Welcome to the Alfa Laval Business Update Conference Call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer session. I must advise you that this conference is being recorded today, Tuesday, 17th March, 2020. I would now like to hand the conference over to your first speaker today, Tom Erickson.
Thank you. Please go ahead.
Thank you very much, and welcome to our call. Thank you for joining us on rather short term alert. I'm here together with Jan Alde, our CFO. And the purpose of the call is to expand on the press release that you have received earlier related to the impact and risk that we see associated with the pandemic of the coronavirus. Let me start with a couple of introductory comments.
First, this is clearly a new situation for us as Alta Laval, but also for industry as large in terms of how to judge the effect on the global economy and our industrial sectors from a pandemic. We don't usually do that type of work. We are all to a degree guessing at this point in time. And today, we are anticipating certain developments, and that's what we will describe later on. Number 2, our primary responsibility in this from an industrial point of view is that we are a core supplier into a number of value chain in important industrial sectors.
And our primary responsibility through this is to maintain, deliver security, customer service and uphold our role in a reasonably functioning environment. And consequently, all of what we're doing and announcing today has as a primary focus to ensure that we continue to focus well in our day to day work in the order to deliver cycle that we are performing. And number 3, of course, we are deeply engaged in the safety and health of our employees. We had a well running crisis team since weeks back. We are working through, as you understand, a whole range of various jurisdictions and local rules and regulations as to how various governments and local health authorities want to tackle this crisis.
And we are following those guidelines and those procedures through the detail all across the world in all kinds of different operational environments. And so far, I must say, although we have isolated cases, largely our workforce is up and running and working so far up to the levels that we would have expected. So those are a couple of introductory comments to why we are here and the purpose of our call. Let me then go to the press release and a couple of observations on our business and what we intend to do. And let me start with quarter 1.
Let me say that quarter 1 in terms of January February was stable and well in line with where we were last year. Both order intake and invoicing is approximately on the same level after 2 months in the quarter as we were a year ago. It's a clear sign of stability. The March is not over. We have uneven order intake during the month, especially with a certain peak towards the end of the month.
So I don't want to speculate too much as to where we will be once the March is closed, but we do not have any clear signs that we will see big deviations compared to last year when it is in terms of the pace of order intake for March. Certainly, invoicing tend to be slightly more stable, so nor do I anticipate any big deviations on the invoicing side either. So Q1 as such relatively stable where we are, and Q1 does not drive the question of why we need to act at this point in time. The open question marks that we have is what is the longer, say, medium term business effect out of the coronavirus problem and not least all of the countries that today are in lockdown. And as you see, the industrial effects spreading from sector to sector, we simply have to anticipate in this point in time that also our end markets will be in the short- and medium term, at least temporarily be affected by the pandemic, and we have to anticipate negative effects on our order intake going forward, although those are not visible yet at this point in time.
Given that we are unsure of the magnitude and unsure of the duration, we have followed the following principles as to how we have designed our response program. First of all, we are focusing on fast and flexible actions. We don't want to have impact 6 9 months from now. We want to have impact on our cost lines in next week and next month. And secondly, we want to be able to implement the cost savings, and we want to go back to normal once time permits.
So fast and flexible is an important principle of the program. Secondly, we are putting, as I said, a very high priority to ensure customer service and full capability in the order to deliver cycle throughout this period. That means that the other activities are to a degree being put on hold. As you know, we have been running significant improvement programs at a relatively high cost, investing money in digital, in product development, in footprints, in Industry 4.0 and online activities. We are slowing the development programs and putting them a little bit on hold in order to put priority on the order to delivery and short term customer service aspects of our company.
Thirdly, we have a high priority to keep stability in our current workforce. We do expect coming out of this crisis that the well trained capable team that we have built up over a long period of time, not least the last 3 years, are highly efficient trained skills unique and absolutely needed for our long term development. And we do everything we can to maintain our current headcount the way it is, and we will focus on other ways of creating flexibility also on the costs that are relating to our payroll. And those are the principles that have been guiding us in setting up the program. Let me touch a little bit on what the components of that program is.
First of all, the scope of that is that we expect to reach a 12 month running rate in cost savings of approximately SEK1 1,000,000,000 related to fixed cost in the company. You can say related to our fixed cost as a whole, that is somewhere in the region of a 15% to 20% cost reduction, and we expect to ramp that cost saving from today and rather aggressively up and running in full speed within, let's say, approximately 3 months. That is our expectations. The components of the program is, number 1, work aggressively with the available reduced working time agreements that are available in many of our important operating markets. There are, since years back, very viable and functional programs available for reducing work time in countries like Italy and Germany.
They are also in certain jurisdictions implemented now as a crisis management tool from another of governments, including the Swedish government, we will negotiate and utilize those agreements in order to bring down working time and also significantly bring down our payroll costs without reducing the number of full time employees. Secondly, we will cut a lot in our external consultant and advisory projects. We are not in a position currently with a lot of people working from home, and we have to expect that the virus infection will spread to a degree, certainly among our own suppliers as well perhaps among our own staff to a degree, we are not ready, willing and able to run our development program at full speed, whatever we would like to do. So at this point in time, we're going to put a halt to a lot of the long term development programs. And I'm happy to say, as you all well know, that we spent the last 3 years with a significant investment into a number of areas.
We've come a long way in that plan. As you know from the last quarterly call, we closed the 1st 3 year plan. We are in a good shape in many areas. I would not argue that we are 100% completed, but after the long improvement program that we've been running, we've come far enough to be able to put things on hold without sacrificing any substantial part of the long term future of the company. Thirdly, we are putting a hiring freeze in place.
We do have an ongoing attrition rate. We have substantial amounts of open positions in the company as is. We will largely put a hiring freeze in place. It will have impact in the short term. Backfilling will, to a degree, stop, and we will see a slow reduction in the number of headcounts in our company without terminating people proactively.
4th, we will stop a lot of our discretionary spending. This is perhaps you could argue the easiest cost item for us to reduce. There is obviously a very limited amount of traveling going on in our company at the moment. Customer entertainment is very small. A lot of our traditional Marl com trade fairs and other typical marketing costs are automatically delayed, postpone, canceled.
And consequently, that cost category will see a sharp decline. It's already a fact as we speak. Lastly, regarding our payroll, obviously, in a crisis situation where we go in, we will see a lighter burden. If we are correct about our economic assumption, we will see a lighter burden on the variable compensation programs that will have limited effect during or limited payout during 2020 if the year goes as planned. In addition, because we are putting through so many of our employees into short work time agreements, they will face various degrees of pay reduction during the period of crisis.
And consequently, group management have decided to go with solidarity into that process, and we've taken down our fixed salaries with 10% over the period of time that we are implementing this program. That would be some voluntary pay reductions that is also spreading somewhat into the senior management cadence of this company. So that is the action program. As such, we have a lot of work to do when it comes to detailing exact number of people, exact jurisdiction, exactly how it will go, but scoping it, we feel confident that, that is a level that we will be able to reach. There are then finally a couple of other things going on simultaneously.
As I indicated, we have the crisis team operating fully since weeks back, mainly related to short term activities to secure the health and safety to our employees and also deal with upcoming emergencies in the company. And of course, we have a very active team related to securing our supply chain and our delivery capabilities. So far up to date, our global supply chain is largely working well in line with what we expect and what we are usually doing. We did see some short term effect in China during the initial crisis. That has since then largely been restored.
And I might add at this point in time that also the economic activity, our business activity and our order intake is seeing a good improvement in China over the last few weeks. So if you want to have any indication in terms of what does a shutdown and the reopening of the business look like, I think that shows for the time being a favorable scenario. I'm not 100% sure that the development in China is sustainable. There are still risks there, and I'm not sure that the rest of the global economy will show the same pattern. But nevertheless, in a situation where we look at some dark clouds, China provides a little bit of light in the tunnel, and it's not a train, hopefully.
With that, Jan and I are open for questions. Thank you.
Your first question comes from the line of Max Yates. Please ask your question.
Thank you. Just my first question is around these shorter time working programs. And I just wanted to understand typically in countries like Italy and Germany that you mentioned, what is the scope of these programs, I. E, kind of what sort of magnitude of production does this lead to, I. E, sort of what kind of production reduction or what kind of reduction in your factory production are you planning for as part of these programs?
Well, let me first say, number 1, and I may not have been fully clear on that. The SEK 1,000,000,000 savings programs that we're talking about now is addressing primarily the fixed cost. So the activities described are related to the $1,000,000,000 On top of that, as we say in the press release, we will adjust the production structure and work with our gross margin as effectively as we can depending on what the volume scenario looks like. So I just want you to be mentally clear that there are obviously cost savings in our supply chain that will come from reduced working hours or reduced deliveries over time. So point 1.
Point 2, at the moment, we are still running very high in our supply system. So when we are talking about some of the challenges that we have, we're going to have to find ways here of dealing with capacity monitoring going forward. So I think we have on top of that, we have about 10 plus percent of our blue collars as temps. So we have with our temps workers and with a big part of our manufacturing in the Scandinavian systems and in Italy, we feel we have a very good grip on adjusting to a reasonable downturn in volumes. So I think I'll leave it there.
I don't want to go into detailing of the each individual jurisdiction and how we will adjust them because we still have a fair amount of work to do. So I think when we get to the quarterly report, I think we will outline you some details as to where we are on those various initiatives. So if you allow me to leave it a little bit fluffy here, that's my answer.
Okay. Thank you. And just my follow-up question is around maybe a little bit around what you've seen in March so far. And I can understand kind of the original equipment orders may clearly come under some pressure. But would you be able to comment on what you've seen so far in your services business and how customers are behaving, particularly in areas like marine?
Have they tended to sort of
more or less shut up shop across the board, both in terms of new vessel ordering and also servicing? Or how has that business evolved through March? And how should we think about it evolving over the next couple of months if the OE side comes under pressure? How resilient would you expect things like Marine Services to be?
You guys are hopeless because for the first time during my 4 years in Alfa Laval, I'm giving you 2 months update into a quarter that consists of 3 and you focus on the 1 month that is remaining. So a little bit you are pushing the envelope a little too far here. I think the comment that I was making was that we do not have the sense at the moment that March is a huge deviation compared to the 1st 2 months. That is our assessment right now. There's obviously 2 weeks left of March.
Anything could happen. But if we were feeling that the business conditions during the month of March would come into a complete halt or a complete different scenario than the one we are having, we would have been transparent with that. The best comment we can give you at this point in time and that is what we are expressing is that we do not expect a sharply different business environment for March compared to the 1st 2 months. Hopefully, we will keep it up until the next quarterly report as planned to give you the full update of what actually happened, but that is the best assessment we can do.
Okay. Thank you.
All right. Your next question comes from the line of Klas Bergelin. Please ask your question.
Yes. Hi, Tom and Jon, it's Lars from Citi. Good to see that you're taking suites and major actions. Can I start by asking if you could give us an update on your manufacturing sites currently? We're getting questions from investors trying to gauge how many sites per country in Europe and how many employees in each as Europe is gradually closing down?
So I will start there.
We are not in a situation where we're closing down. I think our general comment from the introduction is that our supply chain up until today is generally speaking intact. We are not facing any major deviations when it comes to our delivery and supply towards customers. With that said, I follow the same news cycles as the rest of you do. I see that there are companies that take a different path when it comes to how they can run their delivery cycles.
That's not the situation we've been having up until today. But obviously, this is a concern for us. We have people working a lot around these questions. We know that they are obviously, but they haven't materialized up until today. The original Chinese challenge, I would say that has been largely restored.
Yes. No, absolutely. I'm trying to think ahead. Obviously, and it's a challenge for all of us. But I'm trying to understand, so the concentration of factories is Denmark, Italy, Sweden, Germany.
Am I missing any obvious countries? We're trying to map the sector in looking at how this can evolve?
I think you're going to have to make your own guesswork on that.
All right. My second question is on the nature of the program. You were very helpful here in your introduction, obviously. But the typically, we have a restructuring charge. Savings are typically half of what we do today.
Now we have SEK 1,000,000,000 with little charges. And you helped us, Tom, in saying that we should be flexible and quick. Clearly, Alfa is an improved business the last downturn. But I'm curious to hear you describe a little bit more in this slide where are you more agile outside of the fact that you have improved your service share?
No, I think, I mean, let's be clear. This is not we are not doing, I think, anything extraordinary or being outsmarting anything. We all done restructuring programs and seen the one time charges. What we are doing here is not securing a long term structural cost advantage for the company. That would cost us restructuring charges.
There might be some restructuring in the months to come. There is always in the company of our magnitude. There may be outside of the corona's issues a couple of weak spots that we are interested in addressing. So I'm not putting a 0 and all of that. But the program as such in terms of taking a short term reduction of activity, working hours and so forth is really not bringing any restructuring charges with it.
So the good thing is it's quick. The good thing is there is not a one off charge. We are not hiding any other problems behind this other than trying to adjust ourselves to the very specific pandemic consequences that we are seeing. So if this is, as we hope, short to medium term challenge, we will bring resources and working hours and external consultants and development programs back into action as soon as we feel comfortable about the stability of the global economy. If that's not the case, we will likely have at some point in time to look at the more structural adjustment of our cost base.
We have mentioned in the press release that at some point in time, likely early Q3 is the time when we may need to make a new assessment and say, is this scenario the reasonable one where it has the world developed over the last 3 months and do we still believe in the plan we have or do we need to do something else. But for now, we are quite comfortable that we can go forward with this way and that will be economically in terms of speed and long term opportunities for us the best way to go.
Yes, very clear. My final one is on oil and gas. And obviously, these are unprecedented times the next couple of quarters. But I still wanted to discuss oil and gas with you, Tom, and thinking back to the previous downturn. So it appears as if the oil and gas business is high up in the cycle, EUR 7,000,000,000 versus EUR 8,000,000,000 orders at the previous peak.
But a lot of that is weaker SEK, I. E. FX, helping that number. So like for like, I think you're still 35% below the previous peak. So we will likely see a big drop in orders.
But upstream is obviously already at a very low level, and refining in Petrochem is typically more defensive. So I'm trying to understand I know it's difficult, but if you could discuss a little bit in terms of whether we will have a crash or whether we actually haven't recovered that much yet?
Well, let me make 2 comments to that. Comment number we there's clearly some discussions for us down the road to have when it comes to the development in our end segments and how they develop. We will save that dialogue and that analysis for the quarterly report call where we will update you where we are versus end markets and the pandemics. But with that said, I think you are reasonably correct in your assumptions around the market. It is true today that the upstream, especially land based oil and gas business is relatively small and certainly compared to the previous big, significantly below.
It is also true, as we've expressed earlier in a number of earnings calls, that the downstream, especially petrochemical, is driven to a degree by Chinese independence and other things, and they may not be particularly correlated with the oil price. On the contrary, sometimes people argue when oil prices go low, the profitability in the downstream activities may at some point in time even be better. So there is not a correlation between those cycles. And I think that paints the picture of the possible impact on oil pipe changes. And then I would like to come back to this topic at the quarterly earnings
call. Thank you, Tom.
All right. Thank you. Your next question comes from the line of Andreas Koski. Please ask your question.
Thank you very much. And hi, Tom. Hi, John. Many thanks for organizing this update. Very much appreciated.
Firstly, on the cost savings program, you said that it will start to have effect from the 1st April. But when do you expect to be at the full run rate of the SEK 1,000,000,000?
Yes. I don't want to lose my credibility in this earnings call. We are moving very, very quickly at this point in time. So of course, we do have an element of uncertainty on this. We also face a number of negotiations with unions and other stakeholders in these processes.
So while we are ambitious, we may find that some agreements and some decisions are taking slightly longer than we are looking for. We're also in a situation where despite some challenges ahead, as you know, we are sitting with a huge order book and a high delivery pace at the moment. So we may have also to find some compromises in terms of not endangering what needs to be executed shorter. With all those observations, I think we should be very far down the line approximately 3 months from now. That's about the mental picture we have.
And given that we are looking at a couple of quarters as the primary challenges, this program loses a lot of its value unless we can get it relatively quickly into place.
Yes, yes, yes, yes. And on the demand side, at the beginning of the year, you had a backlog for deliveries of around SEK 16,400,000,000 for this year. I understand that you expect to see weaker demand from this coronavirus or due to this coronavirus. But do you think there is significant risk that you will also see cancellations and slippage of that backlog? Or is it mainly weaker demand ahead that you expect?
No, I think well, let's be prepared for I'm not sitting and expecting a lot, right. I'm just planning for being able to tackle and handle the situation where we see a weak situation. I'm not whichever way it goes. Okay. But let's put it
this way. Are you confident that you will deliver the SEK 16,400,000,000 this year?
Well, it's our order backlog, the benefit that we have, I would remind you, I would put it like this. You should remember that there are no orders in our backlog where there isn't a signed agreement and a down payment from customers that we have received. And that gives a certain credibility to the order book. That's point 1. Point 2, we haven't seen any tendencies up until today of order cancellations in our order book in any part of our business, in any segment, in any end user.
I will not be the one who says that it cannot happen. Anything can happen in this world, but the status up until today is what I mentioned.
Yes. And the down payments, are they normally 10% of the total order value or It
can be anything between just below 10% and up to 25%
about. Okay. Yes. And then lastly, you mentioned, I think, that €1,000,000,000 corresponds to 15% to 20% of your fixed cost. And that implies that your total fixed cost base is around €5,000,000,000 to €7,000,000,000 Last year, you had total operating cost of close to €40,000,000,000 which means that your fixed cost accounts for only 15% of your total cost base.
So the remaining 8 yes, go on.
Yes, you should remember that our cost of goods sold, raw materials is about 60%. So when you do the cost structure analysis, I think that's what you need to keep in mind.
Yes, I do that. But the remaining 85% of your cost base, would you say that, that is moving simultaneously more or less with sales?
No. I will not make any statements for the current. You're not going to drag me to forecasting cost of goods sold and variable cost in a scenario which we're not sure where it's going. So you can guess all you want. I can tell you what the cost structure is, but you're going to have to make your conclusions.
Yes, yes. Okay. Thank you very much.
Thank you.
All right. Thank you. Your next question comes from the line of Miles Schulz. Thank you. Please ask your question.
Hi. Good afternoon from my side. I have a question and as although I don't expect a huge issue there, but can you update us maybe on your working capital or your expectation on your working capital development? Do you expect a lot of working capital drag? And what's your current liquidity level and undrawn credit lines, if you can just assure us that you're always enough financed?
Well, maybe I can comment here. It's Jan. I mean, we as you know, we do have a strong balance sheet, We've been working in the last couple of years to strengthen that. On top of that, we also have a strong liquidity buffer in terms of credit facilities and a good credit rating. So we feel good with that position.
On the working capital side, I think this is something we will have to come back and comment on after the or at the Q1 release. So I don't want to sit here and speculate about that situation at this point.
But do you plan to take extra liquidity at
the moment? Or you run it as normal for now?
No. We are monitoring, of course, the situation in a prudent way, watching our cash flow. And so we don't see an issue. As I said, we do have a strong balance sheet. We are monitoring our liquidity and we have good banking relationships.
So I think we feel comfortable with the situation that we are in.
Okay, great. Good to hear.
All right, thank you. Your next question comes from the line of Johan Eliason. Please ask your question.
Yes. Hi. This is Johan Eliason at Kepler Cheuvreux. Just a question regarding travel bans and similar. From other companies, we heard some stories about an impact on the aftermarket business as the service technicians were not able to sort of visit the client side and do the maintenance and deliver the spare parts and similar, obviously related to China initially.
But for you, I think you have more of a distributor type of model in the aftermarket business. So how will this travel ban impact you, assuming that logistics will continue to work as they should? Are you sort of your aftermarket business there parts? How big share is your sort of online sales or similar? Can you give any sort of indication on how this could be impacted in the months ahead?
Thank you.
No, I will not give you any answer to how it will be impacted. If I can give you a status question, a status update and then you can make your own judgment. Number 1, our service business does have a high share of spare parts sales. In fact, part of the service program and service change we've been working with over the last few years is increased the amount of services and changed the mix somewhat. And but it doesn't change the fact that spare parts accounts, I think, for about 70% of the service revenue.
If you look at and It's slightly higher, I think, on the food and water side. At the moment, with IMO and growth on the marine side, it's getting slightly lower on the marine side, but the historical marine business is certainly spare parts driven where the crew typically does the services on board. So yes, the big part is in that sense not affected by ability to travel. That will be and up until now, we haven't seen, including February, any change nor in the order intake mix nor in the invoicing on the service business. Are there some risks going forward?
It could be your judgment.
Okay, excellent. That was all I had.
All right. We'll take one more question and then we're going to call it a day.
All right. Thank you. And your last question comes from the line. Please ask your question.
Sorry, hello. Is this me, Lars from Barclays?
Yes. Hello, Lars.
Sorry, guys. I couldn't see if you dropped out the hostess. Sorry, can I just follow-up on that, Tom, the prior question, if you don't mind? I appreciate that a big part of your service business is spare parts. So that will be a big chunk of which, of course, cleaning and reconditioning of plates for your heat exchanger business.
That does require a fair bit of transportation, I guess, back and forth. But just to be clear, as it stands today, no impact from lock downs and broader limitations to movement from your field force in Europe in particular. And I appreciate it's a very fluid situation, but I think it's a fairly critical question that was asked earlier.
Yes. It's been a good continuity in the service business and the service execution up until the end of February. Then we will have to obviously update ourselves week by week and we'll update you hopefully once a quarter and not more often than that. But so at the earnings call late April, we will have an update for you on that topic.
And finally, if I just can to Jan, you said there hasn't been any change, Jan, around working capital, and I appreciate you'll come back in a few weeks' time on the call. But presumably, around your oil and gas business, parts of your shipping business, I'm thinking particularly cruise, there will have been some stress among your customers. I wonder whether you are doing things differently in terms of any action around working capital, things like connecting receivables, etcetera. Any status update you can give us there as to how you go about managing your working capital at this point?
No, I think the key point here is staying close to our customer, and we have a global sales and service operation that's their job on a daily basis to monitor the situation and make sure that we support the customer, but to get the payments that you've due to us. But maybe one comment. I mean, we've been growing quite a lot these last couple of years, building up inventory, building up receivables. So as to, of course, if the situation reverse. So again, let's come back after the Q1 report, and we can talk about it more.
But rest assured, we are staying close to this, and we view utmost to keep our good cash flow going.
Thank you, both.
Thanks a lot. And with that, thank you for joining us on short notice. Look forward to a more complete update at the quarterly report about 4 weeks from now. Thank you very much.
Thank you. That does conclude our conference for today. Thank you all for participating. You may all disconnect. Speakers, please stand by.
Thank you.