Earnings Call: Q1 2018

May 2, 2018

Ladies and gentlemen, good afternoon. Q1 2018 Results Conference Call and Live Webcast. I'm Sherry, the Chorus Call operator. I would like to remind you that all participants will be in listen only mode and the conference is being recorded. After the presentation, there will be a Q and A session. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Andreas Schwarzselder, Head of Investor Relations at Oerlikon. Please go ahead, sir. Thank you very much, and good afternoon, ladies and gentlemen, and welcome to Oerlikon's conference call on the results of the Q1 of 2018. Your hosts today are Roland Fischer, the group's CEO Jorg Fedje, group CFO and myself, Andreas Schwarzwelle, Head of Investor Relations. As a reminder, all related documents on the Q1 results, including the following presentation, are available for download on our website. Today, we follow the well known agenda. Moran Fischer will start with an overview and an update on the segment's performance, followed by Jurgen Fedje, who will add some comments on the group's financial performance and confirming the full year guidance. After the presentations, we will host a Q and A session to answer your questions. Today's conference is being recorded and the replay will be available on our website later today. Having said that, I'll now hand over to our CEO, Roland. Yes. Thanks a lot, Andreas. Good afternoon to everybody on the line, and thank you for joining our Q1 2018 earnings call. For the period January to March 2018, Eurykorn achieved an all time high in order intake and sales, raising both by more than 35% year on year and a nearly 60% increase in order backlog. This excellent result is driven by all three segments. The Service Solutions segment remained on its steady growth path. The Manmade Fiber segment significantly boosted its top line and operating profitability and achieved growth rates exceeding 100%. And last but not least, the Drive Systems segment realized about 20% gains in orders and sales. Profitability is following. In the Q1, we have been able to improve the group's EBITDA margin to over 15% after taking into account and absorbing our investments in the ramp up of our Additive Manufacturing business. And all three segments contributed to the excellent result and achieved all 3 double digit EBITDA margins. And in the Q1 of 2018, we were also continuing to deliver on our strategy. We completed 2 string of pearls acquisitions in the Service Solutions segment. First, DIAC offers a company which offers thin film technologies that enhance Erlikon Balsa's portfolio for customers in the automotive and precision component industries and will strengthen Eerlikon's footprint in Finland as well. With the second one, sucrotech. EarlyConbulses expands its offering with high quality chemical vapor deposition systems, not PVD, but CVD technology for the tooling market. And in addition to that, we have opened a new coating center in Tohono, Malaysia to meet the high demand from customers in automotive, aerospace, medical, general industry and electronics industries in Malaysia and in Singapore and to strengthen service solutions leadership position. The Manmade Fiber segment executed their market recovery schedule and secured large scale orders. And finally, the Drive Systems segment continued to benefit from its repositioning strategy and executes its growth initiatives in all of its key markets and across all regions. And based on the group's strong performance in the Q1, we are in a position to confirm our guidance for 2018. We expect to the overall positive momentum in our end markets to continue in the upcoming quarters. Also, geopolitical tensions and protectionist policies could impact international trade and business in industrial sectors. And now let me take to address another topic upfront that created a significant amount of media coverage and uncertainty in the capital markets after the Q1. I'm talking about the identification of Victor Wexelberg and Renova Group as Specialty Designated National, so called SDN, pursuant to U. S. Sanction rules effective April 6. And I would like to reconfirm that Oerlikon is and was never neither considered a sanctioned nor a blocked party because Mr. Wexelberg's ownership interest in Oerlikon is less than 50%. U. S. Persons and entities as well as any other persons and entities are therefore not restricted in their dealings with Oerlikon or in investing in Oerlikon. What we also can confirm is that from an operational point of view, our global customer base and our trusted U. S. Customers, in particular, continued to work with our solutions, equipment and materials. Orders we received or projects that were entitled after the April 6 provide evidence to our continued business activities. For example, orders from an U. S. Aerial platform manufacturer and U. S. Construction equipment manufacturer in the Drive Systems segment. In the Service Solutions segment, we received several material orders from customers in the aviation, power generation and general industry, totaling multimillions since April 6. And last but not least, in the Mainmade Fiber, we are in the final negotiations with a U. S. Customer for a leading carpet yarn solution, and we are confident to conclude the project in the coming weeks. And now let's turn back to our Q1 performance and to the Service Solutions segment's performance in the first quarter 2018. The Service Solutions segment continued its positive growth path and delivered another quarter of good performance with organic growth in the top line. Orders increased by over 9% year on year to CHF 384,000,000 Sales increased by 9% to CHF361,000,000. And we noted a significant upward trend in general industries, specifically coating for precision equipment, semiconductors and medical applications and saw ongoing strong demand in tooling and automotive. The small sized acquisitions in the Q1 and a positive raw material surcharge effect added in total roughly to CHF 12,000,000 to the reported top line. We saw a positive growth contribution from coating services worldwide for tooling equipment and precision and medical components. However, on the other hand side, we saw a weaker market environment in power generation, resulting in a softer start in thermal spray materials in general. I'll now spend a second on the ramp up of additive manufacturing business and construction of new facilities continued which are continued according to plan. We have signed a 5 year agreement with Boeing to develop standard materials and processes from powder management to finished products and thus, to enable the development of a wide range of safe, reliable and cost effective structural titanium aerospace components. And this is another milestone in our effort to industrialize and to drive adoption of additive manufacturing. And including the investments made to build up the additives business, the Service Solutions segment sustained its operating profitability level well within the guided corridor of 18% to 20%. We achieved an EBITDA of CHF69 1,000,000 and an EBITDA margin of 19.1%. And from an end market point of view, we observed strong momentum in general industries worldwide. The tooling market shows continued good demand in all regions, which is supported by strategic initiatives and the adoption of new coating solutions. The automotive business remains robust in Europe and Asia, and we continue to see a lot of potential. We see ongoing moderate growth also in the aerospace market. However, as already indicated, power generation remains a challenging market environment, in particular for large gas turbines. From a regional point of view, Europe is showing strong growth, and we see good development in Asia, in particular Japan and India and in North America. Overall, we are pleased with the positive development of the Service Solutions segment, which continued to be the main revenue and income generator for the group and delivered strong results in the Q1 of the year. And now, let's move to the Mainland Fiber business. The Mainland Fiber segment showed a remarkable performance in the Q1, mainly driven by the Filament Equipment business. During the dynamic market recovery, manmade fiber has been able to capture a healthy share of market opportunities and to maintain its leading market position. The segment secured large scale orders and benefited from positive market settlements for upgrading of production capacities. The strong sales for Filament Spinning Machines provided an accelerated project landscape for texturing machines as well. The segment's top line growth of more than 100% was mainly led by business wins in China. However, a high level of demand was also noted in India and Turkey for filament equipment as well as for texturing, stable fibers and carpet yarn systems. In North America, a noticeable uptick in orders was registered, attributed to the healthy growth in the carpet yarn business in this market. And this leads me to the Q1 2018 numbers, which form a remarkable picture as all key figures show a year on year improvement of more than 100%. For orders increased strongly to a record level of CHF373 1,000,000 and sales to CHF243 1,000,000. And as indicated in previous earnings calls, profitability now followed due to the increased sales volumes and the efficiency improvements after the successful ramp up. And therefore, the EBITDA margin increased to 11.1% in Q1 2018, and the EBITDA stood at CHF 27,000,000. The market dynamics continued to improve in the first quarter of the year, in line with the trend we have seen towards the end of 2017. The filament equipment market in China saw strong demand as Tier 1 customers consolidated and positioned sensors aiming for leadership in terms of capacity, technology and efficiency. That's a kind of race what takes place in China right now. And as a result of the increased filament activities, the texturing equipment market was also positive. We saw increasing demand for BCF carpet yarn solutions from the U. S. And Turkey and positive market dynamics in Stable Fibers. And all in all, this has resulted in a strong pipeline, which lead with lead times going well into 2020. And the strong results speak for the performance of the segment and its management. It demonstrates its ability to successfully manage the downturn and for fast and accelerated recovery. And now let's move to the Drive Systems business. The Drive Systems segment drove its business forward, achieving almost 20% growth in order intake and over 20% increase in sales for the Q1. The business attracted new customers and won additional projects in the agriculture, transportation, automotive and construction markets. And in its largest market, agriculture, the segment noted higher demand in India, in the U. S. And Europe. Strong growth was also registered in for passenger cars in India and China supplemented the stable growth in Europe. And now talking about numbers. The Drive Systems segment achieved an order intake of CHF 217,000,000 in the first quarter and sales of CHF 209,000,000. And as a result of the operating leverage from increased sales and not to forget the continued positive impact from repositioning initiatives, the segment achieved an EBITDA of CHF 26,000,000, an improvement of over 80% compared to the same period in 2017. And the EBITDA margin stood at 12.4%, making Q1 the 4th consecutive quarter for DRIVE Systems with a double digit margin. And for positive momentum in the e drive market, so further stimulus where a jump in sales volume for Chinese new energy vehicles was noticed. In preparation for the launch of its first e drive transmissions in China, The segment has signed an agreement to set up a new plant in the Jiangsu New and High-tech Industrial Development Zone. And a slight recovery in the oil and gas and mining industries was also observed, especially in the fracking industry. And in terms of key end markets, we have seen continued global improvement in agriculture with high levels in Europe and solid growth in the U. S. The construction sector also maintained its positive path with growth in the U. S. And Asia, especially in India. And the transportation sector continued to show strong demand for commercial vehicles, mainly in China and India and more moderately in Europe. Heavy trucks are showing high increases, while rail continues to remain weak. In automotive, we see ongoing positive market sentiment, while energy and mining markets showing slowly increasing demand from low levels, mentioning some activities in the fracking industry in the U. S. Overall, our Drive Systems business is today in very good shape. The team did an excellent job to execute the repositioning and to benefit from the market recovery. And after this review on the segments performance, let me hand over now to Jorg for additional comments on the group's financials. Jorg, please go ahead. Thank you, Roland, and good afternoon to all of you. Let me start the group's financial review with a closer look at the Q1 figures. The before mentioned positive development of all segments not surprisingly consolidate to a strong group performance. They add up to an order intake of CHF 974,000,000 in the Q1 of 2018. That's an increase of 37 0.8% year on year on a reported basis or 33.1% if adjusted for currency development. Sales came in at CHF 813,000,000, that's up 30 5.7% year on year on a reported basis. Driver of the top line development was growth in all segments, what you have heard as mentioned earlier by Roland. And the book to bill for the group exceeded 1 for the 8th consecutive quarter. The EBITDA stands for the group at CHF 123,000,000. That's an improvement of 43% when comparing to the Q1 of last year. And the EBITDA margin, as you have seen and heard, stood at 15.1%. That's an increase of 80 basis points versus Q1 of last year. The operating profit on EBIT was CHF 72,000,000, which translates into an EBIT margin of 8.9%. The development of the exchange rate in the Q1 of 2018 compared to the same period of last year was beneficial for the company. This is mainly related to translation effects as we report in Swiss francs, the appreciation of the euro and to a lesser extent, the Chinese yuan against the Swiss francs was slightly compensated by the devaluation of the U. S. Dollar against the Swiss franc. Assuming the stable currencies, orders would have been at CHF 941,000,000. That's a difference of about 3 point 5 percent from ForEx compared to Q1 of 2018, and sales would have been at CHF797,000,000, also lower by approximately 3 plus percent compared to the Q1 twenty 18 reported figure. The transaction and translation effect on EBITDA were 3.2 pole in the same magnitude as orders and sales, hence, with no or marginal impact on the margin itself. The strong recovery in MME Fiber becomes visible when looking at the group's business split as the segments increased its share compared to the same period of last year. The Service Solutions segment accounted in Q1 2018 for about 44% of the group total sales. MEME Fibers increased to about 30% and Drive system represented approximately 26%. When looking at the profitability, the upturn in both manmade fiber and Thrive system become even more pronounced as manmade fibers accounted back now for 22% and drive system for 21% of the total EBITDA in Q1, while Surface Solution delivered approximately 56% of the group's total profitability. From a regional point of view, our proportion and sales increased in Asia Pacific to about 37%, while declining in Europe and North America to 37%, respectively, 19 percentage points. Sales in the rest of the world increased to about 7%. In line with the before mentioned recovery in MAMF fiber and drive systems, the share of our service and spare parts business decreased correspondingly as you would expect to about 30% of group sales in Q1 compared to about 38% in the same period of last year. Looking at the return on capital employed. The ROCE Ehrlichant's return profile shows a positive development. The group's 1st quarter performance resulted in a rolling 12 month return on capital employed of 9.6%, reflecting the higher operating profit over an only slightly increased asset base. This reflects our commitment to create value while executing along our strategy. Ladies and gentlemen, let me conclude this 2018 outlook and a short summary before we start the Q and A session. We do expect the positive momentum in the global economy and in our end markets to prevail despite the fact that certain risks in the global political and macroeconomic environment remain. Consequently, we are in the position to confirm our full year expectations. We expect to achieve order intake and sales for the full year 20 18 up to CHF 3,400,000,000 and around CHF 3,200,000,000 respectively, and to deliver an improved operating profitability of around 15%, including the full absorption of investments into Additive Manufacturing. Consequently, the underlying assumption for the segments also remained unchanged. The strong Q1 performance and our confirmed expectation provide the framework to sustain our growth and improve profitability in 2018. Ladies and gentlemen, this closes our official comments on the Q1 2018. We thank you in advance for participating and are happy to open the lines now for questions. Operator, please go ahead. We will now begin the question and answer session. First question is from Vazir Rizvi, RBC. Please go ahead. Hi, good afternoon. Just a few for me, please. Just firstly on manmade fibers. It looks like the pipeline is spilling up even more and you're talking about being full out to 2020. So are you now at the point where you can give us a relative kind of a big stare as to what the quarterly run rate should be for sales and EBITDA given you're managing your volumes? And then that should then leave the only variability really being on orders. I'm not sure whether I really got it. You asked for the profitability? No. So what should we expect as a quarterly run rate for sales? I mean, we would needed to say and I think we have said that in some of the comments before, that the current pattern of order intake is not to be just rolled over into second, third and fourth quarter. Please look at it from a point of view of exactly what you said, the pipeline continues to fill and the visibility obviously gets greater for us going into 2019, 2020 and to a certain extent even beyond that. Look at it from an overall point of view, if you talk about sales and margin, the way we manage it from an overall capacity point of view. I think we said clearly over the last couple of quarters all the time that we are not on duty, even in a sharp recovering market, increase our capacity and hence, to a certain extent, the fixed cost base going forward. So we do expect regardless of the pattern which you will see in order intake going forward, which to a certain extent, we do expect that to be for the following quarters in the short term to be a tick lower. We expect the sales to continue to trail around the CHF 1,100,000,000. And this obviously is related to the margin development. And the margin development also in light of building down the current pipeline, we expect to be in the vicinity of about 11%, 12% range, depending again. I'm not trying to we are not trying to make it more difficult and understandable, but reflecting again the build down and sequence of the build down of the pipeline per se. And you should expect then, as I said, on comparable levels going into 2019, seeing some better margin orders are flowing into the pipeline to continue to expand the margin going into 2019. Great. Yes, that's helpful on the run rate. And then just going on to Surface Solutions, I was interested in, is there an impact from this equipment and service mix within the margin for this quarter that I need to go aware of? Or is it mainly the investments in Additives that are influencing the margin? It's I mean, there are always some minor adjustments, obviously, from a mix point of view. But if you decompose the number on a high level basis, it's really primarily attributable to the investment in Additive Manufacturing, yes. Okay, great. Thanks. And just one more, if I could, please. It was just on you haven't announced anything with Drive. And I guess, we'll hear an update when it comes. But assuming you that something does happen with that in the future, then your balance sheet looks further under levered. Can you just remind us what your latest thoughts are on capital allocation and what you'll be thinking once you've completed the DRiVE transaction? As you rightly said, you will get the information when it's done. We are in the midst of the process, and it's nothing is decided, and it takes a little bit more time. And yes, our balance sheet is well known. It's stable, let's say it this way. You know exactly where we are. And we also always made it clear that we are focusing on the Service Solution and Material Business. And here, we are not purely focusing on organic growth, but also on inorganic one. The string of growth topic was highlighted today. And all the rest is heavy work and more I can't say right now. Okay. Thank you. Next question is from Alessandro Foletti, Octavian. Please go ahead. Yes. Good afternoon, gentlemen. I have a few questions for you. First question on surface solution. I was wondering if there is any meaningful raw material effect in your numbers in this Q1? That will be the first question. Then I have a question on man made. I understand that the orders that you have announced in January are not into this order intake. Otherwise, it will be much higher than what it is now. So I was wondering if you can give a little bit more information here about how these orders will be booked and why they are not booked all at once and what would be the effect of this? And then maybe I have another 1 or 2 questions depending on your answers. So let me Alessandro, thanks for the question. Let me start on the material surcharge effect. Yes, we had, as you would have expected, in light with the general commodity price increase and effect here, which was trailing around SEK 7,000,000 for the segment. On the man made fiber side, the reason again, let me just repeat the way we recognize those orders and that's absolutely correct. The €500,000,000 which we announced from Hengie and some of the other big players in China are not being reflected in there. Normally, the way we address that and the way we fully recognize and show it as an order intake is depending on a couple of factors. The first one is obviously that some prepayments have been properly made against it, that financing is being secured and most important that the orders have been taken up in the production schedule of the business. And we have said at the time already when we announced that going into the year that this will be orders, which earliest will be in turned into POC in the period of 2019 2020. So that's basically where we are. And as I said, those negotiations are ongoing. Everything is fine. There's no risk related to it. But we want to make sure we have complete fulfillment of those conditions before we recognize it in the books as well. And it's a second contract. It's a huge package, €500,000,000. Exactly. It doesn't come in one shot, right? Exactly. Yes. Right. But it means what you mentioned that there is no risk related, although cancellation risk is, let's say, controllable. I don't know how to formulate it. Cancellation risk is never controllable, but I can assure you that there is no risk of cancellation. All right. That's great. And then can I ask you a question maybe related to this order boom that we have been seeing? Is these numbers that we have now or maybe differently, can you give an indication how much of these orders that you are now seeing are related to your normal business and how much is related to other things like your initiatives to increase the service, your initiatives to enter poly condensation and so on? No, I think you're referring to this big contract, and this is Filament this is a core business, normal standard business. And what we are doing on top in terms of Stabil Fiberenonewoven, Here, we are generating a good progress. But I think it was also clear from the very beginning, these are comparable smaller volumes comparing it with this big 500 chunk order, right? I think the 370,000,000 of this first quarter? No. There is just a normal product mix in filament, PCF, nonwoven. We have a certain amount of nonwoven in, but we do not disclose the split across our product portfolio. All right. Can I ask you just a very small question on the drive system business? You mentioned this factory that you want to open. Is it going to be a joint venture or fully owned? First question. And maybe can you share a little bit of what kind of expectations you have for that sort of additional business in China? We have it's the answer is a twofold one. What we are just referring here is an own factory for the e drive business, which is upcoming. And you know that we do have a joint venture with Canway on this low floor city bus topic. And here, this business is roaring as well. And we have to look for new sites just to be prepared to serve the huge demand, but this is to come. So but this is part of the joint venture in this case? Teletrobon is part of the joint venture with Canvey, yes. Right. And is it too early to share your views on how much business you will make with that? Yes. It's too early because again, we are not disclosing the business split across our product lines. Okay. Thank you. Okay. The next question is from Andy Schneider, ZCapital. Please go ahead. Hi. I have an add on question on the manmade business. Can you talk a little bit about the margin level of these order intakes we are seeing now. So in Q1, it's EUR 360,000,000 is considerably higher than this 11%, 11.5% we are sailing right now. Can you talk a little bit about that? Yes. And not disclosing at the level of the individual project, but I can confirm you that over the last couple of quarters, we have seen now a gradual improvement in the margin profile coming out of the trough. So we are recovering back to levels which we have seen or close to levels which we have seen. And again, the only additional guidance which I can give you here at this point in time is that we said the business the way the business is being set up, the cost structure has been put in place that from a structural point of view, that would allow us to run the business again at a mid teens EBITDA margin. And I think everything which we have on hand, be it on the pipeline and what's being negotiated right now, is leading in that direction. Okay. And in NANO question on Surface Technology, There was an underlying sales growth of about 3.5%, which seems not that high given that the environment is quite good right now. And you are expected to grow, let's say, 2x GDP growth, which would certainly be higher than 3% to 0.5%. Do you expect an acceleration in the coming quarters? Yes. That's exactly what we do. We guided range, I think, 5% to 6%, if I'm completely wrong. And that is what we are believing in and what will happen. From our perspective, you are right. Had a weaker or softer start, especially in the material business for power generation and big units, gas turbines, steam turbines, and you know all these ongoing discussions. I don't know the names of the big players here, but and that was the reason. And yes, you're right. And we are confirming the range of 5% to 6% what is in line what we said and what is overachieving the general underlying industrial growth. That is fine. Was it just some larger project in the Power segment, which were not there in Q1 and which will come back? Or is it the power sector as a whole and further acceleration in other sectors, which will bring the growth back to higher levels? Yes. That is what we expect. We do see a good growth rate in other verticals. So just to mention tooling, I think I mentioned some. And this is good enough to support our guidance. That's fine. That's what we expect. Okay. And do you have already now after 4 months a better view where in the corridor of 18% to 20% EBITDA margin in surface you will land on? Is this 19%. So really midpoint, is this a good number we should put in our models? Or do you have a better view whether it will be rather at the lower end or at the higher end? I do have a private opinion, but which I thought should not disclose here, right? And we have no real sorry for saying that, but we stick to the corridor. And that is what we always said, and that is what is valid for the future as well. Okay. Thanks. Ladies and gentlemen, that was the last question. So thank you very much. This is Andreas speaking. Thank you for participating, and we look forward to talking to you either on roadshows or latest on August 7 when we disclose our Q2 results. Thank you very much for joining, and have a good afternoon. Thanks. Bye bye. Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call and thank you for participating in the conference. You may now disconnect your lines. Goodbye.