Good day, and welcome to the NKT Interim Report for Q2 2018. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Michael Hedegaard Lyng. Please go ahead, sir.
Thank you, operator, and from my side also, good morning to everybody, and welcome to the Q2 announcements call, the Q2 we just released this morning. My name is Michael Lyng, CEO of NKT, and together with me today I have Roland Andersen, CFO of NKT, and also, as usual, Basil Garabet, CEO of NKT Photonics. Together we will go through the Q2 numbers that we announced this morning and try to give a little bit more flavor on what's going on in our businesses. First, I will do it for NKT, then Basil will do it for NKT Photonics, and in the end, Roland will take us through some finance numbers. In the end, we will, as usual, jointly do a Q&A session. Let's look at Slide number five, looking at the quarterly results for NKT, so the former NKT Cables part.
We are delivering a Q2 that, according to our view, is pretty much in line with the expectations. We have seen very good, solid organic growth in all the different three business lines that we are reporting on. As you can see here, top line is up from EUR 288 million Q2 last year, to EUR 306 million standard metal prices this quarter. That translates into a 12% organic growth, with 12% in our solutions business, 11% in our applications business, and strong growth in our service and accessory business with 19%. I will come back to that. On this base, we were able to deliver EUR 32 million in operational EBITDA, and that leaves us with EUR 52 million after the first six months. It should not come as a surprise that we are slightly down earning-wise compared to Q2 2017 as a result of composition of our backlog.
Backlog end of the quarter came to EUR 500 million, slightly down, but that also excludes the Hornsea 2 project with a value of EUR 145 million that we won just in the beginning of July, and also announced to the market, and we will talk about that a little bit later in this call. We also focused a lot on cash flow in Q2, and have a nice positive cash flow as a result of improvements in working capital, but also a stringent management of the investments that we do in the business. If we move to the next slide, let's take a look at the performance in the solutions business. We have had pretty good execution in our business on the various projects that we have been working on, although the activity level is slightly lower than last year.
We have been working on the NordLink project and the Hornsea 1 project in Karlskrona and have had pretty good execution on that. In the Cologne facility that still are producing as much as possible when it comes to the offshore segment, we started up the Borssele Alpha production after having finalized the Galloper project in Cologne. In the low end of the segment, the high-voltage DC market remains to be a challenge, not only for us, but also for the industry. Although we are actually satisfied with some project wins that we have had in that business, among others, a frame contract in Italy. The Victoria vessel have been producing or installing the Johan Sverdrup DC power cable project in Norway and have been pretty busy with that and are now looking into starting installation of the NordLink project in Q3.
Looking at the composition of the backlog on Slide seven, I think the projects mentioned here are properly very familiar to everybody. Backlog is EUR 500 m illion, slightly down, but that also excludes the three projects mentioned in the right side of the slide, lower end or lower parts, where the Hornsea 2 project we were awarded in beginning of July are not included in that number, and also the Triton Knoll and Moray East are also not included. There, as you know, we are having a preferred supplier agreement, and we still expect that to be turned into final orders here in the second half. If we then look at the Hornsea 2 project that we won, first of all, I think we can be very satisfied with that project win. It puts NKT in a significant, strong position with this project compared to without.
It's about supplying 190 km of 220 kV high -voltage AC cable to the world's largest offshore wind park. Part of the agreement that we have with the customer, being Ørsted here, is that we can start up production pretty soon, which means here in August, September. That it will, of course, also improve the situation Karlskrona, because that is the site where we have had the issues with filling up capacity. It's of course not turning around that factory fully, but it has a good impact in particular also moving into 2019. With this order, where we in the end got 50% of the total scope, we again proved our strong position in the offshore wind segments. If you move to Slide nine, some updates on the high -voltage market. I think overall, the business or the industry is still impacted by too little visibility.
Although we are still having a positive view on the number of projects in front of us, and we also start to see some of the projects moving ahead. The Viking Link project have started up tendering phase again after having been put on hold since the fall of this year. Also the SuedLink projects in Germany have started up a pre-tender phase. So also very positive. That doesn't change the fact that we still are challenged in 2018 and 2019 with getting sufficient visibility. But we are working very hard on that every day. We also have a positive view on the market outside Europe.
We start to see significant potential in the U.S. and also Taiwan within offshore winds, and are of course sitting very close to customers there in order to assist them, advise them, and hopefully also in the end, turn that into concrete orders for NKT. I think that was more or less it for the high -voltage market update. If we move on to the applications business, on Slide number 10. Then we are announcing EUR 115 million in top line, which is up from second quarter last year, and it translate into an organic growth of 11%. We have seen a better performance on the earnings compared to Q1, but I also have to say that we are not satisfied with the earnings level that we are reporting for this business.
Good thing is that we can grow it, and we are also satisfied with the fact that we have been able to produce more volume in the factories. Now we need to work hard on translating that increased capacity utilization into higher margins. We are negatively impacted here by a number of these projects that we are working on. You need to remember here that we are moving from a very country-based organization some years back into now a functional organization. That comes on the positive side with the fact that we can utilize our assets better, but on the negative side, it comes also with additional complexity. Complexity is fine if we can manage it, and that is what we are working heavily on now, to translate that complexity into higher margins so we can see a more satisfactory earnings level in this business.
We are confident that we will see that in the coming quarters and next year. Some of the markets here is mentioned. We have seen a recovery of the market in Poland. Other markets are also doing fine. We are still impacted a little bit in Sweden by the fact that the building wire market and that segment are slowing down. We are not significantly exposed to that. It is more the medium-voltage business that we are exposed to there, where it is a high-margin business for us. As you remember, we were in the first quarter negatively impacted by a very harsh winter, which meant that the utility companies could not install medium-voltage cables in the ground. We saw a nice pickup in April and May, also beginning of June.
That has now also turned into a slowdown, not because of cold weather, but the opposite, because of a very warm weather in Sweden over the summer, which has meant that installation work have been stopped because of the risk of having fires. So we expect to see an improvement there as we are moving into the fall with more rain and hopefully be able to catch up there. It is not that we are losing anything, it is just the impact from weather conditions.
The automotive business that we divested last year in April are still in the numbers here, so you need to be adjusting for that. If we move into the next Slide 10, and look at Slide 11, sorry, and look at our service and accessory business, then this is, although still a relatively small business, it represent a big potential for us, in particular in the service business. We are here reporting 19% organic growth, and that translating to a EUR 37 million top line. On that base, we do almost 10% EBITDA margin to EUR 3.8 million, which is pretty good, although slightly lower than last year. This business will be impacted from quarter to quarter from how many repair works we do offshore.
It will be a relatively volatile business until we get into a position where we get a sustainable base load related to, for example, service contracts that we are working on achieving with our customers. But positive development in this business. The railway business is also part of this, and as you know, we are looking into strategic options there, including also a divestment, and we expect to be able to conclude on that process in the second half this year. Then Slide 12, just an overview of the different excellence initiatives that we are working on. Last quarter, we announced a cost reduction exercise, mainly targeting an FTE reduction in Karlskrona and Cologne to adjust for lower capacity utilization. That is being executed according to plan. I think we are approximately 70% done with that, and the remaining 30% will be executed here in August, September.
Then that is behind us. On the operational excellence, which is some of the initiatives that are also short-term impacting our earnings level in the applications business negatively, we continue to roll out our standardized lean-based operating system across the different factories. We strongly believe that that will also yield not only more capacity but also higher margins short term. Roland also have worked on establishing a shared service center in Lithuania. We did not have that last year at the same time, and now we have approximately 30, 40 people sitting there doing transactional-based work. Then we are in the mid of moving more to Lithuania, and at the same time, ramping down those activities in high-cost countries like Denmark, Sweden, Germany, et c. But there's, of course, also a timing impact here.
There are periods of time under which you are running with this double cost before you can really take out the cost. But positive development there as well. The digitalization hub in Berlin is getting more and more established. We are working on some very promising projects there, and I look forward to be able to talk more about that in coming quarters. With that, I have finalized the NKT part, and I would like to hand it over to Basil to do the same for NKT Photonics. Please, Basil .
Thank you, Michael, and good morning. Now on P age 14, through the key highlights in Q2. The quarter worked well for us. We had a good quarter. The top-line revenue came in at EUR 17.6 million. That's up by EUR 6.4 million versus Q2 of 2017. That's roughly about 70%, which is driven by the existing business and also largely by the acquired Onefive facility in Zurich. The organic growth for the quarter was 25%, also very healthy. That came in really from all three business segments, roughly equally. So it was healthy right across the board growth. EBITDA came in at EUR 1 million. That's up from about EUR 0.7 million in Q2 of 2017, again, mainly driven by higher revenue. EBITDA was impacted by provisions of about EUR 0.4 million, which is related to the long-term incentive program for senior management. That wasn't provided for in 2017.
Another healthy sign of growth came in with the order intake, which is at 75% above Q2 of 2017. As mentioned, all the markets that we are in showed growth for the advanced products that we made, and we continue investing in a platform for the future at the company with organizational increases and excellence programs right across the company. In the quarter, we also opened a facility in northern Sweden in Hudiksvall, basically helping us with our fiber facilities in Denmark. This facility is fully operational at the moment and continues to do so into this quarter and into next year.
The financial outlook for this year, we're not changing. The revenue is approximately EUR 65 million -EUR 70 million, and our EBITDA is approximately EUR 10 million. Moving over to the next page on the business development side. Imaging and metrology continues to be our largest percentage of revenue. Markets, again, mainly are in the semiconductor manufacturing side, in life sciences, and our traditional business and scientific. The market was mainly driven by the positive development of our SuperK supercontinuum laser site and our white light lasers.
In sensing and energy, which contributes 31% of our revenue, the increases mainly came from the Koheras line of our single-frequency fiber lasers. That's doing a very healthy increase. In fact, that's increasing by more than 50% year-on-year. Also positively impact by applications and fire detection, power cable monitoring, throughout the different parts of the world. The material processing, which is the smallest part of our business development, but the one that we see the greatest growth in future quarters. The integration of the acquired Onefive business is going well, and we've successfully completed that in Q2 of 2018.
We've also released several new products in the UltraPulse laser line where we will see impacts later on this year and mainly into 2019. We've moved to the next page on our strategic priorities for 2018. They are the same. We've been working on this for three years now. We're seeing the positive impact of those. On moving up in the value chain, the Onefive acquisition is a main example there. As mentioned, that's going well. We focus on organic growth at the moment now that we've done the number of acquisitions we've done the last couple of years. We're integrating these acquisitions, and we are working with the market to increase our top line, so most of it will come from organic growth. In our growth, and if you see the growth from the company, we needed lean operations right through.
That has come also through hiring of a new COO last year, and that scalable manufacturing is working well for us, and we will see the benefits as we go along. Finally, as a high-tech company, we live by fast introduction of new products. We continued introducing new products. Newest products that we introduced in the LIOS line came from our long-range monitoring systems, with a new 70 km range, and advanced RTTR software. On that, I conclude, and I will pass over to Roland. Thank you.
Thank you, Basil. If we move to Slide 18 and just have a quick glance of the group's more detailed revenue development. If you adjust for metal prices and look at the development in standard metal prices, we have been impacted slightly negative by currencies, and that is primarily the weakening Swedish krona. Also, a smaller acquisition impact, which has to do with NKT Photonics' acquisition of Onefive. Then lastly, the cable side of the business disposed the automotive business back in Q2 last year. That means that an organic growth of 12% corresponds to EUR 32.6 million developing in Q2 in the cable side of the business and 25% growth corresponding to EUR 3.4 million in the Photonics business. Now, if we move to Slide 19, I guess not so much new here.
Obviously, a lower operational EBITDA than Q2 last year, partly driven or mostly driven by the project composition in the solutions part of the business and also a too low profitability in our applications. We have had one-off costs in Q2, and there is a smaller part of that related to the remaining integration of the ABB Cables business that is almost done. Then we have a few strategic initiatives ongoing here under the formerly discussed cost base adjustment or deduction. Most of that will be concluded in Q3 this year. So first half of 2018, about EUR 10 million in one-off, and we remain guiding about EUR 20 million for the full year of 2018.
If we move to Slide 20, our operational EBITDA margin. The margin percentage is slightly down this quarter, mainly due to the applications business, also a little bit to the solutions business, but both of those business lines drive up the nominal EBITDA. Here, also clear that the jump from Q1 to Q2 in 2017 was when we had former ABB HV Cables fully consolidated into the accounts. So let us move to Slide 21 and have a quick glance on the balance sheet. Working capital here, excluding Nilfisk, is at a higher level than the same period last year, but it has moved lower than by the end of Q1 this year. The working capital in Photonics is driven up primarily by a higher revenue.
Just a note here that the NIBD number by end of same period last year still contained the good part of the Nilfisk debt. I will move to Slide 22, working capital. Working capital improved slightly in Q2, and that had to do with a bit more firm steering of that, and also that the solutions business had a few projects meeting the milestone criteria for payouts, and that improved the balance in solutions. This overview was separately broken out in our segment reporting in our Q report. Let us move to Slide 23, which is the group's cash flow. We had positive free cash flow from our operating activities, both driven by EBITDA, but also from a positive movement in working capital. As mentioned, we are driving our investments activities a little more firm now than we used to do.
CapEx remained at a lower level for Q2 in 2018, and that means that the positive free cash flow could be used to reduce our net interest-bearing debt. If we move to Slide 24, that is what that is showing. Our net interest-bearing debt came out at EUR 410 million versus EUR 433 million by end Q1, driven by the development in the free cash flow. Our leverage ratio remained at 3.0x, as was the same by end of Q1 2018. Our medium target still remains to go below 1.5x as leverage ratios. Then we can inform that the refinancing process of the group's entire debt facilities is progressing satisfactorily, and we expect this to be finalized in the near future.
If we move to Slide 25, the development in the order situation and solutions and also earnings performance and applications has led us to adjust our guidance slightly, and that means that guidance is updated from being expected to be approximately EUR 90 million- EUR 110 million EBITDA in the NKT business. We now expect it to be in the low end of the previously announced range of approximately EUR 90 million -EUR 110 million. Revenue expectations for NKT remain unchanged, between EUR 1.0 billion and EUR 1.1 billion. For NKT Photonics, guidance on both revenue and EBITDA remain unchanged. With that, I will give it over to Q&A.
Thank you, sir. If you would like to ask a question, please signal by pressing Star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press Star one to ask a question. We will take our first question from Kristian Johansen . Please go ahead, caller. Your line is open.
Thank you. My first question is around prepayments. I assume that you haven't or will receive the prepayment for the Hornsea 2 project here in Q3. If Triton Knoll and Moray East are turned into firm orders, will you also receive the full prepayment for these projects here in the second half?
Yeah. This is Roland speaking. Thank you. The timing of the prepayments depends on where we are in phasing of the projects, right? Depending on when we sign and when we move from pre-engineering into actual production, then prepayments are agreed, and they are agreed a little differently across the projects. But generally speaking, yes.
Okay. For me to sort of try and estimate the level of prepayments here, is it a fair assumption to take the revenue levels or the value levels you've indicated on Slide seven and then apply sort of a 10%-20% prepayment level, giving me—
Yeah.
— EUR 40 million -EUR 85 million for these three?
Yeah. That's a fair generic assumption. You can't maybe do it exactly on signing, but within the first months of project startup.
Yeah. If Triton and Moray is turning unconditional in the second half, we should see a significant net working capital improvement?
We should see pre-payments coming in from those projects. Yeah.
Great. My second question is on the tendering activity and whether you can update us on ongoing tenders and specifically how many projects within high -voltage you expect awarded here in the remainder of 2018.
Yes, we can do that. The question is, of course, difficult to give you a precise number, right? Also in particular how many will be awarded because we have learned that there is a tendency of the orders or award being postponed here and there. But I can confirm that our tendering function or people are extremely busy working on a number of tenders. There will be according to plan and according to customer information to us, there will be a number of offshore wind projects being awarded in the second half or from now on until the year-end. We also have seen some of the other projects in the DC area moving ahead. We were all disappointed with the fact that the Viking Link project was postponed because of permit issues. But that has now been started up again here, or will start up very soon.
We'll expect it to be awarded in the beginning of next year, which is positive, and then also the corridor projects in Germany. Remember there that there are four different projects. Two of them have now moved into a so-called pre-tender phase, which is a very short, condensed phase where the customers are looking into who is it actually that we want to have in the real tender phase. So that we also expect to start up pretty soon. A number of projects is out there and that also ties into our comment in the quarterly report about that we remain to be positive and optimistic on the future outlook.
Okay, actually just to follow up on the SuedLink, I obviously understand that there is uncertainty on the timeline on these types of projects, but given the current timeline for these four parts of the SuedLink, what is the expected award date?
The expected award date is according to our information now. We don't know exactly because it has not started up yet, but it will be over the summer or third quarter is my guess or expectation next year.
Okay. Very clear. That was all for me. Thank you.
You're welcome.
Our next question is from Andreas Willi from JP Morgan. Please go ahead caller, your line is open.
Yeah, good morning. It's Andreas from JP Morgan here. Just a couple of questions. When you have discussions currently with customers on the big solution projects, is there any concerns on their side about the level of debt or level of debt relative to profitability that that would impact you being selected for some of these large projects? Second, on the guidance, could you maybe elaborate a little bit more what made it move to the lower end on profits while it's unchanged on sales for NKT in terms of what the impact is on mix on some of the things you mentioned earlier? Thank you very much.
On the first question, it's not the first time that we are being asked that question, and I can clearly say, no, we don't have any issues with customers around that. Bear in mind that every time we get an order, we somehow issue a performance guarantee through our banks. Our ability to do that is exactly unchanged. We have sufficient power to do that. So there's no concern from a customer perspective around debts. On the guidance side, I will pass it over to Roland to give a little bit more flavor on debts.
On the guidance, I think the positive news for us is that we are actually delivering on the growth side. But the challenges we have had is converting that into sufficiently satisfactory margins. Hence that's why we actually are guiding that we will meet our top line, but we think that our combined group margins will be in the low end of the interval.
Thank you very much.
Our next question is from Dennis Dinkelmeyer from Goldman Sachs. Please go ahead. Your line is open.
Yeah. Hi, good morning. First question is on the refinancing for debt. Appreciate you've gotten comments on this, and you've provided some more information, but this morning we've seen a negative raise on one of the vendor OEMs, and we just were wondering if you could provide a little bit more assurance on how your conversation with your bank are going in that regard.
What did you see this morning? Or what was that?
There was an equity raise.
Sorry, this is Roland.
Hi, Roland. Good morning. There was an equity raise of a German wind OEM. We just wondered, and they had a 2.5x net debt to EBITDA. Your current net debt to EBITDA is around 3 x. We were wondering if you could provide some more reassurance on the options that you have with your bank at the moment, and by when you can actually expect to close the refinancing of your debt.
Basically, as we say, that process is moving forward and is moving forward satisfactorily. We also need to conclude that in the very near future. There is no equity raise planned.
Okay. Then moving to the second question. I appreciate your comments on capacity utilization and pricing trends in the current tendering phases going forward. But in terms of your current backlog, could you help us understand the margins that are actually inside your backlog and how they're evolving sequentially from here? NordLink being one of the examples you mentioned for up for execution in 3Q and 2019, DC contract, which with a 525 kV technology should have a very strong profitability. Could you help us to understand the backlog evolution and the margin here?
Yes, I can do that, although we do not want to disclose margins on individual projects. But it is very clear that given where we are today, where there is an unbalance between demand and supply in the business, it is also NKT having idle capacity, it is also competitors. That of course, put pressure on price because of that starting point. We want to make sure that we get load into our factories. With that mindset, we of course sharpen our pen when we are giving the best and final offer to our customers.
If you look at the competitive environment here and also try to link that into installed capacity, then this is, of course, seen to a higher magnitude in the offshore wind segment, where we do see more competition and a higher number of cable players being able to do that, it is less impacted in the DC segments, where you have a lower number of competitors. The way we do planning and also tendering is, today it is very much similar to the past years. Then during the negotiation phase, you are tying that into your capacity load and planning into your factories, that somehow defines your appetite. I also know that there have been some speculation around the Hornsea 2 profitability level and price level.
As we also communicated when we communicated that, first of all, we are very satisfied with that. We, of course, also communicated that there was an element of being sharp on the pen, looking at the prices. But we still believe that we can get a satisfactory margin given where we are in the supply-demand balance on that project. Long term, there is no question about that the price level in this industry needs to go up, because otherwise none of us or competitors can somehow defend to do further investments into the industry. But today we are impacted by that supply-demand balance.
More specifically on the margins in your current backlog, how much more info orders are you expecting to meet your margin guidance this year and also for next year? If you do not receive more orders, what do you expect your margin outlook to be for next year? Would appreciate if you could provide us any comments around your margins.
Yeah, but that's a bit too early. We cannot give you any margins for 2019 because we don't know yet. I can also not give you a specific margin looking at our backlog. There are definitely projects in the backlog that are not negatively impacted by supply-demand balance in the industry right now. The last one we got, Hornsea 2, there is an element of that. There's still solid profitability in the majority of our backlog that we will execute on this year, but also going into 2019. Bear in mind that the preferred bidder contracts have been there for a while, and we expect them to be turned into real orders in the second half. That's the flavor we can give you.
Okay, thank you. Just one brief last question then. What are you guiding for CapEx this year then? I appreciate you've tried to keep a tight handle on CapEx.
We're not exactly guiding on CapEx, but I think that average levels of what we had done in first half and then second half will probably be less. I think that's what we can say.
Any comments around working capital excluding new orders for Q3 and Q4?
No, it is the same sort of dynamics that is driving working capital. If we want to improve working capital, it is important to get new orders and get the prepayments that Kristian was alluding to. The applications business is more stable, building inventory and working capital in these two quarters that are relatively high season, and then as a normal seasonal pattern, reducing it towards New Year. So it is a requirement to improve working capital from here to get new projects.
Okay. Thank you very much. Very clear.
As a reminder, if you wish to ask a question, please signal by pressing Star one. We will take our next question from Claus Almer from Nordea. Please go ahead caller, your line is open.
Thank you. Also a few questions from my side. First of all, the Triton and the Moray East projects, it seems like you have expanded the possible value from these projects. Is that correct, and why is that?
No, that is not correct. Unchanged value there.
But didn't you normally use a value of EUR 245 million as a combined value, and now you are having a range for the Moray East project. So that's actually in the upper end, it will be more than EUR 245 million at least.
Yeah, EUR 245 million is the minimum value.
Okay. So, okay. So no—
But—
Sorry?
Situation is unchanged.
Okay. Then coming back to your full year guidance. You are now aiming for the lower end, but also saying you need to sign some more orders, not large orders, but more orders in the latter part of this year. Can you provide some magnitude of orders you need to sign or a win rate expected or more color on this part?
It is a little bit difficult, Claus, but we are still working on orders that we hope will impact the fourth quarter. We are, of course, given where we are today, we are not talking about big money. We are maybe talking about EUR 3 million, EUR 4 million, EUR 5 million kind of thing. But that is, of course, also important to get in, with the guidance that we have. EUR 3 million, EUR 4 million, EUR 5 million can be a result of getting more orders. It can also be a result of very smooth execution in projects, et c. So there are some pluses and minuses in that. But of course, the more orders we get in, the better we are, not only for 2018, but also 2019. So that is somehow the magnitude that we are talking about.
On EBITDA level, I guess.
Yes. Sorry. On EBITDA level.
Okay. That was actually my questions. Thanks, Michael.
You're welcome.
As a final reminder, if you wish to submit a question, please signal by pressing Star one. We have a follow-up question from Claus Almer. Please go ahead.
Thank you. I just forgot to ask another question regarding your backlog. It seems like that you have won some smaller deals that have been included in the backlog. Is that correct? Is this a project in Canada or what has actually happened in the below announcement limit?
Yeah, that is correct. We also win smaller orders that are not meeting the threshold for announcing to the markets. It is not projects in Canada. It is projects in the core markets, in the Nordic region, et c. We tend to focus on the bigger ones here.
Sure. Those small orders, that is the ones you are talking about not being impacted by the current imbalance between supply, demand.
No, that is not what I said. Of course, you also need to be sharp on your price there. They are smaller projects, which is also managed under a different structure. It is not a structured tendering process. There is also variation orders that we managed to get on existing projects that are contributing healthy to our margins, etc . So those kind of things.
Okay. Thanks, Michael.
It appears there are no further questions at this time, so I'd like to hand the call back over to the host for any additional or closing remarks.
Good. I have not so much more to add. Thank you for this call. We will be back on November 15th, with the announcement of our third quarter results. Thank you everybody for listening in. Goodbye.
Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now disconnect.