Earnings Call: Q1 2020

May 8, 2020

Good morning, everyone, and welcome to the first quarter presentation of Kongsberg's results. You will get results presented by our President and CEO, Geir Håøy, and Executive Vice President and Chief Financial Officer, Gyrid Skalleberg. Since this is only a webcast of the presentations, you will have to submit the questions through the webcast. You will find a button to the bottom right corner of the webcast where you can submit questions, and please fill in also your name and company. I'll now hand over to Geir Håøy to present the results. Yes, thank you, Jan Erik. Good morning, everyone. Welcome to this first quarter presentation. As we can't meet physically, I'm very pleased to see that so many of you have logged on to this webcast, and I hope that all of you are well. Let me start with some reflection on this extraordinary situation. I have, in the previous quarters, stated that we see a more challenging and uncertain time for the global society, and that was even before the COVID-19 pandemic impact. Now the new current situation underlines that we are an international and connected world. Many restrictions have been imposed, creating unpredictability and more uncertainty for countries, economies, and individuals. When these are the circumstances, as a business, I'm really grateful to see that we have employees, customers, and other stakeholders which are able to adapt to a rapidly changed new normal, and that we have technology that allows us to do so. Kongsberg's key priorities in this extraordinary situation are, first and foremost, to safeguard the health and the safety of our employees. We are going to do our utmost to deliver on our obligations to customers, and we will make the necessary efforts to ensure financial robustness. We implemented extensive measures to adapt to the situation during this quarter, and we are prepared to take further actions if the situation changes. Before I give you some more details on how we have been impacted and the measures we have taken, let me just ensure you that Kongsberg, as a company, is robust, agile, and adaptable, and we will withstand these challenges. We will meet this situation in the best possible way, ensuring the interests of all our stakeholders. That said, Kongsberg is impacted by the COVID-19 pandemic, like several other businesses. We took immediate measures when the virus first started to spread in Asia, impacting our offices in China and South Korea. Since then, we have taken further steps to reduce costs, to protect our operations, and to support proactive value-creating initiatives. We have adjusted our capacity globally, both through temporary layoffs and other measures such as salary reduction. Full-time working man-hours are temporarily reduced, currently affecting approximately 715 positions globally. We are also confident that it's now vital to accelerate national and international programs and initiatives, which generate activity and value creation to mitigate some of the economic impact due to the pandemic. This way, we can safeguard jobs and continue the roadmap for a more safe and sustainable world as a whole. Kongsberg is working closely together with other key industrial players and governmental bodies on several initiatives. We are hands-on to an even larger extent than before, as we feel that the situation demands increased stakeholder attentiveness. We are reviewing and postponing certain internal projects and directing the focus elsewhere. Our board of directors has proposed to the General Assembly to put the extraordinary dividend on hold. When that's said, financially, as you will see, this quarter has not been impacted greatly by the COVID-19. Despite challenges related to COVID-19, Kongsberg delivers a strong quarter. We have growth in all our business areas. As most of you know, we ended 2019 with a very strong order backlog, which gave us good speed in coming into 2020. We have continued to deliver on this in the quarter. Our defense business has a solid order backlog and is still experiencing good activity. We have got some important call-offs on our significant frame contract agreement with our key client, such as the Kraus vehicle program to the US Army. We have a call-off of approximately $500 million in the quarter, and the NSM over the horizon to the US Navy, where the call-off was approximately NOK 200 million. Our maritime business is impacted more by COVID-19 than our defense business. Still, we see solid order intake in the quarter. I'm particularly pleased to see that we already see revenue synergies or crossover sales in the new KM due to our expanded maritime product portfolio. This was part of the rationale when we acquired Commercial Marine. The sale of the underwater technology company Hydroid was completed at the end of March, providing us with solid cash flow. We will come back to that later in the presentation. The integration of Commercial Marine is going according to plan, and we maintain our accelerated ambition to achieve annual cost savings of $500 million already within this year. I'm also pleased to see that our digital business maintains its strong position in the market, despite a market with stable order intake and increased revenue. Despite the challenging oil and gas market with extremely low oil prices, we see that the market is showing growing interest in our digital solutions. Among others, these enable customers to monitor and perform operations remotely, which I believe has been underlined further in these times with extensive travel restrictions and social distancing rules. The key value proposition, however, is still that they significantly contribute to optimizing customer operations in general. I will leave the floor to our CFO, Gyrid Ingerø Skjaldberg, to take us through the financial status. Thank you, Geir. Good morning, everyone. Stay safe, stay healthy. I'm happy to announce another great quarter for Kongsberg. But, and it is really a but, we are in uncertain times, and we need focus. Unfortunately, we are not able to give you the guidance on outlook that we normally do because of these uncertain times. Before we worry about the future, let's look at the figures this quarter. The Q1 figures are only to a limited extent impacted by the COVID-19 situation. Let's start with the top. In the corner on your left-hand side, we start with the orders. Kongsberg had an order intake of $6.8 billion the three first months of 2020, an increase of 86%. If we add on the Commercial Marine first quarter last year, the increase was still 21%. We have increased order intake in all business areas. Kongsberg Maritime had a growth of $500 million, while the defense area had a good quarter with new contracts, and the digital got several contracts on the energy side. We have a book to build ratio of 1.02 this quarter. If we go to the next, you can see the revenue. I have earlier said, "Look at this," and I say it again, 93% revenue growth. Even if we take out the acquired growth from Commercial Marine, we still have a 25% growth this quarter, of course, also helped by the weak Norwegian currency the last weeks. Kongsberg collects 82% of our revenue outside Norway. So all in all, NOK 6.68 billion in revenue from the first three months. If you look back, this is already half of the revenue that we had in 2018, only 15 months ago. Looking at the EBITDA, we delivered an EBITDA of $640 million with a margin of 9.6% this quarter. That's up $290 million from last year. The margin is somewhat down compared to the first quarter of 2019, as Commercial Marine was not part of Kongsberg Group last year. Kongsberg isolated has delivered a healthier margin than Commercial Marine. But up from the end of 2019, as we delivered 9.2% EBITDA margin in 2019. You should also be aware that in these results, we have booked $39 million in integration and restructuring cost. Looking at the EBIT, $300 million in EBIT, up from $120 million last year. We have now closed the final purchase price allocation from the acquired company, Commercial Marine. So the figures you can see in the quarterly report are the level of amortization that you will see throughout 2020. Looking at the orders, the order backlog increased by $1 billion from year-end and up to $33.3 billion. Out of the order backlog today, 42% will be delivered already this year, meaning that $14 billion will be transferred to revenue. If we add on the revenue from this quarter, we have $6.7 billion, adding on $14 billion, we have a speed now of $20.7 billion on the top line. Normally, you can also add on revenue from the aftermarket that we normally have about around $7 billion for a whole year. Last year, we had revenue of $23.3 billion if we deduct Hydroid that we sold this quarter. So we still think it will be possible to grow in 2024 Kongsberg, but having said that, it's cloudy out there. Looking at the cash flow, yes. Normally, I comment on cash flow at the end of my presentation. In terms of COVID-19, our strong balance sheet needs some comments. We ended last year with cash at bank of $5.65 billion. On February 4th, we announced the sale of Hydroid, and on March 26th, we received $3.6 billion from that transaction. The investments this quarter have only been $180 million, as we have put some of our development projects on hold due to the uncertain situation. Bonds of $550 million have been repaid, and shares for the employee program have been purchased. Last but not least, cash from operations of $940 million consists of the EBITDA of $640 million and change in working capital of $400 million. I want to bring your attention to the working capital with positive development of $400 million. That amount consists of received cash from the NASAM Qatar contract of $1.4 billion on the invoice prepayment from December, while trade receivables in general actually have increased by $500 million. In our cash position as of March 2020, you should be aware that we have almost $3 billion in prepayments from customers, and the cash also includes tax related to the Hydroid sale that has not yet been paid. Mid-May, we will also pay out 2.5 Norwegian kroner per share in dividend, in total $450 million. Hydroid transaction. Sometimes it's all about timing. All the cash from the transaction is already received and at our account. After federal tax and state tax, we have approximately $3 billion left. In addition, tax will occur in terms of the allocation of funds. In our quarterly report, you will find more details on cash flow and accounting gain in note 13. Working capital. Since the working capital is developing quite differently in the two business areas, it's more valuable for you when we split. If you look at the graph down here, you can see Kongsberg Defense and Aerospace. As our defense division has received prepayments from customers throughout first quarter, where Qatar is the largest one by $1.4 billion, we now have a negative working capital of 25% at the end of first quarter. In maritime, you can see an increase in trade receivables of $500 million. Out of that, $200 million is currency-affected, and increased activity during first quarter has increased the outstanding with approximately $300 million. We have not seen major challenges with customer payment in March, but follow-up on payments from customers are a number one priority these days. The working capital is still at a very comfortable level, but as I said, this is what we keep an eye on on a daily basis. Some more about the cash focus. After the capital increase, if you look back here, you can see the fourth quarter '18 and the first quarter '19. After a capital increase, when we acquired Commercial Marine, the focus was to turn that loss-making unit to be positive. A successful integration with a very focused organization came out with positive contribution already from the second quarter in 2019. At our capital markets day late September, we said that we will aim for a net debt EBITDA of 1 and a range of plus-minus 1. We started that journey. Then we had a successful fourth quarter and the sale of Hydroid in this quarter. On top of that, we have now collected payment from defense customers for almost $3 billion. With uncertain times ahead, we are at the moment comfortable that we have a solid position to meet the next quarters while we monitor the development regarding COVID-19. To give you a rule of thumb, last year, Kongsberg Maritime had $16 billion in revenues. So delays in payment from our customers are number one focus. Days outstanding on the customers today are approximately 60, meaning that the working capital will increase with approximately $1.5 to $2 billion if all the customers delay their payments with approximately one month. So this is then probably the most important KPI to calculate going forward. Looking at return on capital employed, we deliver a return on capital employed of 10.2% this quarter, despite the increase in capital employed, as we now have full year with Commercial Marine added. Let's look at Kongsberg Maritime. Kongsberg Maritime got NOK 4.8 billion in new orders this quarter, with a book to bill of 1.02. This is a 12% growth in order intake and an increase of NOK 500 million. Order intake in maritime had cancellations of approximately NOK 300 million this quarter, mainly from the Norwegian company Hurtigruten. The value of the order backlog is also increased in terms of currency, as we have had a weak Norwegian krone the last weeks. An example to explain: If we have an order backlog in Rauma in Finland, for example, the order backlog is in euro. In NOK, the value of that order has increased. Out of the order backlog of $12.4 billion, 61%, you can look at that on your right-hand side down to the corner, are for deliveries in 2020. That is $7.5 billion. In the first quarter, maritime delivered a revenue of $4.8 billion. That gives a run rate of $12.8 billion before aftermarket. As I said, normally, we have at least $7 billion in the aftermarket for a full year. Looking at the split in order intake, you can see that the first quarter, we added on $4.8 billion in new orders, and that came from global customer support. Integrated solution has one large contract that's Mystic Cruises that is expedition vessels. You can also see that almost 40% of the new orders are from global customer support. If you compare that to the last three quarters last year, you see that we had 42%. But what we know is that we still have a strong position in the aftermarket, and that has continued throughout 2019 and also into the first quarter of 2020. Maritime has a growth of 139%, including acquired company. If we put on pro forma figures for the last year, Maritime still delivers 20% growth in a very uncertain market, mainly driven by growth, as I said, in the aftermarket, propulsion and engine, and integrated solution. Maritime delivers $390 million in EBITDA this quarter, and in addition, Hydroid delivered $40 million on top of that. Hydroid is reported as discontinued operations as the closing already has taken place. With an EBITDA of $640 million for the group, Kongsberg Maritime has a very strong first quarter 2020 by delivering 60% of the group EBITDA for this quarter and doubled the EBITDA since last year. The margin of 8.6% is affected by $39 million in integration cost and revenue for the all Commercial Marine that had lower margins in the order backlog that we have included and delivered on this year. Even with that, maritime is up from 7.8% last quarter, which also was a very strong fourth quarter. The EBIT margin is down from 4.5% last quarter due to a write-down of $45 million in maritime. That's on an R&D project underlying its healthy development also in the EBITDA margin. My EBIT margin, sorry. Then the value capture. As you know, we measure annually effects. For 2019, compared to 2018 baseline, we realized $260 million last year in annually cost savings. For the first quarter, we have an annual effect of $135 million. So on track to reach annual savings at $500 at the end of 2020. We can also confirm that all the 450 employees that we announced we should scale down after a plan when we acquired Commercial Marine now have left Kongsberg. In addition, we have launched several new headcount reductions during 2019 and also new headcount reductions this year. We are working on the streamlining of the product portfolio at the moment, and almost all planned activities in our value capture program have now been launched in one way or another. Here we have provided you with details, so it's possible to calculate and follow the process and areas that we announced efficiency plans on one year ago. Integration and restructuring cost is also just provided a slide, so you are able to calculate and follow the plans that we announced one year ago. To the defense area. Increased order intake compared to first quarter last year and continue high order backlog. 30% of the order backlog will be delivered this year, so almost $6 billion. On top of that, $1.9 billion in revenue for the first three months. That gives a run rate of approximately $8 billion at the moment. Compared to revenue of $7.2 billion last year, delays can occur in deliveries in terms of supply chain, and travel restrictions can influence and delay new negotiations. Otherwise, defense has seen limited financial impact of COVID-19 year to date. Order intake of $1.7 billion, mainly driven by orders on CROWS in the land business and on the over-the-horizon contract in the missile division this quarter. We also received orders on the C-UAS anti-drone system, a framework contract that we have with Germany. Book-to-bill in defense for this quarter was 0.91. Revenue growth of 42%. $127 million also from the acquired company AIM last year. If we deduct that, they still have 32% revenue growth. The revenue growth is driven by the large programs on air defense system, Qatar, the F-35 program, and the crows program. Defense delivers $240 million in EBITDA with margins at the same level as last year. EBIT margin is up compared to the first quarter last year, but KDA normally has a weaker first quarter than a fourth quarter, which is normally the strongest for our defense area. Back to more business updates. Thank you. Thank you, Gerid. Then we go into some more business update details. Kongsberg Maritime business was moving in a sound direction in a somewhat challenging market going into this quarter. We have already touched upon the sale of subsidiary Hydroid sold to Huntington Ingalls Industries, which is the number one US shipyard to the US Navy. At the same time, we are also entering into a strategic alliance agreement with Huntington related to underwater technology and other maritime solutions. This strategic alliance was effective from the date of the transaction, and we have already kicked off the cooperation, and I think both parties agree that we see several opportunities ahead. We are also continuing to strengthen our position as a key maritime contender, as our contract scope and contract design are increasing due to this extension of our product portfolio. As Gerrid already mentioned, our largest contract in this quarter was for the three plus one expedition vessels to Mystic Cruises. As the COVID-19 pandemic has spread worldwide, governments have implemented a number of wide-range measures and restrictions to mitigate further spreading of the disease. This has contributed to curbing international trade, hindering flow of goods, impacting the maritime industry. Kongsberg has, as mentioned, taken several steps to reduce cost and adapt to the situation, also affecting our maritime business. I think we now see clearly that the benefit from our international setup with offices in 40 countries enables us to stay close to the customer and solve many of the assignments locally. We have also been able to provide services to our customers due to our worldwide remote support solution. I would like to underline that we are experiencing a highly solution-oriented attitude among our customers and partners. The maritime industry is working together proactively with governmental bodies to find ways of generating activities and creating values. Our defense business had a solid fundament when entering the quarter with a strong order intake and a record high order backlog. This position remains strong and a record with good activity levels in all divisions. We are continuing to deliver on our programs signed in previous quarters. We are also progressing on ongoing campaigns. To mention a few, Norway-Germany submarine cooperation. TKMS has now submitted their updated offer where Kongsberg Defense is a subcontractor, and the contract negotiations are ongoing with the ambition to reach an agreement within this year. Linked to the same Norway-German cooperation, we have received a request for serial production of the NSM, and the offer is scheduled to be delivered before the summer. Then, of course, the negotiation will start after that. Here, also, the ambition is to reach an agreement before the end of the year. Patria shows a 12% growth on the revenue, and this is mostly due to the acquisition of the Belgium Engine Center. The EBITDA improvement is a combination of the acquisition mentioned as well as improvement from Q1 driven by the ongoing cost initiatives. In other words, we now start to see the effect of the cost-saving measures implemented last year. It's good news that Patria's 6x6 vehicle platform is now selected by the Finnish-Latvian-Estonia development program, and we are excited about that. In general, our defense business is affected by the COVID-19 situation to a lesser degree than our maritime business. It has not experienced major consequences so far, and our operations are progressing close to normal with, of course, some adaptation. However, Kongsberg is working to identify ways to sustain jobs and activity in the defense sector, basically in the same way as for the maritime sector. Our digital business delivers a good quarter as well. The area is experiencing a growing interest in the market for its digital solutions. Kongsberg has taken steps to ensure close dialogue with existing and potential customers despite COVID-19 restrictions for all parts of our business. One such example is the extensive digital marketing campaign, so-called webinars. Last week, we had more than 350 people tuned in to listen and learn during Kongsberg Digital Power Hours. A string of highly relevant webinars on digital teams and offerings has been presented in the market. Topics range from vessel insight to the digital twin technology to the digitalization of the maritime industry and several others. The webinars have, in several cases, resulted in concrete interaction with potential customers contacting us for proposals. Our maritime business has launched similar campaigns with the same positive feedback. In general, we see the benefits of Kongsberg digital and remote solutions becoming increasingly visible to our customers and other market players due to the current circumstances. We have stepped up and will continue to actively engage with the customer. Then to the outlook. COVID-19 has caused severe global disruption and tragic loss of life. It has had a significant impact on the world order, and we have not yet seen the full extent of consequences. This makes it very hard to predict how the market will develop going forward. In general, we see difficulties related to logistics and the international flow of goods, which might lead to delays in our supply chain further down the road. We also expect the current challenges for international trade to continue affecting the maritime sector. Kongsberg has not been severely impacted financially in the first quarter, as I said earlier in my presentation. Our solid order backlog in defense is expected, as Geir mentioned, to fund further growth in 2020, and we are continuing our campaign despite COVID-19. In the maritime sector, order backlog coverage is also good, and we have the important life cycle business as well. However, segments within the new build market will remain challenging. This we have seen over some time now, and we are not expecting this to be improving going forward. Of course, certain segments also in the aftermarket are expected to be impacted by the negative trend in the oil and gas market and, of course, low oil price. We expect our digital business to maintain its solid position, but we also here have to expect that the COVID-19 will have a certain impact in certain segments. Kongsberg has been able to maintain critical international operations even with this extensive travel restriction. This is due to having our office and our remote service systems and facilities in 40 countries. Even despite the challenging situation, our sales organization has managed to maintain its customer contact, and we are still tendering and signing contracts for all parts of our business. We do, however, anticipate seeing more of the COVID-19 effects ahead, and we are prepared for the situation to stretch out in time. Finally, I want to assure you all that we are monitoring the landscape closely, and we will implement further measures as and if required. This is to safeguard the interest of all our stakeholders. By that, I thank you for listening in on our presentation. I think we will open for some questions. So Gerid, if you would like to join me on the stage. We have some questions from the webcaster. The first three questions are from Kennet Sivertsen, Pareto Securities. The first one is, could you elaborate a little bit more on the after-sales and service revenues you see quarter to date so far in Q2, so to say? In Q2 or Q1? In April. Oh, okay. If you have seen any sign. We see still the activities in the aftermarket have been good in Q1, and we see also in April that it's actually on almost the same level. But we expect that this will be affected more as we go forward. And then the second question from Kennet Sivertsen. Could you also elaborate a little bit more on the level of prepayments? Yes. Prepayments have been mainly from the defense area, and of course, it's affected by the large prepayment from NASAMS Qatar that we got in mid-March this year of $1.4 billion. Normally, we have prepayments around $1.7, $1.8 billion in a normal situation. But due to that extraordinary large payment and also some other minor prepayments, we have a level now that's almost double what we have normally. We also got prepayments from Malaysia this year. Thank you. And the final question from Mr. Sivertsen. Finally, with the strong balance sheet you have, do you see any opportunities with regards to M&A in the current market environment? We are always monitoring the market, and of course, the current situation with the uncertainties we see now, and of course, also with, I would say, all the restrictions, of course, that makes it at least a little bit more difficult to be following up concrete. But yes, we are monitoring the opportunities closely, but I will not comment anything more on that for the moment. Okay. I have one more question that is from Kristoffer Møller Løkken Carnegie. This goes to the CFO. Could you elaborate a little bit around the currency exposure and eventually quantify as precise as you can how much a weaker Norwegian kroner has impacted your Q1 order intake or revenues? Yes. If you look at the order intake, it has increased by approximately $1 billion. Out of that, you can also have in mind that we have cancellation of $300 million in that, not in the, yes, in that order intake. Approximately $800 million has lifted the order backlog, but not the order intake, but the order backlog. In terms of the order intake from the defense area, you see that we normally secure the large contract, but in terms of the order intake from the aftermarket, we obviously have a positive situation around the currency or the weak Norwegian currency. So it's almost the aftermarket that is affected on that, both on the order intake and on the top line. Okay. And it came in one more question here. You mentioned the potential impact on working capital if there are outstanding changes. Can you comment on the day's development so far in Q2? And the question comes from Karl Mathisen. Yes. On Q2, of course, we just have very limited insight in the April results, but we don't have any bad signs on day outstanding that they are increasing a lot at the moment. But as I said, that's the KPI that we are monitoring very tightly and actually on a day-to-day basis today. Thank you. That was the final question from the webcast. Okay. Once again, thank you all for joining us.