Welcome, and thank you for joining the DEUTZ AG first quarter 2020 results conference call. Throughout today's recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. If you would like to ask a question, you may press Star, followed by 1, and you are switched to a telephone. Please press the Star key, followed by 0, for operator assistance. Now I would now like to turn the conference over to Leslie Iltgen, Head of Investor Relations and Corporate Communications. Please go ahead.
Welcome and good morning. Welcome to our conference call on the first quarter 2020 results. My name is Leslie Ilgen, Head of Investor Relations and Corporate Communications at DEUTZ. With us today is our CEO, Dr. Frank Hiller, and our CFO, Dr. Andreas Strecker. Mr. Hiller will give a short update, as always, on the business and point you to the key highlights of our first quarter results. Whilst Mr. Strecker will then cover the financials in depth. As always, both will be happy to answer any questions you may have in our Q&A session at the end of this call. Also, let me remind you that this call will be recorded. A replay will be available on our Investor Relations website after this call. Before I hand over, please also pay attention to our usual disclaimer that you will find in the presentation.
It is now my pleasure to hand over to our CEO, Mr. Hiller. Please go ahead.
Yeah, ladies and gentlemen, warm welcome to our conference call on the results for the first quarter of 2020. Overall, we can say that DEUTZ is facing a challenging situation by the coronavirus crisis, for sure. We have also some effects by the new emission regulation and the prepay effect, but the major topic here is the coronavirus, and we have a double-digit percentage decrease in new orders and unit sales and revenue. Also, the EBIT margin falls to a minus 3.5%. We have a significant drag on our operative activities in the first quarter, but also now in the second quarter. In April, beginning of April, we had to stop our production more or less completely for around two and a half weeks. Already in the first quarter, we had a lot of implications by the coronavirus in China.
We had to stop our production in Spain for some time and also a lower efficiency in our factories in Germany by the demand of keeping the distance of the workers. On the other side, very positively is that we have a profitable service business, which is still growing also under these conditions, and the increase was by 2.9%. We reached a turnover of EUR 92.4 million on our service business. Also, our China strategy is good on the way, so we are processing according to plan, even if the first quarter was quite challenging in China. A lot of the work for the project has to be done out of home offices, but the team between DEUTZ and SANY is really working very closely together, and we are on time plan. We have started an efficiency program two months ago, Transform for Growth.
This is now in the detailed work on the measures. A catalog of different measures is now put together, aiming on further improvement on efficiency over the whole value chain, including reduction of operating costs, shared services. Automation and digitalization are the big topics. Also, optimization on production on the further global production network will be done. I think we can start with the implementation of the first activities in two months, and we will keep you updated on the effects and the opportunities we are following with this program. Together with the management team, we have defined a vision of success for 2020 in an outstanding pandemic year.
Besides performance targets and strategic targets, which we have every year and which are defined also for the year 2020, we think it's important to add also additional targets for this year to go in a smooth way through the crisis. Therefore, we have defined this vision of success 2020, which works towards our different stakeholders. This means for customers and dealers, for example, to keep up our performance, especially on the service side. It's also in the direction of our employees. For sure, the most important thing is safety and health here, also clear communication. Another stakeholder here, which is important for us, is the supplier, the supplier base. We will see in the future, I think, really challenges on the supplier base because our suppliers are normally also suppliers to the automotive industry.
It is our clear intention to treat them fair also in the crisis, to have a robust supplier base also in the future. On the shareholder side, for sure. Having a closer look on EBIT and especially on our cash situation, and also to go on with the most critical elements for long-term company success on the product process and technology side, for example, things like our China strategy, electrification. There will be no change, clear focus also during this crisis time. For sure, also on the society, to support the society with our equipment to build up the necessary infrastructure and also to support on the health side. We did quite a lot on this by sending masks to hospitals and things like that. I think besides performance and strategic target, that is also an important topic for our company in the year 2020.
On the guidance side, so this for 2020 remains still under review. It's too early to say anything on this. I think especially quarter two will be very important for that topic. I'm changing now to page five, sales figures. You see here the sales figure for new orders, a decline of nearly 31%. On the unit sales, a decline of minus 16%. This is positively influenced by the products of Torqueedo. Here we produced and shipped more than 8,500 motors to our customers. This is an increase by more or less five times by a new product line. For sure, this product is on the revenue side, not contributing to the average. This gives a negative product mix effect. This is also the explanation why revenue dropped down much more than unit sales.
Drop of minus 25% and means overall a revenue amount of nearly EUR 340 million. Orders on hand on March 31 was on a level of nearly EUR 270 million, a clear drop from last year coming from around EUR 500 million. Looking into the regions on page six, revenue by region, you see that we are mainly affected by Asia-Pacific region and Americas. Asia-Pacific, for sure, was very heavily affected by the corona crisis in Q1. In Americas, this effect was not on the customer, on our direct customer side so far. It's more on the end customer side. End customers in the U.S. are mainly rental companies, and they react very quickly. When they recognized the amplifications of the corona crisis, they more or less stopped their orders. Therefore, we have a very sharp drop down in Americas.
Yeah, under the conditions of this crisis, more or less Germany is, I would say, more stable and Europe. We will have a closer look on Q2 in the next weeks. For sure, there will be some more amplifications because a lot of customers have had also shut down their production in April. Revenue by application segments on page seven. First of all, here you see the nice development on the service side. It means that all our measures we are taking on the service side are paying off. On the material handling side, we have the sharpest drop down, and this is also very much related to the American business rental companies behind. That is the reason for that. Agricultural machinery dropped down of nearly 36%. This is also affected because a lot of our customers, they are sitting in crisis areas of the coronavirus, for example, Italy.
We had here some really tremendous impacts. Construction equipment minus 26%. That is it so far from my side, and I will hand over now to Andreas Strecker for the key financials in detail.
Hey, good morning from my side as well. We continue on page nine with operating profit and net income. We've seen a negative EBIT of EUR 11.8 million in Q1 2020, which is a drop from previous year numbers, driven mainly by this sharp fall in revenue caused by the coronavirus crisis and also the customer selling the inventories of pre-buy engine from last year. With the reduced volume, also we've seen these economies of scale in our factories. There also were some continuation agreements with suppliers that go through insolvency proceedings. We see the tail end of that. Good news is we continue to receive materials from these suppliers. Reduction in net income resulting from decrease in EBIT. We've seen a positive income tax situation through tax income.
If we go to page 10 with the two segments, compact engines and customized solution, we've seen that the new orders were more affected on the compact engine side through situation in the U.S., as an example, whereas customized solution was much more stable with -4.5% order intake. On the EBIT side, driven by volume reductions and the insolvency proceedings, the segment compact engines was significantly affected with an EBIT margin of -6.5% as opposed to a profit in the first quarter of 2019. On the customized solution, we still have a very solid EBIT margin of 11.1%. If we go to page 11, the segment other comprises of Torqueedo and [Fort Harvis] mainly. Therefore, we've seen that new orders were increasing by 5.4%. Very good development on the Torqueedo unit sales to 8,500 units.
Big increase in revenue and improvement in EBIT, also positively influenced by the deconsolidation of [TAMSA] that we had in Q1 2019 that caused a loss in that period. Overall, Torqueedo had quite a good development in Q1 2020. If we look at page 12, the R&D spending slide increase was expected and planned as we work on e-D EUTZ products, China for developments, and the further extension of the product programs. On the capital expenditure, we have seen that we had extension of leases and replacement of expired leases. We have a strong look at all expenditures as we speak. On page 13, working capital was increasing compared to December 31, 2019, which is no surprise because at the end, usually working capital ratio is quite favorable. The increase to 18.3% is lower than we anticipated.
Also, we have a very strong eye in conserving cash and introduce working capital as much as possible. The cash flow from operating activities is negative, mainly driven by the reduction in operating profit. If you look at page 14, there you see the free cash flow at EUR -35 million and comes driven by the cash flow of operating activities. The net financial position, same reason. Also there, an increase in lease liabilities that we've seen here. Page 15, we see the equity ratio and funding is still very healthy at plus of over 50%. On the funding side, we continue to have our [syn] loan, EUR 160 million as in the past that runs over a long period of time. Nevertheless, we are in discussions with our banks to receive an additional credit line in the low single and triple digits euro.
Discussions are ongoing just to be on the safe side that we continue to do what we need to be doing to secure also further funding of future activities. With that said, I would hand back to Frank Hiller for the outlook for 2020.
Yeah, ladies and gentlemen, as already mentioned several times, there is a clear impact of the coronavirus crisis on DEUTZ. For the timing of our guidance for 2020, there is no timeline right now because it is too early and very difficult to predict. Together with the supervisory board, we took the decision to propose in the annual shareholder meeting to suspend the dividend payment for 2019 to keep financial stability. On the other side, as Andreas Strecker mentioned, we are currently in an advanced stage of negotiations about obtaining a further credit line for a low triple-digit million EUR amount. Despite the coronavirus crisis, growth projects are to continue being implemented as planned. These are, I would say, the big levers after the crisis: our China strategy, electrification, and all the activities which go towards increasing our profitable service business.
Maybe so far from our side, and we are open now for your questions.
Ladies and gentlemen, at this time, we'll begin the question and answer session. Anyone who wishes to ask a question may press star, followed by one on their touchscreen telephone. If you wish to remove yourself from the question queue, you may press star, followed by two. If you are using speaker equipment today, please leave the handset before making your selections. Anyone who has a question may press star, followed by one at this time. The first question comes from Charlotte Friedrichs of Berenberg. Please go ahead.
Hello. Thank you for taking my questions. Three, if I may. The first one would be if you could give us a bit of color on current rating. I know the visibility is low, but what are you seeing right now also in terms of order intake, commentary from your customers, etc.? Second question would be around potential for cost reductions. Do you already have an idea of what magnitude of cost savings you could generate with your cost-cutting program or roundabout where is your fixed cost base, break-even number of engines, etc.? Then thirdly, on the customer—sorry, on the supply situation, could you give more detail on the continuation agreements that you have with some of your suppliers?
Okay, maybe I start with the current rating. To be honest, this is very volatile, and a lot of our customers had shut down their factories for several weeks. Now, this is more or less recovering now in Europe. We see quite a good situation in China. China, more or less, I would say, is back on 70-80% before the crisis. Europe is—we have to see the next two weeks. It's too early to predict. U.S. is, I would say, very low right now.
Okay.
Cost reductions, break-even point. We had in 2019, our break-even was roughly in the neighborhood of 150,000 engines. We are working strongly now to bring that more in the direction of 140,000 engines. We have reduced apples to apples 250 people since the beginning of the year. We also have strict expense controls. Every invoice or any planned expenditure above EUR 5,000 goes over my desk at the moment. We are working hard on it. The program transformed for growth. I think in the next couple of months, we will be able to bring more detail to that. Supply continuation agreements, we have [good work] in Leipzig and Saarbrücken. They run until June 30. They are finished at that point. The same with the supplier of [Weber] runs until the end of May. That would be the end of continuation agreements in insolvency proceedings.
As I said earlier, we receive a very, very steady supply of parts from these suppliers, which is positive.
Okay, thank you.
The next question is from Frederik Bitter of Hauck & Aufhäuser. Please go ahead.
Good morning. Thank you very much. Good morning, gentlemen. I would be very interested to hear a bit about the inventory. What do you think, or what you hear, what you see are sort of the inventory levels at your key customers, including, I think it is very crucial, also the pre-buy engines? If you could share any light on this one, it would be very appreciated.
On the inventory side by the pre-buy engine, this was an effect overall of around it goes over two years, and it was around 35,000 engines and over two years, around EUR 200 million. What we had out of the year 2019, this will be more or less finished. This first EUR 100 million will be finished at the middle of this year. For the year 2018, this will be finished at the middle of this year. The pre-buy engines out of 2019 will be finished mid of next year. We think it will be around maybe half of this 200,000 means 100,000 is still on stock on our customers. That's what we predict.
Yeah. Obviously, if you say mid next year, 2019 pre-buy engines, that obviously is not what sort of the whole market demand obviously would be, but it's rather it's been phased into next year, I assume. It will be slowly reduced.
Yeah, it will be slowly reduced, for sure. This is now the regulation, and we hope that there will be no postponement in the regulations. Some of our customers are working on having some new regulations so that this could be also suspended for some months. This is now the regulation. It goes 18 months. Mid of next year, it will be finished.
Yeah. Okay, sure. Thank you very much for the insight. Another one I have as well is, do you still expect the cash in from the property sale of about EUR 60 million or so, if I have it correctly in my mind, this year? If so, what quarter do you think you will receive the cash in?
Yes, we plan to receive it this year. It will be in the fourth quarter of 2020.
Okay, great. Thanks. The last one I have for now, and I have some others, but maybe I'd like to stage with other questions. Could you tell us roughly where your covenants are, financial covenants?
The covenants from the credit agreements we have right now, it's 2.5. Maybe we are way, way below that. There is, as we speak, headroom sufficiently. Nevertheless, it's a measure of precaution we are discussing with the banks to increase the lines, as we speak.
Yeah. No, obviously, you still have financial credit clearly. Just wondering, do we need to take into account any adjustments on the net debt or [ EBITDA] side? Say net debt, for instance, adjusted for IFRS 16, or the [EBITDA], are there certain factors we should exclude as regards to covenants definition?
I mean, there's a clear understanding with all banks at the moment and all clients that in the current environment with corona, when companies have reduced results, that they would not hold it against anybody in the next month to say, "Look, we have a covenant issue now." That is, I think, for 2020, that is not an issue if companies in general would come closer to the covenants because the results go down. That is a clear understanding between companies and all banks that 2020 is, at the moment, a clear exception.
Yeah. And Net debt, is it excluding IFRS 16 effect or?
It's including.
Okay. Cool. Okay. I suppose the EBITDA is on a rolling four-quarter basis for the last 12 months, if you want to.
Yes. Yes.
Okay. That makes a lot of sense. Okay. It is not moving as fast, right? Okay. The last one, actually, on this one, the two- and- a- half times, is that a hard covenant, or is that something you would have an upcharge on the interest rates should you cross two- and- a- half times? If maybe, I do not know, there is maybe an early termination clause, maybe, I do not know, obviously, a higher rate?
There are brackets. Mr. Bitter, there's a grid when you are at 0.5 and at 1 and 2. There is a slight increase depending on which bracket you are in. That is industry standard.
Okay. Sure. Got it. Great. Thank you very much.
Yep.
As a reminder, if you'd like to ask a question, please press star, followed by one on your telephone keypad. The next question comes from the line of Richard Schramm of HSBC. Please go ahead.
Yes. Good morning, gentlemen. I have a follow-up on this supply chain issue with [GKN] support in Leipzig. I'm not sure if I understood you correctly, but the deliveries are running until mid of the year, and then you will change to another supplier? Or how will it work with the current insolvency of these two suppliers here?
Yeah. We receive parts from [GKN] both locations until June 30. In parallel, we have built up a second source already. With the corona crisis, then the new second source in Turkey and Spain were also shut down due to corona. We elected to extend Saarbrücken by another quarter just to be sure that we get parts because, again, the new source was shut down by governments, and that is why the extension came into effect for Saarbrücken. The second source build-up is running completely as planned.
Right now, Mr. Schramm, I think that the biggest challenge is on the customer side. There is no risk on the supply chain by our suppliers. It is more on the customer side. Low number of demands.
What comes to a problem is now a lot of shifting orders on the customer side because they have also some shortage with some other materials. They are shifting also the engine types on our side. It is more on the outbound and less difficult on the inbound.
Okay. Just let me summarize. These [GKN suppliers] in Leipzig will be replaced by mid of the year by your two new suppliers in Spain and Turkey, right?
Among others, yeah. I mean, we spread it to more suppliers because there were many parts. As an example, as two of these selected suppliers were shut down, we elected to continue with [Weber] for another quarter.
Yeah. Maybe I have missed this, but did you mention how much of extra cost this cost in Q1 and what to expect for the full year on additional costs from this side until this change is now completed?
Yeah. We had north of EUR 6 million in Q1. It will be a little bit less in Q2.
Okay. I have also another follow-up on this pre-buy engines you mentioned. Did I understand you correctly? You mentioned 100,000 units because of.
No, EUR 100 million. EUR 100 million in revenue.
In revenue. Okay.
Yeah. Yeah.
In unit terms, it's, of course, then I thought.
15000 to [20,000].
15,000-20,000.
Exactly. Yep. Correct.
15,000 to 20,000. Okay.
Yeah.
The last point I have concerning your investments. You mentioned that these were pushed up by new leasing agreements. Is this then net figure, or are all new leasing agreements going into investments on a gross basis here?
We have to show all the future liabilities that we have out of the leasing contract, yeah, in that number.
Is this increase then only a quarterly issue and will level off over the year, or should we expect for the full year in general?
Yeah. I think as we go forward and we are reducing overall spending, we will not see that the increase over the whole year. I think what we've seen in the first quarter is also an overflow of things that we did not fully pay in 2019, when the money outflow was in 2020, in the early months of 2020. That is not anything you should take time for. It will come down in the next quarter, the difference to previous year.
Okay. Thank you very much.
There are no more questions at this time. I hand back to Leslie Ilgen for closing comments.
All right. Yeah, thank you, everybody, for joining the call today. Should there be any follow-up questions after this call, do not hesitate to contact us, as always. We are happy to answer any questions you may still have. Other than that, I wish you a great remainder of the day. Cheers and goodbye.
Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.