Kitron ASA

OSE:KIT

Earnings Call Transcript 2018-Q3

[Lars Peter Nilsson, CEO & President]

Welcome to Kitron's Third Quarter Results 2018. I'm Peter Nilsson, the CEO. As usual, Ms. Cathrin Nylander, the CFO, joining me here today.Looking at the third quarter, we see a very strong growth on our order backlog, 27% on a comparable level, reaching almost NOK 1,280 million for the full year on a comparable level. Orders received in the month were particularly strong at NOK 669 million, that's up 25% from last year. We have a slightly lower-margin than we had last year, slightly lower actually than we expected. Some of this is due to some program postponements primarily and a slight, of course, the expected downturn in the Defence. But we have some programs that came in mid-quarter and started to slide over into the fourth quarter and will be delivered in the fourth quarter. EPS, however, is much better than last year, over 30% increase, with just over NOK 0.12 per share in EPS.Looking at our operating cash flow and our net working capital, you can see our net working capital is up almost 35% and the cash flow in the quarter was down NOK 41 million. This is really due to inventory buildup to secure our future deliveries and future growth. The challenges we've had on the electronics component market with limitations and capacity has forced us to make decisions to really get the inventory inside our factories and secure our fourth quarter -- or our first quarter, and somewhat even into our second quarter of next year. Some of this inventory, as we see, has been financed by ourselves, but large portions of it is also being financed by our customers.Looking then at the first 3 quarters so far this year. Revenue growth is about 6.3%. It's a 21% growth, excluding Defence and Aerospace. And looking isolated actually at the third quarter, the growth was 18%, excluding the decline this year in Defence and Aerospace.EBIT margin so far this year at 6.1%, slightly better than last year. Our EPS is NOK 0.47. I'd say it's significantly better than last year. And again reiterating when we look at the order backlog, a strong growth in the order backlog.In the third quarter, we signed a new agreement with a new customer within the industrial sector. It -- we expect it to generate about NOK 150 million over the next 3 years. Productions will be taking place in Kaunas in Lithuania and we expect revenues from this contract starting even in the fourth quarter now.We also announced in July our plans to expand our Eastern European presence and add more capacity through a new facility that's being constructed in Northern Poland. The production square footage will be about 8,000 square meters. The -- and production is actually, output from this new site is scheduled to begin in the fourth quarter of next year.We see, about the staff, of about 100 the 200 in the first 3 years of the operation, climbing to about 500 employees. So it will be a comparable site to the site we have in Lithuania. Our target for our sites is generally to be around EUR 100 million of revenue, and we expect to reach that with our Polish facility in the coming 5 years.So moving over to our financial statement in a little bit more detail, get some meat on the bone, Cathrin's here to take us through that.

[Cathrin Nylander, Chief Financial Officer]

Thanks, Peter. An important decision about Poland, I think. So the financial statements for the first 3 quarters and Q3 2018. We start with the new accounting standard that we have implemented this year and some comments on the effects on Q3.So in Q3, we have an income effect about NOK 25 million and an EBIT effect of NOK 1.7 million, compared to the year-to-date figures of about NOK 36 million and NOK 2.5 million. So this really implies that we have increased our finished goods and our working process during the quarter, which is then taken to income. And part of this is actually to even out some of the production levels we're having. It's about NOK 15 million of that. The rest is actually keeping more WIP, basically.And if we look on the revenue growth for the quarter. We have an 18% revenue growth if we exclude the Defence/Aerospace sector. In total, we show a growth of 5.1% and up NOK 28 million compared to last year, landing at NOK 563 million. However, within the sectors, we see some significant variations compared to last year. So industry grew 26% and NOK 50 million compared to last year. Defence/Aerospace is down 34% and NOK 45 million, so quite substantial changes. Medical devices is up NOK 25 million and 22.8%. Energy/Telecoms is down 8.9% and some NOK 9 million, and then we have Offshore/Marine is up NOK 6 million and a whopping 150%. So substantial changes within the quarter compared to last year.

[Lars Peter Nilsson, CEO & President]

And it is a testament to the extreme flexibility of our facilities. We were able to shift like this within a quarter, especially when -- even when you look at the industry sector, we said it was up NOK 50 million, and we had some postponed -- some fairly large postponements within Industry in the quarter.

[Cathrin Nylander, Chief Financial Officer]

Yes, that is true. So expectations were slightly higher on Industry coming into the quarter than we ended with.And if we look on the total year, landing at NOK 1,881 million and net of 6.3%. So we still have 21% growth, excluding Defence/Aerospace sector. Again, if we talk about real figures, the growth in the industry sector is about NOK 200 million compared to last year and 31%. Defence/Aerospace is down NOK 150 million compared to last year in the same area and time.Medical devices is up NOK 60 million, which is a good figure, and around 20%. Energy/Telecoms about even, same level as year, although we see improving higher fees this year coming later. And then Offshore/Marine is up 40%, some NOK 9 million compared to last year. So again, we see shifts between the sectors and that is a testament to stability in total because of the different sectors we have.

[Lars Peter Nilsson, CEO & President]

Right, and impressively enough, the NOK 150 million down so far this year is primarily in our Nordic facilities, Sweden and Norway, and even so, we see margin improvements in those facilities. So they've also been able to shift around, turn around and secure profitability, which is good, looking at the outlook for next year when we expect Defence/Aerospace to come back strong.

[Cathrin Nylander, Chief Financial Officer]

True, and talking about that, looking into the shifts that we'll have in the quarter from the sites. As Peter said, Norway and Sweden are affected by the reduction in the Defence/Aerospace sector. So you see the growth reducing about 6% and about the same figures, about NOK 10 million, compared to last year.Lithuania, despite the postponements, are -- have grown 15% compared to last year. The others is a mix here. It's the U.S. facility, and it's also our operations in China. Our operations in China, they have grown about 30% compared to last year. So a very strong quarter. Also in that sense, we have to say that the operations in the U.S. are suffering for -- from the postponement of one program coming into Q4 instead of starting in Q3, which we can also see on the profitability a bit later. Still, very good growth in the quarter from Lithuania and then some reductions that were expected.Again, on the first 3 quarters, Norway and Sweden, Norway is down 12%; Sweden, 7%. Lithuania, still on growth above 20%. And as you can see on the Others again, China has grown strongly, whereas the U.S. has declined due to Defense projects. A quite hefty mix change during the year I would say.

[Lars Peter Nilsson, CEO & President]

But also during the year, we started the U.S. or ran the U.S. last year with basically one customer being invoiced. And as per the end of the third quarter this year, we had 10 customers being invoiced, albeit still at a low level, but really setting the scene for next year.

[Cathrin Nylander, Chief Financial Officer]

We see good expectations from the U.S. going -- a lot of hard work has gone into it to attract all these customers, and I will say that Q3 will be their lowest point in my opinion.Seasonal variations in profitability. Well, we can see now, it's quite clear that Kitron is having 3 good quarters and one that's slightly lower on top line and on profitability. We are very sensitive to the mix changes in the quarter when it comes to the third quarter because basically, the vacation period in Europe reduces our top line in that sense.What we also see now is that the component allocation creates less flexibility for short-term changes in demand. Previously, we could pull in and push out revenue a bit more than we can today. It's very hard to do changes in the short term, which also affects our profitability in this quarter this year, specifically.

[Lars Peter Nilsson, CEO & President]

I mean, on the component side, a push out of demand used to result us pushing out the actual components coming in. We don't do that anymore. We bring the parts in because we will be needing them and you don't want to take a chance on not getting them later.

[Cathrin Nylander, Chief Financial Officer]

So we have 2 areas where postponed programs have affected the profitability, it's partly in Lithuania and partly in the U.S., specifically, I would say.When we look on the EBIT by country, I am glad to say that we see quite improvements in Norway and Sweden. So in spite of about 6% revenue reduction compared to last year, Norway is increasing their profit margin from 1.3% to 3.7%, and Sweden is going up from 4.4% to 5.5%. So quite some good work to reach those figures looking at adversity and the top line, if you put it that way.As I said, Lithuania has late demand pushouts into Q4 partly, but mostly Q1 actually. So we see that the profitability growth is not so strong this year as it has been in the quarter. And looking at -- there is a decline in the Others. So U.S. is severely affected by 1 program postponement into -- starting into Q4 than starting in Q3. So they're actually running at a loss in Q3 and a higher loss than we expected. Substantial changes between the sites, I would say, in this quarter.Looking at the profitability for the first 3 quarters. Lithuania continues to drive the profits there at about NOK 59 million in total for the year so far and up from NOK 47.4 million last year and a profit margin about 8.2% compared to 7.9% last year. Sweden and Norway, about the same level, I would say, but an improvement, 4.4% compared to 4.0%, 4.8% for Sweden, which is 1% up from 3.8% last year. So in spite of that revenue pushout of the NOK 150 million, so far, they are managing to create profitability out of it in Sweden and Norway, whereas the U.S. has less things to work on that, showing a larger loss.Inventory buildup to secure deliveries and future growth. The cash flow was a minus NOK 40 million (sic) [ NOK 41 million ] in the quarter compared to a positive NOK 22 million last year. It's basically because of the inventory buildup, I would say, and the major reason for it. And it's -- as Peter said, it's partly allocated material that we have purchased to keep in our stock for our end-customers. And as also said that we're keeping a lot of stock for our customers, but not in our books as well.We have postponements on some programs where we already have the goods in hand and in-house, which also is affecting it. There are some effects for growth into fourth quarter, and there are some effects on production for later deliveries, and that is basically about NOK 15 million.So we expect a slightly better cash flow into Q4, but it's not going to be as strong as last year.

[Lars Peter Nilsson, CEO & President]

Do you hear the forecast?

[Cathrin Nylander, Chief Financial Officer]

Yes. I'm giving it a try. I'm giving it a try. We need to do something. Financial gearing. NIBD, net interest-bearing debt or EBITDA, is 1.5 compared to 0.9, and most of that change is based on the higher net working capital, and that's the higher financing need. And part of it is also, if you compare to last year, an effect of the higher dividend we have last.So unfortunately, most of our key figures on the capital efficiency are then not improving in this quarter compared to last year, so net operating working capital as a percent of revenue is 25% compared to 21.9% last year. Cash conversion cycle is up 14 days, 94, compared to 80, and mostly the inventory. And then our ROOC is 14.4% compared to 16.3%. We assume most of this will improve during the fourth quarter; however, not a strong improvement as we have had the last few years.

[Lars Peter Nilsson, CEO & President]

But again, looking at the working capital and the inventory, mostly a result of actual decisions we've made to really secure our future growth and not happening. So we knew this was coming and we prepared for it.

[Cathrin Nylander, Chief Financial Officer]

And it has -- as you can see, it has leveled out at about NOK 600 million and are expected to stay there basically and reduce somewhat.So Peter, market development.

[Lars Peter Nilsson, CEO & President]

Yes. Okay. Well, let's take -- first, let's take a peek at our order backlog. There we go. So NOK 1,279 million versus just over NOK 1 billion last year. That's the 27% growth I spoke about earlier. The Defense side orders have started to come in, an improvement of 22% so far. I expect further growth in Defence/Aerospace from primarily 2 larger programs in the fourth quarter and running over next year. Medical it's stable, NOK 180 million. Industry, also a big, strong -- another big, strong push on growth there, just over 35%. Energy and Telecom is driven by Energy and primarily for rollout of infrastructure on some big Energy programs over both the fourth quarter but then also ramping even further into next year. Offshore, you see a big increase of 160% on our order backlog. This does not include the order and contracts signed with a Norwegian seismic customer, and I think we released that just early now in October.

[Cathrin Nylander, Chief Financial Officer]

A few days ago.

[Lars Peter Nilsson, CEO & President]

A few days ago. And so that's not in those numbers. It will come in in the fourth quarter. We'll see somewhat of that.Again, we say that we expect some fluctuations on defense going forward, but primarily, the outlook right now is, I think, favorable on Defence and Aerospace.

[Cathrin Nylander, Chief Financial Officer]

Yes, they're probably beginning the order backlog in. So the order backlog under the Offshore arm is higher than the 3-quarter revenue, actually.

[Lars Peter Nilsson, CEO & President]

So sort of in summary here. The strong order intake of NOK 669 million that generated close to 27% growth in order backlog. Although margins are slightly weaker in the quarter compared to last year, the earnings per share actually improved 33% to NOK 0.12 per share. The new quote pipeline grew 15% in the third quarter compared to last year, indicating that future prospects continue to be strong. In total also, NOK 329 million of annual revenue was booked as new wins in the third quarter.Component availability continues to be an issue. Several mitigating actions have been implemented to alleviate the stress in the supply chain, and the resulting actions, as we've spoken about several times here today, have driven an increase of our inventory level during the quarter. But this will improve delivery capability over the next few quarters.Oil and gas market continues to recover. But after the end of the quarter, we signed a major contract spanning 3 years with Magseis. So we expect the continued significant improvement in 2018.The trade and tariff sanctions are starting to affect supply chains with increasing movements of production to and from China, U.S. and Europe. Kitron is well-positioned to serve these customer requests. And I'd say, we've seen about NOK 50 million, NOK 60 million or so starting to move around -- or request to move it around between our sites. And so the top line outlook and bottom line outlook won't be affected. And I'm now happy that we can continue to serve our customers. I think it's a very competitive advantage for us.Looking at 2019 and 2020, the increases in Defence/Aerospace and the oil and gas-related sales increase our confidence in our strategic ambitions of NOK 3 billion revenue and an EBIT margin of 7% in 2020.So the outlook then for 2018. We reiterate, for 2018, we expect to grow between NOK 2.5 billion and NOK 2.7 billion. And EBIT margin is expected to be between 6.1% and 6.5%.Growth is primarily driven by defense sector and the energy part of Energy/Telecoms. We have said before that defense is down. So far, we have said this year, NOK 150 million, first 3 quarters.The profitability has continued to be driven by cost-reduction activities and improved efficiency.That's it.

[Cathrin Nylander, Chief Financial Officer]

That's it.

[Lars Peter Nilsson, CEO & President]

Thank you very much.