Welcome to the Alfa Laval Q2 earnings call. At this time, all participants are in a listen-only mode until we come back to the question and answer session, and instructions will be given at that time. If anyone should require assistance during the conference, please press star then zero on your telephone. Just to remind you, this conference call is being recorded. I would now like to hand over to the Chairperson, Mr. Lars Renström. Please begin your meeting, sir, and I will be standing by.
Thank you very much, good morning, and most welcome to the presentation of the second quarter report. I will start by giving you my three highlights. Demand remained on the same high level as in the first quarter, order intake increased year-on-year by 6% to SEK 7.9 billion. Contributors to the growth year-on-year were the Process Industries segment and the Marine & Diesel division through the acquisition of Aalborg Industries. All regions in Europe grew compared to 2011, thanks to several large orders. My second highlight is that the operating margin year-on-year was negatively affected by lower capacity utilization in some factories, lower margins in Marine capital sales, and product mix. Sequentially, the operating margin was unchanged. Finally, we expect demand in the third quarter to be on about the same level as in the second quarter.
Now we move over to the key figures. There you see that orders received rose 6% to SEK 7.9 billion, net sales increased 11% to SEK 7.8 billion. Adjusted EBITA declined 3% to SEK 1.3 billion, adjusted EBITA margin reached 16.5% compared to 19% one year ago. For the first six months, orders received rose 14% to SEK 15.8 billion, net sales increased 13% to SEK 14.6 billion. Adjusted EBITA declined 2% to SEK 2.4 billion, adjusted EBITA margin reached 16.5% compared to 19.1% a year ago. Now we move over to orders received and margins. Orders received on rolling 12 months rose to SEK 30.6 billion, the increase in order intake was 3% year-on-year at constant exchange rates. We are pleased to note that excluding large orders, order intake grew sequentially with 5%.
Next slide gives order analysis, there you find that year-on-year, acquisitions contributed with four percentage units, organic growth was -1.2%. We have positive currency effects of 3.6%. Sequentially, the organic growth was -1.2%, we had 1.2% positive currency effect, resulting in unchanged order intake. Next slide. The EBITA margin declined to 16.5%, the operating result was SEK 1.3 billion. Now we move over to the development per segment. Here you see for the first six months that most of the segments were unchanged or declined. We can see that the Process Industries stands out, they had a positive development, the same goes for Parts and Service in Equipment division and the Marine & Diesel division. Now we move over, take a closer look into the divisions. Here you should note that here, all comments are sequential.
We start with the Equipment division. Thus, we see that sanitary was up, driven by food and beverage, as well as pharma and personal care. Industrial Equipment was significantly higher, boosted by seasonal demand for HVAC. OEM and parts and service was unchanged. We move over to the Marine & Diesel division. There we enjoyed substantially higher demand for diesel power and continued growth for environmental, and we also enjoyed continued growth for environmental solutions. Demand for marine equipment, the traditional Alfa Laval products, was unchanged. Marine and offshore systems was down significantly due to non-repeat large order. More upgrading and repair works lifted parts and service. Next slide. In the Process Technology division, food technology grew, supported by beverage and viscous food markets. Energy and environment declined due to non-repeat large orders. Process Industries showed strong growth, driven by refinery in Asia and Middle East.
Parts and service declined due to non-repeat large orders. You heard non-repeats a few times in the sequential comparison, but remember that Q1 was all-time high in large orders. Now we move over to the next slide, the first six months, and there you see that year-on-year and like-for-like, the aftermarket for all divisions was stable or growing, whereas most capital sales segments declined. We proceed with the geographical developments. There you see that in the quarter, all European regions had growth year-on-year, and the other regions showed modest decline. Let's take a closer look at this interesting fact by going deeper into the regions, starting with Asia. Please note that all comments are sequential. The decline of 7% in Asia was caused by non-repeat large marine order. It's positive that both Equipment and Process Technology division reported growth.
The best segments were Process Industries, food, and sanitary. Korea and India did well, and China had good sequential development if we exclude marine. Moving over to Europe, we see that in all European regions, we had double-digit growth. Western Europe, including Nordic, orders rose, boosted by large projects. It's positive to note that despite negative macroeconomic news, both base business and parts and service were unchanged. In Central and Eastern Europe, both Equipment and Process Technology division contributed to the growth. Russia is the best-performing big country in 2012, and base business continued to grow. We move over to the Americas. There you see in North America, we declined 25% due to non-repeat large orders. We are pleased that base business, particularly in the U.S., showed a continued good development. Industrial Equipment, food, and Process Industries did the best, while energy and environment declined due to non-repeats.
In Latin America, we had a good development for the base business while large orders declined. Argentina and Chile reported good growth, and Brazil's base business grew as the overall intake declined. On the next slide, you see that the first six months, all regions delivered growth, with Central and Eastern Europe standing out. Here, Russia has been the main contributor. On the next slide, we see the top 10 ranking. The green bars are whole year 2011, and yellow bars are last 12 months. We see that the U.S. has had a positive development and strengthened the number one position. China has declined due to slowdown in marine. Nordic has grown and is challenging China for the number one position. South Korea has grown substantially, thanks to oil buoy industries and the success of Korean EPC contractors.
Mid Europe, consisting of Germany, Switzerland, and Austria, has declined and is now challenged by Southeast Asia, where Indonesia and Singapore have grown significantly. The ethic has declined modestly, they are now overtaken by Russia, where we have had a broad-based growth. Brazil has grown mainly due to Petrobras. India's decline reflects the state of the Indian economy. Now I hand over to Thomas for the financials.
Thank you, Lars. Good morning, all of you. Let's then take a bit of a look into the details of the financials. As I think Lars has covered orders in some depth, let's move on to sales. Sales was up organically 3.7% over quarter two of 2011. If we then include acquisitions adding a further 3.5% and positive FX effects adding 3.9%, we had an increase in absolute terms of just over 11%. Also, sequentially, sales was up to the tune of 13% on a like-for-like basis. This is explained mainly by the sizable backlog from 2011 and seasonality, as we tend to have less of revenue recognition on contract-based sales in quarter one every year compared to the other quarters during the year. Let's move on to gross profit margin.
We ended the quarter at 37% flat, compared to 41.1% quarter two of 2011 and 38.5% in quarter one of 2012. With the Q1 report, I gave the following forecast for gross profit margin. In the near term, we do not see conditions being different than those that prevailed in Q1. However, with the order levels of Q1, load is likely to improve somewhat and mix deteriorate with a relative increase of capital sales revenues. Let's look at the deviations and the actuals for Q2. Of course, we can see that the actual came out slightly below this forecast. As projected, mix gave a negative effect sequentially as well as year-on-year, so in line with the projection of the Q1 report. Currency was negative year-on-year, also as predicted. Impact from load was negative year-on-year and sequentially.
Of course, sequentially, that is a deviation to the forecast I gave three months ago. The main reason is that order inflow was lower in the beginning of the quarter than anticipated. Please remember Lars' comments about sanitary and Industrial Equipment in the quarter. We saw a much stronger inflow in these two segments during the latter part of the quarter. The effect of that was obviously we did not have the anticipated load throughout the quarter. Let's get to the first forward-looking statement. In the near term, we expect conditions to be largely similar to those that prevailed in quarter two. However, order levels of quarter one and quarter two can support load somewhat, while gross profit margin is expected to be adversely affected by mix within capital sales. With that, let's move on to overhead costs and the rest of the P&L.
Starting with R&D. R&D ended at SEK 180 million second quarter, which is an increase with 7.9% like-for-like. This is, of course, proof of continued investment in future products and entirely in line with the established plans for product development. In terms of relation to sales, R&D represented 2.3% in the quarter. Sales and admin amounted to SEK 1.26 billion in the quarter. That meant a reduction like-for-like of 2.7% year-on-year. A trend shift compared to quarter one, where you remember we still had an increase in sales and admin year-on-year. This is, of course, evidence that the measures initiated at the back end of last year are having an impact in the organization. EBITA margin for the quarter ended 16.5%, as Lars commented, which is on the same level as Q1.
In summary of above comments, is explained by lower gross profit margins compensated by higher sales volume and lower overheads. Again, let me repeat, the implementation of the savings program launched at the end of 2011 is progressing and effects are realized. Looking at profit before tax, this P&L line was influenced by negative exchange differences in the quarter to an amount of SEK 36 million. That is to be compared with a positive SEK 58 in Q2 of 2011. Profit before tax following above just exceeded SEK 1.1 billion, a reduction of some 6% over last year. EPS for the first six months is down about 5%. If I exclude the amortization on step-up, EPS is down just 2% for the first six months, that is. Before leaving the P&L, let me also comment on taxes. Taxes ended with a charge of SEK 386 million in the quarter.
This relatively high number is explained by negative results in a few countries in this particular quarter, as well as some non-recurring items relating to Aalborg Industries activities. Our guidance, however, remains 30% based on profit before tax. Moving on to cash flow and cash flow from operations. This amounted to SEK 640 million compared to SEK 669 last year. Slight reduction, mainly explained by an increase in taxes paid and somewhat lower tax profits generated. Also an influence, of course, from working capital. With regard to returns, return on capital employed, almost 28%, slightly lower than Q1. Of course, the capital coming from the acquisition of Aalborg is having an impact on returns in comparison with last year. Return on equity, almost 22%, close to last year's level.
Coming back to cash flows, looking a bit more into the details of the cash flow statement for the first six months, the following can be concluded. We are reporting an increase in cash flow from operations of 51%, and that is despite an increase in working capital of almost SEK 300 million. Acquisitions represented a cash out of SEK 1.25 billion and is a result of the delisting in India that is now involving a cash out of almost SEK 800 million. In addition, cash out of SEK 460 million relating to the acquisition of OTEC systems , as well as delayed payments on some other earlier acquisitions. Free cash flow, that is exclusive of acquisitions, divestments, and dividends. Free cash flow reached almost SEK 1.4 billion for the first six months, which is about SEK 200 million above what was generated same period last year.
I think it is fair to say that it has been another good quarter and first 6 months in terms of cash flow generation, despite an increase in sales volume and the following increase in working capital. Moving on to FX effects. In the quarter, we had, for a change, a positive effect with some SEK 12 million coming from positive translation and negative transaction. For 2012, assuming exchange rates of EUR/SEK 8.75 and EUR/USD 1.26, we anticipate a net of negative SEK 40 million for the full year. That, of course, includes a negative transaction effect of some SEK 130 million, and then an improvement in our estimation for translation effects, giving an improvement in the net total effect for the full year of some SEK 65 million.
SEK 40 million negative for the full year, and for 2013, given current hedges and the exchange rates mentioned before, we anticipate a positive SEK 50 for 2013 as far as transaction effects are concerned. Let us look a bit at the backlog as per end of June. Our total backlog amounted to SEK 15.1 billion, again, representing about six months of LTM sales. If we look at the backlog development by division, you find an increase in Process Technology, a reduction in Marine & Diesel, and basically the same level of backlog for the Equipment division compared to end of June last year. Looking at the backlog to be shipped during the rest of this year, it amounted to SEK 9.8 billion end of June. This also means an increase compared to end of June 2011, with about SEK 500 million.
Please have that in mind, and let us take a look at the next slide. That is to take a look at a summary of what I call the known and the unknown parameters for projecting full year sales for 2012. Again, as we just concluded, like for like, the backlog will give increased sales of SEK 500 million during the last 2 quarters of 2012. As we had Aalborg Industries only for 8 months in 2011, we must add these final 4 months of sales from Aalborg. The actual addition January, April from Aalborg was SEK 900 million. That comes on top. Based on our current exchange rate assumptions and the rates applied end of Q2, we expect a positive translation effect of some SEK 100 million.
This gives a subtotal for the knowns of SEK 30.2 billion, an increase that is from the last reporting of the Q1 with some SEK 700 million. As always, it is of course up to you to form an opinion about demand for the full year 2012, which would give you a basis for estimating en route orders for the rest of 2012. Remember when you think about en route orders and demand for the latter part of 2012, that 2011 was a year with a very strong demand situation for the first nine months, and we reported an all-time high in quarter three with regard to orders received. Commenting on prices, let me just repeat what I have commented already before. Prices for metals have been going down compared to 2011. That is to be noted. We have adjusted prices as we typically do as per the beginning of the year.
These adjustments have been very limited for standard products. This is, of course, to be kept in mind when you make your projection for sales for full year 2012. With that, I give the word back to Lars for the outlook and closing remarks.
The outlook for the third quarter is as follows. We expect that demand during the third quarter 2012 will be on about the same level as in the second quarter. I have two forward-looking comments. The first is that we expect the lower level of capital sales to the shipyards to continue, given the contracting at the yards in 2011 and 2012. This affects about 10% of Alfa Laval's total sales. The other comment is that we expect the high activity level in the Process Technology division to continue, especially within the Process Industries segment. By that, we have completed our presentation, now I hand over to the operator for the Q&A session.
Thank you. Ladies and gentlemen, if you do have a question at this time, please press star one on your telephone keypad. To cancel your question, please press the hash or pound key. Once again, that's star followed by one to register your question, then the hash or pound key to cancel. There will be a short silence while participants register for questions. Our first question come from the line of Ben Mathison. Please announce your company name and go ahead with your question.
Yeah, morning, everyone. It's Ben Mathison from Merrill Lynch. Just a couple of questions, please. Firstly, part of the explanation you gave for the weaker margin was lower capacity utilization in some factories. Can you just say which divisions that utilization is lower? Should we read from your comments on loading going forward that you think the gross margin can stabilize at this level? That's the first question. Secondly, on Marine, the margin is down quite a bit year-on-year. Can you just give us a bit more color on what the main driver of that is? Is it mix? Is it more Aalborg, less existing business, lower overhead recovery, et cetera? When I look at last year, the Q3 Marine margin went up to almost 30%. Would you expect a similar seasonal kind of spike in margins in Marine & Diesel this year?
Thank you.
Okay. That was quite a few questions, Ben, we'll do our best to deal with them all. Weaker gross margin. As I mentioned, we did have the projected negative mix effect. Of course, sequentially, the increase in revenue recognition in capital sales plays a big role. That is all in line with what we expected and in the right direction as far as you should expect as well. When it comes to load, we did have a weaker load in quarter two than we anticipated, as I commented before. Has to do with how orders came in for the fast-moving businesses in sanitary and Industrial Equipment. Of course, that is having an impact on Equipment, but it does also affect standard products sold in the Process Technology division as well as in marine. For instance, smaller standard size, standard type heat exchangers.
Okay. Thank you.
Marine down year-on-year. Yes, we did mention that we had a price mix effect, negative year-on-year as well. Of course, looking at the EBIT margins reported for Marine, quite a bit of that came out of the Marine division. That has to do with two things mainly. Firstly, if we look at the Aalborg product range, we tend to have a longer order cycle than for the Alfa Laval products. What we see is, say, a normalization of the price level for the Aalborg range. Something that we have commented upon for the Alfa Laval range, post the peak and the adjustments in metal prices.
Secondly, we have an adjustment of the costing methods in Aalborg, meaning that we are increasing the overhead charges included in cost of goods in Aalborg, sort of going on to Alfa Laval standards for product costing. That's the second one. You were asking about a projection for Marine for the third quarter, and of course, I'm sorry, Ben, we are not providing any divisional projections as far as margin is concerned. You have to remember what I said before about gross margin. That we expect possibly a bit support from load and a continued negative year-on-year on mix.
Great.
That's as far as we go.
Okay, thanks. If I can just follow up on that, I was more trying to just understand whether there is any seasonality in this business, because we haven't looked at Aalborg for very long, and it did a 30% margin in Q3 last year, and then it's fallen back to 17% Marine & Diesel. How much of that is a reflection of the exceptional pricing that you just talked about coming out of the backlog, and how much is it mix and seasonality and things that maybe
Ben, I think my comment to that is we have spent a big effort in bringing Alfa Laval or Aalborg onto the standards that we apply in Alfa Laval and the recorded profits of the Marine & Diesel division as they are reported now. They well represent the standards and the way we account in Alfa Laval.
Okay. Got it. Thank you, Thomas.
Our next question comes from the line of Ben Bayer. Please announce your company name and go ahead with your question.
Yeah, good morning, gentlemen. Also a couple of questions on the margin development, more on a sequential basis. I think I understand what you mentioned on sanitary back end loaded demand, on the other hand, the Equipment margin improved sequentially from 12.8% to 15%. Given what you said, I wouldn't have expected an improvement in the margin in that business. Also on Marine & Diesel, I do understand what you said year-on-year, makes total sense. If I look at it sequentially, despite 10% higher sales, you had zero contribution margin. Was just wondering what happened sequentially in that business. Just finally, also coming back to your sanitary comment, I think in Q4 last year, you saw that business slowing throughout the quarter, I think, or Q3.
Did you see something similar just on the kind of stocking behavior because of the Euro issues again, people kind of normalize that behavior towards the end of the quarter?
When it comes to Equipment and the Equipment volumes, your comment is of course, pars pro toto, I did mention mix. I did not mention price, and I can report that Equipment did achieve a positive price effect in the quarter. Your comment about sanitary. Our assumption is that we have a restocking situation. We've seen somewhat of a restocking situation during the second quarter, and that sort of gave this pattern of increased demand towards the end of the quarter in some of the segments.
Was not a destocking at the beginning of the quarter, followed by restocking at the end, or?
Well, possibly we've seen somewhat of a destocking from even earlier in the year, maybe the estimates of our channels, they were incorrect to begin with in the early part of this year, they have restocked.
On the sequential marine margin development?
Well, again, we have elaborated quite extensively on the development of the margins. We are seeing a normalization of the margins for Aalborg products. We are also adjusting the costing methods for the Aalborg range, and those are the main elements of the explanation.
This does also have a sequential impact, not only year-on-year.
It do, yes.
Okay. Thank you, Thomas.
Our next question comes from the line of Peder Frölén. Please announce your company name, then go ahead with your question.
Good morning. Peder Frölén from Handelsbanken. A couple of questions, if I may. Thomas, you mentioned that the savings are coming through according to plan from the savings program by the end of the quarter. Could you please try to help us with the profile of the savings? Have you reached an ongoing rate now that we can expect, or are we still on a climbing phase? How much were those savings in the quarter? That's the first question. The other question is to both of you gentlemen regarding the outlook of demand on about the same level. Last quarter, given the very high activity of large orders, you excluded the large orders in the outlook. When now combining the outlook again, does this mean that an activity of around SEK 600 million+ of large orders, is that what you see currently? Is that the new normal?
Even that is a very high level. Please elaborate a bit about maybe the ongoing activity for larger size projects. That's it.
Yeah. I can start with your final question. We see a continued high activity level in the Process Technology division. High activity level, high quotation level, that is the main reason why we maintain or why we have our outlook. It's correct that we haven't made any comment on large orders. This is the total. We say that demand will be on about the same level.
Yes. Thank you.
On the savings and the achievements under the savings program, we have realized between SEK 30 million and SEK 40 million on the sales and admin line in the savings program. Of course, we do have activities ongoing as far as manufacturing overhead is concerned as well. You have not seen the full impact yet. We will see a further increase in these savings effects during the second quarter. Remember, as far as total savings for the full year are concerned, we estimated with the launch of the program, savings of overheads to the tune of SEK 200 million for the full year.
Yep. Very clear. Okay. Just final. You mentioned prices, Thomas, that limited price changes for standard products. At the same time, input in terms of metal is down. I guess the price changes on standard products is slightly up, right?
We are adjusting our list prices up.
Yeah. I just want to clarify that.
That is not to say that everybody accepts those, of course, unfortunately.
I understand. Okay, that's it from me. Thank you.
Our next question comes from the line of Martin Probst. Please announce your company name, then go ahead with your question.
Good morning, gentlemen. It's Martin from Bernstein. Two questions, please. The first on the strength on orders in Europe and the Nordics. Were you surprised by the level of demand in the quarter, given the broader macro trend? Can you kind of expand a bit in terms of where the strength is the strongest? Second question, in terms of your guidance, how important is the parts and service order outlook there? Do you expect to see continued level of growth around the 4.5%-5% range that we saw in Q2?
Europe, where we saw growth year-on-year and sequentially, it was mainly driven by large orders since base business was unchanged. When we look at the large orders that we have communicated in press releases, we had an order to offshore for Norway. We had to vodka distillery in Russia. We had to a chemical plant in Germany. We also had an order for, let's say about half of the contract for an FLN G plant outside Australia was booked in France through Technip. There you see the large orders that have been visible to you, we see that these sectors have been quite active in the second quarter, and that explains why we saw growth due to large orders. We think it's quite positive that despite the macroeconomic outlook, that we came in on this level.
You had the second question was?
It was about the parts and service impact on our outlook and whether there was any reason to expect a change from sort of the growth pattern of 4%-5% in parts and service. I think there is nothing that to us proposes that we should see a change in that trend. We are continuously building our presence and resources as far as parts and service offerings go. We're anticipating a continuation of the trend, yes.
Just one follow-up on that. In terms of marine, are you seeing any change in parts and service demand there, given slower operating rates on ships, et cetera?
What I would say, still global trade is growing this year. That is one thing we should remember. Global trade is projected to be growing about 3% in 2012. What we saw was an increased activity level when it came to upgrades and repairs. We have seen a continued good level of activity in parts and service in the marine sector.
Thank you.
Our next question comes to the line of Andre Quinane. Please announce your company name and go ahead with your question.
Oh, hi. It's Andre from Credit Suisse. Thank you for taking my questions. I just wanted to take a step back and look at your margins, say, versus the worst period we've seen of 2009, and we're trending at broadly the same level or slightly below. Should this trigger a reaction from you at some point in terms of an acceleration of cost cutting or launching a further restructuring program like you did in 2008, 2009?
We do not have any intentions of any further cost savings initiatives at this juncture. No. We continue to implement what we initiated at the back end of last year, and that's where we are. Of course, in an engineering company, it's a continuous work to improve productivity and look at all various cost elements. That's a continuous effort to adjust, and that is regarding the operations side and cost of goods sold, as well as in the overheads.
Okay. That's clear. Thinking about margins further, I think before you cited there were a couple of relatively one-off reasons for margins to be under pressure, like abnormally high IT spend and investment in SG&A. Has this now been normalized, or are we still running at a high level?
When it comes to certain IT projects related to distribution and channel sales, we are still year-on-year running at a high rate in the second quarter.
Would you expect this to normalize later in the year or in 2013?
That is absolutely our intention, yes.
Great. The last question is, we talked about stock levels in the sanitary segment, but I wonder if you could comment on, a bit more broadly, about the segments that are more faster moving and shorter cycle for Alfa Laval. What are you seeing in terms of customer stock levels? Are we up compared to the beginning of the year? Have we now de-stocked?
As we've elaborated a bit on earlier on the call, our take on the uptick in orders in sanitary and Industrial Equipment towards the back end of the quarter is evidence that quite a few of our channels, they are restocking. They probably went a bit too far in the early part of the year, and then they are restocking. That is our take on the order pattern we've seen through the quarter.
Is this something you see continuing still, increasing?
We have no comments when it comes to order inflow in July at this juncture.
Fair enough. Great. Thank you very much for your time.
Once again, that's the last follow-up I want to register a question, and [inaudible]. We have reached the end of further questions at this time.
Okay.
Thank you.
Okay. No further questions, I would like to thank the audience for your attention and your questions, and I'm wishing you a nice summer wherever you are. Thank you, and goodbye.
Ladies and gentlemen, thank you for your participation. This concludes today's conference.