MTU Aero Engines AG

Good morning, ladies and gentlemen. Welcome to our conference call for the Q3 2019 Results.

As always, we will start with business and financial highlights presented by Reiner Winkler. Peter Kameritsch will give more details on our OEM and MRO segment.

Before we will open the call for questions, Reiner will give some more explanation on our confirmed guidance for 2019. Last, but not least, you will have time to ask questions.

Let me now hand over to Reiner for the business highlights.

Yes. Thank you, Thomas, and welcome from my side.

The market environment for the aviation industry remains robust, also despite some uncertainties. Passenger traffic increased by 5% and load factors remained at record levels of 85%.

Our GTF deliveries in 2019 will increase by another 30% and we are on track to meet our commitments. Our MRO segment continues its success story.

Year-to-date, we signed new contracts in the value of more than US$6 billion, which already exceeds the volume of 2018. Latest significant addition was JetBlue, which covers the V2500 preselect fleet.

We are very excited to add LEAP engine to our MRO portfolio. In September, a general agreement was signed between China Southern, MTU Zhuhai and CFM International, which will allow us to maintain LEAP engines at our shop in China.

This is a natural evolution for MTU Zhuhai, which is the largest narrow-body engine shop already in Asia. The strong growth in both segments, OEM and MRO, requires capacity increases in all our facilities.

All extension projects are proceeding very well. In September, we successfully placed a new convertible bond of €500 million with a slightly negative yield and a maturity of 7.5 years.

The proceeds of this new convertible bond were used to finance the partial repurchase of the outstanding convertible due in 2023. With this transaction, we optimized our financial structure without limiting our flexibility.

Also in September, MTU has been included in the DAX 30 index. This index comprises Germany's top 30 publicly listed companies.

This underlines the success story of MTU and confirms trust into our profitable growth strategy. Let me now switch to the key financials, before I hand over to Peter for more details on the business segments.

The group revenues increased by 3% to €3.4 billion, driven mainly by the OEM segment. Adjusted for the change in the contracting and invoicing process at MTU Zhuhai and some U.S.

dollar effects, group revenues would have been up 6% organically. The group EBIT increased by 10% to €558 million, resulting in a margin of 16.4%.

Net income adjusted was up by 8% to €392 million. Last, but not least, the free cash flow increased by 85% to more than €300 million, driven by both better cash flow from operating activities and lower cash flow from investing activities.

Let me now hand over to Peter for more details on the business segments.

Yes. Thank you, Reiner, and good morning, everyone.

And let me start with the OEM segment. Total OEM revenues were up 9% to roughly €1.5 billion.

Military revenues increased by 7% to €324 million, driven by EJ200 and RB199. Commercial business was up 10% to €1.1 billion.

Within that, organic OE sales were up, low teens, mainly driven by the ramp-up of our different GTF platforms and also a higher demand for GEnx engines and also business jet engines. Organic spare part sales were up mid to high single digits, mainly as in the quarters before driven by the V2500 platform.

EBIT adjusted in the OEM segment increased by 9% to €370 million, resulting in a broadly stable margin of 25%. For the next page, let's have a look on the commercial MRO segment.

Total MRO revenues remained stable at roughly €2 billion. As already mentioned frequently in previous calls, we report lower MRO revenues due to the change in the contracting and invoicing process at our Zhuhai facility.

Organic MRO revenues in U.S. dollars would have been up 8%.

In the quarter, we saw organic revenues being up around 12% due to a pickup in work scopes as already expected in our Q2 results. EBIT adjusted increased by 11% to €187 million, mainly due to a strong equity contribution from our MTU Zhuhai facility.

And EBIT adjusted margin improved consequently to 9.4%. So now, let me hand back to Reiner for a look on our guidance.

Yes. Thank you, Peter.

Based on the strong results in September, we can confirm our guidance 2019, which we increased after Q2. So we expect group revenues at around €4.7 billion based on an average U.S.

FX rate of 1.15. Within that military revenues are expected to be up by 10%.

Commercial OE will be up in the low-teens mainly driven by the GTF deliveries. Commercial spare parts are expected to grow by mid- to a high single-digit number.

And commercial MRO will be up high single-digit organically. The EBIT adjusted margin expectation remains unchanged at around 16%.

Net income will grow in line with the EBIT adjusted. And we see our cash conversion rate unchanged at 65% to 70%.

So thank you very much for your attention and we are now ready to answer your questions.

Yes. Good morning everyone.

I have two questions if I may. The first one would be on the impact from the convertible bond.

So we can see on the net debt detail that it increased by €200 million. But could you give the actual new dilution impact from the new structure?

The second question will be on spares. Can you tell us what were the spare momentum in Q3 and some detail per platform please?

Thank you.

So on the spares, the spares in Q3 were up mid- to high single-digits, so 7%, 8% roughly, 7% in that range, so driven by the V2500. V2500 in the quarter was up mid-teens, so in the range a little bit above 50%.

CF6 and PW2000 were down slightly as expected. So on the convert, yes, we had -- I mean we bought back basically so we issued a new convertible bond for the underlying shares.

And the new convertible bonds are 1.3 million shares. And through the repurchase of the old convertible bond, we canceled 2.2 million shares.

So all together, we improved the dilution by -- the maximum dilution by 900,000 shares and postponing the dilution point of time to 2027. So it was a reduction of the maximum dilution, but also from a timing perspectives pushed it to the future.

Thank you very much. Very clear.

Hello. Thank you for taking my questions.

One is on GTF deliveries. I think you've targeted full year deliveries up 30% here.

I wanted to kind of check in on that given the low deliveries reported by Pratt & Whitney in Q3 and see how much of a job you have in front of you for Q4 to meet that full year target. And the second question that I have is around the backlog of shop business looking into 2020.

Clearly, some operators have delayed maintenance activity as a result of the MAX grounding. Yes, how much visibility do you have on a potential surge in maintenance activity in 2020 given the state of supply?

I mean regarding GTF deliveries, we are fully on track to meet our commitments. I can't remember that Q3 was weaker than the other ones, so more or less flat.

So for the entire year, we are fully committed to the 30% increase. No issue about that.

Regarding 2020 visibility in the MRO business, I think we have full or high visibility. We mentioned that €6 billion of new orders we won in the first nine months this year.

I think all the shops are really fully loaded and there's no indication of any weakness in our MRO business. The opposite is happening, so...

If I can follow up on that and, I mean, it was more kind of the other way I was thinking. I mean how much pent-up demand is there for shop visits in 2020, given that some operators may have been delaying those this year with the MAX grounding?

I don't think that it's going to be a significant trial for our MRO revenue front.

Okay. Thank you.

Good morning, ladies and gentlemen. Two questions, if I may.

First on commercial OE, new engine sales. When looking at consensus estimates and also if I compare reported results versus my estimates, I get the impression that the momentum in OEM has been somewhat below expectations.

And my question would be, would it be fair to assume that the sales momentum in new engines has significantly declined in Q3 versus Q3 2018 in a way to assume that the ramp-up of new engines production has been steeper in H1 2018 that is that the base in H2 2018 has been higher. On the question -- the second question would be on the spare parts momentum, as a follow-up.

I mean, we saw the spare sales pretty strong in Q1. We saw it at the lower end of the guidance range in Q2 and now somewhere in between.

How should we think about that going forward? Would it be fair to assume that basically we are seeing here, to the major part, quarterly fluctuations?

I mean, your indications regarding the aftermarket, the MRO growth implied that overall demand in the aftermarket remains really strong.

I mean, regarding OE deliveries, I wouldn't read too much into a comparison between 2019 and 2018, because I mean 2018 was a completely secured year. I mean, if you remember, we had a very poor first quarter due to the delivery stop for the PW1100 due to the knife-edge seal issue, then extremely strong Q2.

And then it was reverting back to more normal levels. So that baseline effect you have always when you compare 2019 to 2018.

So -- but looking into 2019, I mean, we have a rather smooth development throughout the year and you're going to see a bit of a stronger quarter. So Q4 will probably be the strongest delivery quarter for new engine shipments.

That is due to the fact that GTF further ramps up, but also we see in 2019 compared to 2018 a higher demand for GEnx. So GEnx has grabbed the higher market share on the 787.

And also, I mean, the business jet -- our new business jet platform, the PW800, also ramps up. So definitely a stronger fourth quarter in OE deliveries.

I mean, spare parts, I mean, after nine months we are at low to mid-single digits. So that is our guidance.

So the fourth quarter will be in that range and we have that kind of a quarterly fluctuation as always. So -- but the major underlying driver are unchanged.

So we think that V2500 can grow somewhere in the range of 15% to 20%. We have the CF6 and the PW2000 being stable to slightly down.

So these are the drivers. Up to now we don't see any change in that development.

Great. And maybe one follow-up, if I may.

Now that you mentioned that Q4 should see the strongest deliveries in new engines, can you give us an update regarding cost conversions and development of margins in new engines?

I mean, what do you mean update on new margins -- on margins?

Update on margins in new engines, in particular, cost conversions in the GTF. I mean, we are looking for declining losses in the GTF on the ramp-up.

Yes. We are fully on the way.

I mean, on the GTF, we are -- I mean, we are down the learning curve more or less. I mean, as you know that the GTF production is highly automated.

So what happens is that we can spread a lot of the depreciation over a higher volume. And that obviously by definition leads to lower unit costs.

And that happens, as we speak.

Okay. So it's on track with expectations.

Exactly.

Great.

Yes. Good morning, everybody.

Thank you for taking my questions. The first one I had was on freight.

We've seen freight traffic being negative now for 10 months in a row. Do you think this is a bit of a risk for you going forward?

So just if you could give a little bit of color around that. And then the Boeing 787 rate from 2020 on Wednesday at their results how do you think this is going to impact you?

And any color around that would be great. Thank you.

I mean, first of all, yes freight is weaker. But this is mainly related to regions like Asia Pacific, Europe and Middle East.

They suffered more than the other regions. And especially, North America we saw more or less flattish development of that in 2018 and 2019.

And we have -- our business is more related to North America. For example, we have customers like MS and others.

So our aftermarket -- our business is still robust in this area. We do also not see increasing retirement of parking activities.

So all-in-all it's not a big issue for us. On the 787, yes, they slightly declined production rate.

But on the order side, GE has gained market share on the 787 compared to Rolls-Royce. So all-in-all, it's also let's say, no big issue or negative impact for us.

So the lower production rate would be compensated by the higher market share.

Okay. Great.

Thank you.

Yes, good morning. I had three questions.

I'm going to start with the first one. It's on the pension provision.

I mean, I may have missed something, but it's up close to 13% since the start of the year. What is the trend here?

I mean is it part of -- I mean can you explain basically why it is up? The second question is on the order book up 18%.

It's -- I mean, the backlog I mean -- It's significantly -- I mean, I think, it's the highest number you have ever reached and…

Yes.

And how does -- I mean, it may not have been your plan at the beginning of the year. I mean, you probably did better than this.

My question is how does it change your planning in terms of the MRO visibility? I mean, it must clearly improve your visibility into that activity going forward.

Should we I don't know expect potentially better margin potential going forward? And the last question is just a clarification.

We read somewhere that Airbus was considering imposing some royalty fee on MRO, but it seems to be only airframe. Can you confirm that it only it's only on airframes not on engines?

Yes, it is only on airframe not on engines to start with the third question.

In pension provision Christophe it's -- I mean that's a result of the low interest environment. So I mean what we do is I mean we -- our pension provision is basically the net present value of a few of our future pension payments and to discount that with a A rating basket of bonds so -- and the interest rate has come down and so the net present value goes up.

And now we are close to €1 billion of pension obligation. And so as soon as interest rates move up again then we see lower pension provisions now.

But it doesn't -- I mean it doesn't run through the P&L. So it's an OCI component which goes directly into equity.

Okay. Great.

That’s just…

Order book, yes, we are at 20 -- 21 -- almost €21 billion of order book the highest, highest level ever. And I mean if you compare that with Q2 where we are at €18 million or so.

So we have added significantly into the order book. I mean then the major -- major things that we won some MRO so independent MRO contracts.

And the biggest one we added to the order book was the JetBlue contract which is a lifetime contract for a part of the JetBlue fleet or for the preselect fleet. And that is a very high-volume contract running until 2030s.

So, yes. And this definitely gives us a higher visibility.

But the MRO margin, I would say that that is I mean 9% in that area. It's a margin you can achieve with that kind of business given the fact that you have 60% -- 65% this is without any margins.

So all the spare parts, which you purchase is coming with zero margin. So 9% is -- I think is what you can really achieve on a long-term basis with that business.

And so just a follow-up on this. Did you -- in those new orders are you getting more repairs?

Or is it still the same type of contract as usual? Is there more repair contract?

No. It's the same as usual so no big difference.

Okay. Thank you very much.

Thanks.

Thank you. Good morning.

I've just got one question, which is about the drop-through from EBIT to net income in the quarter. The EBIT was clearly up 11%, but only 6% net income.

And the difference appears to be a significantly higher tax rate both for Q3 and for the nine-month stage. Is this of itself significant?

Or is there just lumpiness in the tax rate that you recorded in this quarter? Should we use this quarter's tax rate as the ongoing planning rate?

Well, I mean for net income adjusted we use our 20% -- 29%. That is the expected tax rate, but we have quarterly fluctuations.

So regarding tax there's not a big impact in the quarter -- nothing abnormal in the quarter, I would say. I mean, the only thing which is going from EBIT to net income in that quarter you have that what you call early repayment penalty for the convertible bonds.

So we bought back 55% of the convertible bonds and you have the nominal value of the convertible bond in your books, but you paid obviously roughly 200% because the bond was deeply in the money. And part of that markup has caused early repayment penalty.

So as you book that directly the major part is booked directly into equity, but part of that is -- runs through the financial results also into equity and that is something like €9 million. And you see that in the -- that the interest expense in the quarter is a little bit elevated due to that effect.

But that's the only abnormal thing in that quarter.

Okay. Great.

Thank you very much.

Thank you.

Hi. Alex Hauenstein from DZ Bank.

One quick comment. Maybe I could ask you to give us some color on the Swiss air turbine and software issue related to that.

We read this morning something in the press or maybe it was also yesterday. But maybe if you can share -- yes share some views here and if there are any potential impacts for your parts of the engines or for Pratt's part of it or any impact on the potential solution on any idea how this thing might develop?

Thank you.

I mean, first of all, we have to mention that it's a limited population of engines, which are affected only. It's not part of MTU's production values.

It's Pratt & Whitney's responsibility. I think they mentioned it in their call on Tuesday or Monday this week.

I think it's really a minor issue. The fleet has been inspected and grounded for roughly one day and all the aircraft are back so we don't expect a major impact on our results coming from that.

Okay. Thank you for that.

And also this comment in one of the press release or press statements this morning that the software is somewhat impacting the turbine itself. You don't get nervous about that?

No.

Okay. Thank you.

Yeah. Okay.

Thank you. Good morning everyone.

Just a question on the cash flow statement and I'm looking at slide 16 in your presentation. Just a couple of items I needed clarification on please Peter.

The first one is the net investment in intangible assets. What exactly is that?

Because that's gone up by about €30 million, so just trying to understand what that number is and what it relates to. The other one is the net investment in financial assets, which has gone the other way.

It's gone from minus €84 million to minus €16 million. And then the adjustments line, so there's the €30 million there.

So if you could just help me understand what those numbers are and what they relate to that would be very helpful.

I can. So, net investment into intangible assets is normally the part of the capitalized R&D.

So capitalized R&D, which is not a payment to the OEM goes into that number. So, more or less that's the major portion.

In...

But you got that on the next line, Peter. That line after that is the net investment in R&D.

In R&D payments.

Yeah.

There you have R&D payments, but not engineering hours. So all the things we do internally which we capitalize this is the line above.

And...

Okay. So this is basically capitalization minus amortization is it?

No. I mean when we spend R&D then we have R&D hardware and we have engineering hours and we have payments to the OEM.

So -- and the major parts are payments to the OEM, so that is -- and these are -- that's with line number two. And in line number one, we capitalize all but our engineers through internally testing and so on.

That is in the first line. So -- and in the second -- in the first line, so now we have -- we are €20 million, €25 million higher compared to 2018.

And there we acquired a license for the IGT business in Berlin, so the license to maintain industrial gas turbines in our Berlin facility or with GE and that is also intangible.

Okay.

And that moves the number up in 2019 compared to 2018. So our net investments into financial assets, there we typically have -- so capital injections into our joint ventures.

And in 2018, we injected a lot of capital in the LeaseCos, so that is the company in the U.S. which runs the GTF lease pool.

And also, there we had equity injections into the -- a transaction with Lufthansa Technik in Poland the EME joint venture. So on both of these capital injections they go down significantly in 2019.

So we need less buildup of lease pools so less capital injection there. And the EME joint venture in Poland is more or less ready, so there we also come to an end.

And in addition, we received some aircraft -- we received some -- back some money from aircraft financing. And that is a cash inflow in financial assets, but we adjust that, yes.

So we -- that is the minus €30 million more or less. But if the adjustment for the positive inflow will be -- which we have been net investments into the financial assets, and you can see that also on the page number 15, so the slide before.

You see the sales financing the minus €31 million. So then minus €30 million is a plus €30 million in financial asset and we adjust that back in the adjustment line.

I see. Okay.

Presumably you don't have very good visibility on these things at start of the year when you gave the guidance on...

Exactly. That's why we adjust it.

So that why we do the kind of adjustment for sales financing, because you'll never know. I mean you -- if an airline comes and really wants sales financing, typically they get financing with banks or other elsewhere.

Okay. That’s very helpful.

Thank you for that.

Yes. Good morning.

Good morning.

I just wanted to get an update on the GTF in terms of the solving the bearing number 3 seal related issues and the amount of incidents still on this one; and also the combustion chamber and the program the performance improvement package that you were supposed to submit to the OEM before the year end. And where are we on the progress on that?

Thank you.

Celine, all the technical issues we have had in the past are either solved or are on track to be solved. So it's -- we are in time with all the solutions together with Pratt & Whitney.

That also includes the improvement program, but it's not this year. It's coming in -- I think in two years time, but it's also in line with the original plan.

Thank you. And when you say on track to be solved, I mean is it a matter -- can you provide some sort of timescale, in terms of when you...

No. The solutions are already available and are introduced in all the new engines.

But as you know in all the new programs, you have ongoing improvements. So that's the normal process.

But it's nothing unusual. We -- actually we have.

So the bearing number three seal you have a final -- like another final solution that is supposed to be working and is it being retrofitted right now?

Yes.

Yes. Yes.

Okay thank you.

Yes. Thank you.

Just two questions left for me. First, Boeing's delay on the new 777, I thought that this is also due to delays in the engine development, where you're involved.

So does this have an adverse impact on your financials? And could you maybe quantify it?

And secondly just with Brexit presumably around the corner, are there any supply chain issues where MTU is involved? Or it could be directed -- directly or indirectly affected?

Could you shed some color on that? Thank you.

On the 777X, we do not expect an impact on our financials. Up to now we have no indication for that.

It was also a minor issue in GE's parts the MTU parts. But as said, we don't expect that, to have a big impact on our financials.

On the Brexit issue, we have a very limited number or first of all we have no location in the U.K. production location.

And we have also a very limited number of suppliers in the U.K. So up to now, if it's in whatever -- however the Brexit will work, but we do not expect a major impact on our business from that.

Okay thank you very much.

Sure. You're welcome.

I think I received an email that I have said something wrong. I mean, we expect of course -- I mean a mid-to-high-single-digit growth in our spare parts business this year.

Somebody wrote me that it's a low to mid-single digit. I said low to mid-single digit.

But now we are at, mid-to high single digit after nine months. And we expect also growth in the Q4, mid- to high single digits.

So for the full year expectation, as Reiner mentioned also in the guidance, it's unchanged now. So now we are clear.

So if we don't have more questions, as it looks like, I would suggest that we close the call for today. Thank you very much for joining us.

Thank you for your questions. And for all of you have a nice day.