're outside the business model, either you pay us a higher margin or you do a prepayment or somehow you change the business, the parameters of that business model, be it payment terms or whatever. Now at this point, when customers are feeling more unsure about what's happening next year, right? They know they have stock at their site. They know when they sell through distribution channels, the distributors have stock. And they see sort of a hesitant end consumer demand. They're not quite sure how quickly this will deplete. Some companies, large companies that are public and you listen probably to some of their quarterly reports in Q3 they expect stocks to be depleted in Q1, right? And then but I have no proof of exactly when this is going to happen. So I think that's the answer to your question.

Great. And more specifically on defense, what type of assumptions are you basing your 20% to 30% growth on -- and is this potential upside to that figure as well?

Hans Petter, why don't you.

Well, first, the commentary is your previous question about inventories, defense is one that is off. They have been stockpiling now for 2 years in funding. So we have vast amounts of semiconductors in our position funded by customers to support the growth coming forward. So that's a clear indication of our ability to serve the order backlog. The order backlog is possibly even a little bit underrated because of the fact that they have been stockpiling material. So we believe that our order book in combination with what we see in inventories will tell the story about a significant growth for the years to come.

What you're also saying is that you have everything on firm order basically.

Yes, we don't operate with the forecast at all. Everything is firm orders.

Yes. So, just I have several questions, but I can start with a couple of ones. Can you tell us what the revenue capacity is in the current footprint?

Total or a facility?

Total.

Did you say Kristoffer?

In euros maybe 900 or something.

900.

I think when we look at individual months and look at the output on an individual month, and we do that and then we annualize that and we see peak months this year, it's been around 900 but it varies substantially because some products have a very long throughput time. So other months you'll see 600 coming out, other months you'll see 900 coming out. Always push to the end of the quarter as it is with a lot of businesses.

And just I'll try to figure it out, but I wasn't able to do so, but everybody at least listening [indiscernible] are talking about capacity expansions. Do you have any good kind of market figures with regards to supply demand because the demand side is at least it's easier to get your head around, but the supply side is kind of difficult.

But I'd say the supply -- demand is pretty firm, right? It's not something that's easily movable, especially not, I think, with much of the demand that we have with those types of customers and those kind of products. Yes, I mean, over time, a customer could decide to jump ship and go somewhere else. But it's not very fluctuating demand also because of product life cycles being slightly longer. And you tend not to want to industrialize your product twice and take that cost twice and the chance of disrupting your supply chain. So that's when moves happen between competitors, it usually happens in a generational shift, right? It can happen also when you have built up a lot of stock like we are right now. So there's opportunities out there now to either win new business or lose business potentially also. But I don't see -- nobody is sitting around with excess capacity in the form of equipment or personnel, right? You can have footprint, but footprint doesn't cost a lot. And then when we look at Poland, right, we're running around, what, about EUR 100 million this year. The capacity of that site that from a footprint point of view, probably EUR 200 million right? But the budget and the calculation and the cost to recover costs, they're probably set at EUR 75 million on that footprint cost. So do you follow?

Yes, slightly at least.

Which is the same. When we started in the Arendal factory, we set the revenue at NOK 500 million per year for the site. The next year, they're going to be -- from the same site, also with some added warehouse space outside the factory, it'd be doing EUR 200 million. So that's how quickly you can change capacity by replacing old equipment with new equipment, automating much, much more and really efficiently squeezing everything you can into a site.

And that is kind of my point and slightly worried with regards to oversupply.

And, yes, no, I don't.

And just a final question from me. Can you at least in 2023, you had 30% return on operating capital and 9% EBIT margin. In 2027, you say 9% EBIT margin, but 25% return.

25% is our target on return on operating capital.

Yes. But can you help us bridge?

I mean the bridge is what we may be carrying more inventory, maybe have other payment terms, right? So yes, you could probably say if you look at individual sites within Kitron, you'll have sites that have 60% return on operating capital and others that will be at 28% and that some 1 or 2 would be maybe at 23%, depending on what type of business they're in, defense products, really difficult products that Hans Petter deals within Norway, the throughput cycle time in that factory is longer than at other sites. So the return on operating capital becomes longer also because we still have to -- there's some movement in margin you can do, right, to compensate for more inventory, but it doesn't extend to 15% margin or 20% margin. There's some upper limit there. I don't know where it is, but 13%, 14% may be. And sometimes, you don't have those margin levers to cover. So that's why we say we're happy with 25% ROCE.

But if we have an even revenue and even buildup of working capital, we should be higher than 25%.

Yes, we can probably do some online questions. We have a lot of those. We have some very detailed and some more general. And let's start off with a more sort of general ones about markets. For instance, as 1 saying other EMS providers are saying the same thing that the market is weak. And 2024 will be soft. Why is the market weaker right now? And why will it get better in 2025 and onwards?

The economy is the short answer. The long answer is increasing interest rates and drop in consumer demand because a lot of people are spending more money on interest cost and a lot of people are spending more money for inflated prices of consumer goods. Now in parts of the world, we see deflation, and we see it in parts of Asia. We see prices dropping rapidly in the U.S. on some parts of the consumer segments. We see interest rates starting to either drop or a plan to drop. And I think if there anticipated reductions of maybe 3 reductions on interest in the U.S. next year maybe and a couple in the Nordic countries that will pick -- that will allow demand to pick that up. Because right now, when people feel that there's a pinch in their wallet, they're not spending that extra money. They want to feel secure. Everybody wants to feel secure. And you feel secure when you have a buffer in the bank and not when you bought the new heat pump for EUR 10,000.

One other question related to the market and the demand. Has the slowdown in the market been more significant than you had expected?

Yes. I think it's gone quicker over the past, let's say, 6 to 8 weeks. Prior to that, there was a steady demand. Looking at the -- I've looked at the demand for this year. The underlying demand for the first 6 months of this year versus the underlying demand for the first 6 months of next year. And underlying demand is product sales, right? Hardware equipment that customers order and buy from us. On top of that, we have service sales, which can be up to 10% of our revenue. But looking at the first half of this year versus the first half of next year, I see pretty identical numbers. I don't see a big drop in the first half of next year, actually. But there is some -- that's because we have really strong growth in the Nordics and we have this -- it's lower in Central Eastern Europe and a bit lower even in that in China. So depending on what region you're looking at, there's more or less growth. And for the first 6 months, it looks the same between this year and next year which is contradictory to a bit of what I'm saying, but we're trying to be and that demand that we see actually that strong in the Nordics is pretty much firm orders, all of it.

And then moving on to some more details. This is a question from one of the analysts following you. So it is more of an analyst-type question. You state that customers have noted a cautious approach to demand in Q1 with a more optimistic outlook towards the end of Q2. First question, could you give more color on this and any indication on revenue level in Q1?

I mean, a little bit more color without naming customers that are all listed companies would be within connectivity, right, where we see there is a buildup of inventory in distribution channels. EV charging is another one. I mean that EV charging market is very, very low right now. Other products connected to green technology. There is inventory sitting with our customers. There's inventory in the distribution chains on that. And I think there's a -- the outlook from the customers is that will burn off in Q1, possibly even during into Q2. Now how true that is. I'm not going to speculate them. All I can do is draw conclusions and make a prediction myself or an assumption about our sales.

Okay. The second question from the same analyst. Also, how has customer forecast R12 changed since Q3.

The rising on customer forecast has changed a lot. So if you look at Q4 -- Q3, Q4 next year, it's not where it should be. It's not where it's going to be because even on the defense side, even though we have a really strong outlook with 50% growth next year. It's not all in the R12, right? But it's sitting in inventory at the site. The customer has already paid for the inventory, and they're going to release orders towards that inventory. So when you look at -- in our books, it's sort of a weakish Q3, Q4. But that's a completely normal situation if you back to pre-pandemic because that's what it looked like when you start the year, you have pretty good Q1. You have 80% Q2 and you have 40% Q3, Q4. And I think that's normal in any business. And the outlook for Q1, well, I think I answered the question when I said when we look at the total underlying order book for -- or demand outlook we have for the first half of the year, it's similar to what we had in underlying demand for this year.

Third question is about segment. Could you give any indications on segment split in your guidance for 2024. Your midterm guidance on defense is 20% to 30% revenue growth. What will be the approximate growth level for defense in 2024?

I think we mentioned it a couple of times. Didn't we?

Yes, the growth rates, I mean, we are experiencing 50% rolling 12, and we are looking at growth rates probably in the 30% range and beyond that.

Last year, we did EUR 80 million in defense. This year, we're doing EUR 100 million in defense. Next year, we'll do EUR 150 million in defense.

So you're looking at doubling over 2 years.

Yes.

So there are some questions about defense specifically. One is, is there capacity to meet the forecasted growth in the defense sector? Or is there a need for expenditure or acquisitions?

Yes, there's capacity to deliver what we undertake. It will require us moving out some nondefense products out of Arendal. But that's good because we have unutilized capacity in Denmark. And then Denmark now belongs to Hans Petter. So it's his site also. His responsibility to make a double-digit margin there.

But coming into 2025, we probably need to look at some extensions.

Yes. I mean we have an expansion plan for Arendal facility. The Arendal facility is very, very crammed now. And either it can be solved by changing out the automation equipment to even newer equipment that's smaller, but I think we need to actually have a new facility, and we're looking at that in the 2 to 2.5 year time frame.

Expansion with normal acquisition.

Maybe should -- are there any other questions here?

Maybe a bit more basic question, but the overall growth targets that you have, what is kind of the split between existing and new customers, and it's also above the kind of the market growth? Who are the typical competitors that you're taking market share from?

Our strategy is to have customers, existing customers that generate an average of 10% growth per year. Some of them will be growing 20%, 30% or even more. Others will show modest growth. But on average, we experienced about 10% growth on existing customers. On top of that, we want to win 10 -- 5% new business every year. And then there's a little bit of attrition. But overall, we should then see about the 10% year -- annual average growth rate in our business. So where do we find these customers Kristoffer?

2/3 from existing customers and 1/3 from new customers.

And where do we find those new customers?

And where -- what do you mean where?

Where, geographically?

I mean, geographically -- I mean we're focusing on the Nordics, Scandinavia, Northern Europe market is where we are focusing our sales. We are selling in all the sectors. We have focused on the growth sectors, electrification, connectivity for some time now, of course, in defense, but that's not mainly our growth is new business on existing customers from defense, while in the growth sectors for connectivity and electrification, we have focused on new customers, mainly adding on that.

But the new customers are these start-ups? Or are you taking it from the long tail of smaller competitors.

Both not so much. I mean, from -- if you're saying stealing from other competitors, of course, we are competing, but there is a lot of -- both start-ups but also very -- a lot of new businesses coming into play. If you're going back for the last couple of years, there has not been so much moving from 1 competitor to another. It has been more new products coming out to the market, both from start-ups, but also from many existing midsized customers that are fairly big. So it's not so much moving from 1 competitor to other. That's not the big thing.

We are seeing more requests from Germany now and when we look at those programs, they tend to be bigger in the EUR 20 million, EUR 30 million, EUR 40 million, EUR 50 million range for those contracts. And of course, on those types of deals, we're competing with the European suppliers.

Yes. We're going more so, competition from different competitor -- you mentioned change...

Name those customers -- those competitors because we're working projects now that are critical for us.

And then a final 1 on the margin side. You've had an incredible journey of kind of improving EBIT margins over time? And what is the potential for kind of further improvement from here? And what is really driving those. What are the main drivers of improvements on the current level.

Automation and economy of scale are drivers, right, bringing down fixed cost with manual work and automating a digitization bringing down indirect labor costs, automating processes are also drivers for improved efficiency and increased profitability. Of course, competitiveness also maybe drives down some pricing. So it's a balance there, right? And you cannot keep everything for yourself and grow infinitely on margin because even today, you look at some of our biggest customers and you look at their margins and then you look at Kitron's margins and in many cases, Kitron is a better margin. So we believe that even though we will continue to improve efficiency and profitability, I think we'll stay at around 9% when we talk about. And then there's also over time, there's always a facility or 2 that struggles. Last year, we had significant losses in our U.S. facility, bringing down our margin to 7.1%. Once we got that under control and got it to start a breakeven, well then, we achieved over 9% in Q4 last year, right? And now we've had 4 quarters with over 9%, still not making money in the U.S., but we're not losing money in the U.S. Next year, they're going to make money. And 1 of those reasons is you want to take care of whatever balance sheet stuff you have that's not good and clean that up fully before you start showing profitability. So there's always those things that can bring something down. And the question 2 roads back in the middle.

Yes. It was partly already answered, but more specifically on 2024. I mean you're guiding revenues at midpoint marginally down as but capacity has come up through the year. So I would assume utilization is probably a bit down at some parts.

Utilization, correct.

Yes. So could you help me just bridge the margin there because you're still guiding 9% for next year or mid.

So we're quick to reduce all costs that we're able to reduce. So on the equipment side for depreciation, we quickly now move the line out of Poland that was sitting on standby for growth for next year. We move that line out. It's either on its way or being installed in Norway right now for the growth in Norway. On the labor side, about 30% of our labor pool, 10% on direct labor tends to be temporary. So large parts of that have already shifted out of, for example, China. So sites in China are still delivering double-digit margin, albeit at that lower level that I'm talking about next year already. So I don't believe that our China facilities will go down further than they are in Q4 this year. And I think there's been stability in those reductions for the past 6 weeks in China.

So basically, you're saying more of the cost is flexible and could you maybe give like an estimate on how much is fixed and how much is flexible on the cost side there?

Well, our direct labor cost overall, not all of it is super flexible, of course, because some of it is regulated in different countries. So you'll have more regulations, for example, in Norway and also in Sweden and Denmark. But now about 9% of our sales is our direct labor cost. And then you look at, okay, a large portion of that is in the Nordics. The Nordics are growing, the Nordics are not planning to bring any of that down. So it's -- and we have that flexibility in Central Eastern Europe. We have it in China. We're executing on that. And the U.S. will probably the organization is going to be growing, Hans Petter, right? So everybody still has the same profitability requirements on them from me on even if the lower -- they can temporarily over a few months or so, maybe show a little bit softer results, but they all know what they need to be doing.

You said that automation and scale is what's going to drive further potential improvement going forward. What do you see when -- or do you have any thoughts about potential M&A among the Nordic players? Is there any rationale for that? I mean there's a handful of larger players in the Nordics.

Yes. I know who they are. No, we admire, and we have a great relationship with some of our competitors. Both Kristoffer and I have a lot of former colleagues with [ Skan Field ], for example. We know people at NOTE. We know people at [ Hansa ], for example. And in some cases, [ Hansa ] is a supplier on the mechanic side to us. So we have great relationship with all of these companies. Perhaps there is some strategic rationale. I mean I'm not going to say what we are and not do -- and what we're not doing there. But we're always thinking about those things, and we're looking at some of them but there's no process going on now. Whatever we do, it has to be accretive for our shareholders, it has to bring more EPS at the end of the day. That's what's important.

To what extent are your customers demanding a cost-plus model sort of limiting your margin upside?

Basically, all of our quoting is cost plus. So I mean -- and some people in the past tried to quote what they call a market price, right, and say, we're not telling you what our business model is. We're not describing the cost structure of your product. But the business model in EMS is cost plus. It's the material content. It's the cost to bring that material home and the cost to plan production and the cost to store and warehouse that material. It's the cost for the direct labor. It's the cost for the factory and the depreciation cost on the factory. It's the cost for the overhead with supervisors and factory managers and sourcing organizations and IT costs. All of that is part of that indirect overhead cost. So that's the baseline. Material, value-add in form of direct labor, driving overhead cost. And on top of that, you look at how much capital are you using? And how do we achieve 25% return on operating capital. Do we need to apply 5% margin? Do we need to apply 7%? Or do we need to apply 12%? And then how scalable is our business. How much more can we utilize the existing overhead before we have to step up and hire another IT manager or something like that. And the more we can sort of use that existing overhead the better scalability we have, the better economy we have, the higher margins we get. So in theory, it never stops the margin development, right? I heard a presentation from my colleague at NOTE a few weeks ago talking about how much of new business and volume increases falls down to the bottom line. It's about 15%. EUR 100 million in new business, EUR 15 million will fall down to the bottom line. And over time, you should theoretically be able to grow your margins too. There's no end to it almost, right? But in reality, you build new sites. You won't always be full everywhere, right? You're expanding and you're competing.

There are some sort of balance sheet-related questions online here.

I will give them to Cathrin immediately.

Yes. Yes, you will. First one is, should we expect significant working capital release in 2024?

A bit, yes.

Brief answer. All right. Another one is, will you prioritize paying down debt going forward?

We're doing that continuously. And the reason was, as I said before, we have 6% interest currently, which is a toll on our net income, I would say. So we are doing that continuously.

And sort of following up on that, given expensive funding, would you consider skipping dividends?

I think we have a dividend policy that says we're going to pay 20% to 60%, and that's the current dividend policy we have.

All right. We have some new questions.

We're not in the -- it's not our game to change the dividend policy every single year. That's why we have 20% to 60%.

It gives us enough flexibility to manage without changing it.

Some more questions that are sort of returning to the market situation. One saying you are the only Nordic EMS to guide for a decline in revenue, somehow next year despite the wins of new contracts in 2023? Have you deliberately chosen to give up on some customers for margin reasons.

Not to any significant extent, right? There has been a few customers that have been shifted out, but it has no material effect on top line. And really, it's not because of margin, but it has because of outlook for the customer or that the volume is no longer in sort of where we want to be, right? We don't -- we tend to favor accounts that are a little bit bigger.

And one about acquisitions. Our acquisitions more likely going forward now that the guiding for 2024 is on the lower side. Are you currently looking at any?

We looked at one yesterday. So I mean that's all. And prices are still high. Expectations on sellers are still high, high EBITDA multiples is still out there. And to some extent, if you look at some of our -- both Kitron and our Nordic competitors, even though we're the -- some of the most profitable businesses within the EMS industry, our multiples are somewhere between [ 10%, 11%, 13% ], maybe and on an earnings level. And some of the sellers there, that's the kind of money they're looking for. And of course, they are not the listed company. They do not have good contracts with their customers if they even have contracts with their customers. So there's a lot of unknown. There's a lot of potential liabilities. There's a lot of potential obsolescence and other factors you have to consider when you look at those companies. And that's why I'd say the EBITDA multiple to be attractive should be well below 7.

One question here about your margin target around 9% in 2024 on midpoint. Is this due to a higher share of defense revenue in 2024, as you will have capacity increase with the new factory in Malaysia.

Yes. The Malaysia factory, we have not counted any significant portion of sales or anything from that facility nor on a cost level, really. So because I don't want to speculate what that may or may not be, but it's also the strategy is carbon copy from China, move business from China. So it's sort of a zero-sum game if the budget is currently in China or if there's 0 for Malaysia. What was the question really?

It was actually your margin target around 9% in 2024. On midpoint, is this due to a higher share of defense revenue in 2024 as you will have a capacity increase within your factory in Malaysia.

Well, there's no defense manufacturing. So those 2 are not related. But yes, we'd expect a higher margin from defense versus something like connectivity, where there's maybe a point or 2 lower margin.

I think we have the Malaysia facility for 2024. We've taken a very conservative approach on top line and that brought in the cost that we see will come and whatever exceeds our expectations beyond that will give a positive add-on.

So it's more that we look at the past 4 quarters, and we see revenues of between EUR 170 million and EUR 210 million. Well, that gives us the range of profitability for each of those quarters. And then we look at next year for each of those quarters, say, okay, where will we be, right? Where will we be here? And do we have any underutilization that will be pulling this down? And do we have any overutilization like Nordics that will be pulling it up and compensating. And that makes us feel comfortable with the 9%.

Okay. We will do 1 last online question and then see if there are some more here. Last 1 online is, do you expect flat growth in the first half of '24 versus the first half of '23 if I understood you correctly and flat growth in Q1 '24 versus Q1 '23.

What Peter says that is you see the underlying demand to be the same. But naturally, last year, we invoiced other things too, in Q1 and Q2, like more PPV and more services than we have anticipated so far. So a slight decline because otherwise, we would not be mid-guiding on a slight decline for the full year, right?

So we can say that the top line this year is a little bit inflated because there's PPV cost in the top line, right? We're not speculating about any PPV cost on the top line for next year. Underlying demand looks the same. And then on top of that, there's service sales. There are some repair sales. There's over -- there's field services that we do. There's development work that we do. That's also part of the top line this year. How big the extent of those services will be in Q1 next year is extremely difficult to forecast, right? Because that's very project that connected and the lead time of those is probably not more than 4, 5 weeks anyway. So when I see that's where we are. Any final question from the team here? Great. Well, I hope to be seeing you soon again. And with that, my team and I thank you, and welcome to get together with us for our Q4 presentation in February. Thanks.