Metso Corporation Unsponsored ADR

Rita Uotila - VP, IR Markku Teräsvasara - President and CEO Jari Älgars - CFO

Peter Murdoch - Morgan Stanley Magnus Kruber - UBS Michael Kaloghiros - Bank of America Jonathan Hanks - Goldman Sachs Manu Rimpelä - Nordea Antti Suttelin - Danske Bank Andrew Wilson - JPMorgan

Good afternoon, ladies and gentlemen, and welcome to Outotec's Q1 Interim Report Teleconference. We will hear a presentation from President and CEO, Markku Teräsvasara, followed by a Q&A session, with the CEO and CFO, Jari Älgars.

Now we are ready for the presentation. Please go ahead, Markku.

Good afternoon from my side as well. As always, we start with our safety performance.

When it lost time incident rate, it's quite stable on a 2, LTIR level of 2. And of course the ambition is to further improve this score going forward.

Market development, if you take Q1 in a nutshell, I think from the overall picture it is mostly positive from our side. It improved order intake throughout basically the whole range, when it comes to equipment, plant, and service, they all increased.

Of course, that is coming from two things. Partly it is an improved market sentiment and the activity level in our customer base, but also I think it's good to keep in mind that the low comparable period last year that of course makes a difference there.

When it comes to Metals, Energy & Water, the profitability is still challenged, and our cost activities continue. And during the quarter we were able to finalize the negotiations in our German entity.

So we expect to get some cost savings going forward further. A good performance in MP continued in terms of sales and order intake, and also profitability improved.

For the Company level, profitability improved through fixed cost savings and higher sales volume, and on the other side maybe the fact that was pulling it a bit down was the sales mix. We had a lower portion of service sales included.

So the sales mix impacted negatively. Low level of advanced payments and material order backlog resulted in negative cash flow for the quarter.

When it comes to order intake, of course, there's a big difference compared to Q1 last year of €170 million to €318 million, and an improvement in both in service order intake and in CapEx order intake. We had three orders that we announced during the quarter, two in Americas and one in EMEA in Bahrain, and this aluminum technology order in Bahrain was the biggest order that Outotec has received in nearly two years.

Seasonality I think is obvious when it comes to MP orders. So we have had - and on the left side, we Mineral Processing.

We have order intake 6-month rolling annualized, and the other color is showing the sales or the invoicing, the same thing analyzing what is obvious is that quarter 1 has traditionally been our weakest quarter when it comes to order intake. So this year we start on a higher level than we had been for a couple of years.

When it comes to Metals, Energy & Water, thanks to this order or actually these two announced orders and some smaller ones, we had a trend break on the order intake for the 6-month rolling orders going up and naturally leads to also the sales improving as we go forward. When it comes to service, orders increased 13%, but the sales declined the same 13% due to fewer shutdown services.

And the drop was on the Metals, Energy & Water side, while it was actually an improvement on the Mineral Processing side. For the quarter, Service represented 37% of the sales.

And what we want to illustrate on the right-hand side, payroll show that our order intake that actually was on the low level for the first quarter last year, and then the sales will follow that with some six month delay. So we see that there is a delay in our sales convert to order intake in Service as well.

Otherwise, I think that positive thing, again, is that recurring services, namely spare parts have increased, and that is of course a positive thing. When it comes to our order backlog, it's improved.

So it's now €1.051 billion, of which 21% is Services. And out of that roughly €680 million will be delivered during this year.

And traditionally as we have said before, we are not including the Iranian orders into this backlog, other than where we have financing arranged. So now some key numbers by Jari Älgars.

Thank you, Markku. So as we start to go through the overview numbers first, we can see that the sales increased from €240 million last year to €268 million in this year's first quarter, by which was an increase of 7% in comparable currencies.

However, that sales increase came from capital sales because the Services came down from €114 million last year to €99 million this year, a decrease in comparable currencies of 18% due to the low order intake we had in Services during last. So the share of Service business is down to 37%, being 48% last year, same period.

It was mostly due to this slower service share came down slightly from 24% to 23%. And the adjusted EBIT was €1 million positive, while it was minus €5 million last year for the same period.

And the result for the period was minus €3 million. But it was minus €12 million last year, same period.

The exchange rate was during the first quarter this year €2 million, while it was €1 million last year. If we go into the Minerals Processing, the performance has further improved.

The equipment orders have increased, the order intake up 35%. The sales increased by 31% in comparable currencies, and the profitability has improved.

If you look at the numbers, the order intake increased from €104 million last year to €146 million this year. Sales also increased significantly from €113 million last year to €153 million this year.

And the Service sales was further up from €64 million to €68 million, so a slight increase, and in comparable currency no increase. It all was due to exchange rate.

And the adjusted EBIT was €11 million for the first quarter this year. It was an improvement from €5 million last year, and last year it was helped by €2 million of exchange rate gains.

So the change was a bit higher, if you look at in comparable currency. If we then to go Metals, Energy & Water, our order intake improved, but the result is still significantly negative.

And we had an increase in order intake of 161%, which obviously was helped by the very weak first quarter last year. Sales declined 12% in comparable currencies, due to the low backlog we had, or in other words the lower order intake we had during last year.

If we look at in absolute figures, the order intake was €172 million during the first quarter this year, while it was €66 million last year. Sales was €140 million, while it was €127 million last quarter.

And the Service sales was the whole amount of sales came down was from Service sales, which came down from €50 million last year to €30 million this year. So a change in comparable currencies of minus 40%.

And the adjusted EBIT was same as last year, minus €9 million, if we look at it with the currency effect had on this, we were helped this year by €3 million exchange rate gains, when last year it was - we had decline or a loss of €1 million by exchange rate. So the result was looking at taking the exchange rate gains and losses into account, the result was bigger this year than last year.

If we look at the cash flow, it was negative due to that we have quite a mature order backlog at the moment, so if we really do an aging analysis of it, it means that we have gotten the advances, we have gotten the prepayments for most of the projects we are working with at the moment, and now we are working to finalize, which is increasing the POC receivables, which has also increasing the inventory, and this has benefited the change in working capital, which ended up minus €42 million, and this led to that net cash flow from operating activities was minus €34 million. In addition to that, we paid interest for the last issued hybrid €11 million, and this was financed by corporate papers at the corporate level.

So the net cash from financing activities was minus €1 million. If you look at the liquidity and the equity, they both remain solid.

The net interest-bearing debt is now €44 million positive, which is due to that we have used up quite a lot of cash in building up the projects we have at hand, as said aging projects which we then have to finalize and collect the final payments from. And gearing due to this is plus 9%.

It was minus 13% last year, same period. Equity-to-assets ratio climbed slightly, mainly due to debt we paid out in hybrid interest.

And return on investment at minus 8%, return on equity minus 12%. The working capital at the end of the period was €18 million, and the advances received was €178 million, compared to the previous year same period of March last year was €229 million.

And equity is solid with €490 million. We then go to Markku to talk to some guidance.

Here's Markku.

Thank you, Jari. If we look at the market outlook, of course the market overall is on a more positive level than last year.

On the MP side, the opportunities continue to be mainly in the smaller improvements, equipment and plant upgrades and services. On Metals, Energy & Water side our wide portfolio gives us different opportunities in different parts of the end markets in different regions.

So there definitely we can see that we have more things ongoing and bookings approaching the decision point. But still, as we have stated earlier, that the timing of these large order remains difficult to foresee.

In the mining area, metals area, end markets gold and copper remains the most active, while is there is other metals as well improving and being more active at the moment. When it comes to guidance, it basically remains on both on sales and profitability guidance.

And so we expect our sales to be between €1.05 billion and €1.15 billion, as we have said earlier. And that comes from, of course, from quarter 1 sales and then €680 million comes from existing backlog, and then €100 million to €200 million from new orders received during quarters 2, 3 and 4.

And adjusted EBIT expectation remains between 3% and 5%. When it comes to focus areas going forward, I think that the focus is still on winning the orders in a fairly competitive landscape, and continued savings in Metals, Energy & Water business unit to reach stability and then turn this business into a profit situation.

We will have a strong focus on Service going forward, and the new Service, dedicated Service business unit is now active since April 1. And we will continue our competitiveness improvement.

We look - comes to product, we're starting improvements, and also best-cost outsourcing and supply activities. We have a good story to tell.

Our experts have tremendous experience and knowledge on metallurgical process improvements, among others things, and service improvements. And that, of course, we will use that competence when we strengthen our customer centricity and as we go out to meet customers.

Now that the work has been started and with an ambition to review our work strategy for the next three years, and as earlier mentioned that will be communicated in the coming Capital Markets Day, September 21. Okay.

That was the presentation part, and now we open the line for Q&A.

Three questions if I may, I'll take them one by one. The first one is just on cost savings.

Could you talk about what the cost savings were in the quarter, and what you're aiming for the year, just in MEW? And then I want to ask Markku, since being at Outotec, have you identified any potential areas for cost savings?

How are you thinking about that, if I may just start off with that?

Yes, I can start. Of course, when it comes to potential cost saving activities, I think we are continuously reviewing our operations in all aspects and all dimensions to see that that the cost is in good balance with the activity level.

So where we have a special focus at the moment is of course, as we said, in Metals, Energy & Water side. But of course, we continue to review all parts of operations.

Just let me state that when we reported the end of year figures, obviously we have savings actions ongoing in Metals, Energy & Water, which we are still planning to finalize during Q2, and then getting them into effect. So we are still looking to further see cost savings in Metals, Energy & Water to help with the stabilization.

Okay, loud and clear. And then in release, and I think you've mentioned it as well, Markku, on MEW you talk about basically a strategic review of the business.

Can you just explain what this involved, what you're looking at, and any ideas of what we should we expect should be the result of this?

I think what we have at the moment as a strategy overall, at an ambition level, is to achieve 10% adjusted EBIT by 2020, and then also in average grow faster than the market and also grow our Service business within 15% a year. And I think what we do in this strategy review is to really go through and first to see whether that ambition level is right going forward, and also how to achieve the stated ambition level as well.

So I think we look - not only look at MEW, but maybe look at all the three business units, Minerals Processing, Service, and MEW going forward.

And you said we should hear something in the Capital Markets Day. Was that right?

Yes.

And then my final question, and you talked about it, was just the mix impact in the quarter. Can you just comment on where equipment profitability sits today, I mean for the group, I imagine because of MEW is it still negative?

And then we can back out what Services is doing.

Yes. As we have stated before, the price pressure is quite tough, but we feel reasonably happy with the margins we have been able to get from the new orders.

So what we have in the backlog, apart from this one order we have had challenges with in Metals, Energy & Water, I would say apart from that we are reasonably happy with the profitability we have on the CapEx side, as well as on the Service side. Obviously, we would like to have more Service orders and sales, and that we are working on.

Okay, got it.

First I'll take them one by one. So I think you grew about 30% in Minerals Processing this quarter.

But the drop-through, I think, was limited to 14% there. Is there anything within that that we should think about?

Sorry. Could you repeat the question, you mean the margin.

Yes, I mean incremental margins, yes.

I think this is due to small increments. Obviously the increase is mainly from CapEx sales and then also secondly we have had some smaller impacts from FX and similar.

So nothing really to comment on.

So it's sort of a level we should be sort of comfortable going forward also in the division?

I think we are aiming for more - as we have stated, we are aiming to improve the profit margins of MP, and we are expecting it. Usually the first quarter of the year has been a little bit depressed.

So we expect going forward that we should see things continue to improve.

Okay, excellent. And then I was thinking the last announced aluminum projects in the Metals, Energy & Water; when will you start to invoice that?

I don't think we have guided for that separately. But obviously we have got the order now, and we expect to start to ship payments coming in reasonably soon, the first payments, and then going forward as the project goes along, as it is a big project, their delivery time is reasonably long.

And my final one also on the service decline in Metals, Energy & Water; can you expand a little bit on the background to these shutdowns on the service contracts?

I think the service decline in service in Metals, Energy & Water side is typically related to the modifications and shutdowns of some recurring sales, and they can vary a lot from quarter to quarter. So I think it's just that there have been less activity in sometimes Services and in bigger modifications in that customer segment.

Okay, brilliant.

My first question on free cash flow, I think you mentioned that there's some legacy orders that you're delivering at the moment that are dragging on free cash flow. Can you give us any details on when this would be finally realized and when we should start getting some improvement in cash generation?

We could see at this more as a balance of things. So obviously still our, let's say, new orders is a clear minority compared to the old legacy orders.

And when we continue to have new order intake and, let's say, the average aging of our backlog starts to get lower and we also will see the cash flow starting to improve. So we will still need some, let's say, good order intake months, and then finalizing some of the old projects.

Then things will start to improve.

Okay. But you're not seeing any change in payments terms in orders that you book compared to the one that's bidding there.

No. In the last few years, so things, let's say we had since 2013 in principle the payment terms have not changed significantly.

So they have been more or less the same. So this is really due to, let's say, the very aging backlog we have at hand.

Right. Next question on Mineral Processing, I think you just highlighted that Q1 was a slow start, I mean with still a very decent margin.

Where do you think that margin can go back to in current volume environment, in that division? And if I take a step backwards, if you got a target of 10% margin for the group, what is the target for Mineral Processing?

What is the target for Metals, Water & Energy division please?

I think we have not guided for those separately. But obviously Minerals Processing, with having a higher Service content, we are expecting more profitability from than we are expecting from Metals, Energy & Water.

And the two balanced obviously then would end up at 10%.

And on Metals, Energy & Water, I think last time we spoke you were highlighting that you were in negotiations for large orders. And you did book that very large order in Q1.

What is the pipeline like for large orders? And how many of these large orders you still need to refine the guidance, given you pretty much have most of your sales this year in the backlog now, and should have a better visibility on the delivery this year?

Of course, first of all we got more than that one order. I think we announced even over 10 million orders, two of them was related to this one.

And there is a different number of different sized orders in the pipeline. So as we stated, there is quite large orders in the pipeline, and there's smaller ones.

And really when they're converted to real purchasing orders that is discounted to foresee and also in which order. So I think it's a little bit difficult to give a very firm outlook for your question.

And of course, in comparing the situation versus one year ago, it's definitely a better situation than it was then. And to come back to what we said, I think the guidance we kept as it is.

So we expect to get a sufficient level of new orders to make the guidance. Yet, I think it's very important to remind that in the Metals, Energy & Water side, it takes time to convert orders into invoicing.

So basically almost everything that we have counted as sales in 2017 is orders that have been received earlier.

Sure, but I think you mentioned previously that even an order for delivering in '18 or '19 would help your absorption in that division, and just one ring on the back of these orders that you got, whether it had not helped enough for you to narrow the guidance, which is still very broad, given you pretty much have all your sales in the backlog for this year.

I think what you mean when the project - what more we can realize some revenue out of it. In that sense, it depends.

It makes a difference when you get these big orders and how quickly you can get into implementation phase. But it is not having a major impact in that most of the invoicing for 2017 is already in the order backlog, particularly from Metals, Energy & Water.

Just following up from that last question, really, it sounds maybe like maybe you're playing down the importance of large orders a little bit relating to guidance. What should we think about as the key drivers of whether you end up at the top end of guidance or the bottom end of guidance, I suppose, most importantly on the margin side?

I think the biggest driver for that, of course, is as we have stated earlier, when do we get these big orders? And if they come early, then we tend to up on the upper end of the guidance.

And if they come later, then it affects, but of course we have different size of orders, depending on whether it's Service or whether it's Minerals Processing, or whether it's Metals, Energy & Water. So of course, there is that the fastest converting orders are related to Service, and then Minerals Processing, and then Metals, Energy & Water, if you want to generalize.

But of course earlier, you get orders and then more order intake we convert.

And then just one more, relating to- apology if you already mentioned this and I missed this. But relating the problem project where you took an impairment in 4Q, is that still ongoing, or has that been finalized now?

It's still ongoing. And I think while the impairment that we did at the time, we feel today that is well in balance with what the activities are in that project.

Great. All right.

Thanks very much.

My first question would be continuing on the working capital theme. So how do you see the - I mean if we see a kind of order trend stabilize and at this current level, so the aging of the order backlog and the work in there, so how basically is that impacting the working capital outflows for the remainder of the year?

Should we still expect those outflows to continue and that you will see a kind of normal reduction in net debt from Q1 towards the end of the year, or should we kind of expect that the working capital build still continues?

I believe we should start to see a stabilization, and hopefully maybe even some increase towards the end of the year. But purely the first half of the year still is depressed.

And then would you remind us on the cost savings that you are doing in the Metals, Energy & Water business?

Yes. We have finalized now the negotiations with the labor union in Germany and we are moving ahead with the layoffs.

So we are really in the middle of the layoffs with the individual persons at this very moment. And this, as stated earlier, we expect to have finalized by the end of second quarter.

So paired with still some additional order intake in Metals, Energy & Water, which will help our workload situation and then also reducing the workforce, we plan on having a second half of the year which would be in a different state than now, where we are significantly bleeding still in Metals, Energy & Water, which is obviously affecting our whole profitability.

And how much do you expect to realize in cost savings in 2017's P&L and then how much is the carryover into 2018?

We have not guided for this.

And then the final question would be on the Services activity. So what are you seeing in terms of these larger modernization and maintenance and shutdown orders?

Is the client activity improving there as well, as you've seen in the first quarter metals larger orders, or what is kind of the leading indicators that you are looking there, and what are they telling you?

You should consider them a bit like this bigger modifications that we talk about, or bigger shutdowns in Services. Consider them like a CapEx investment, where it is sometimes difficult to really see when the customers are ready to make that decision.

But even there we see that we have some projects, some more projects in the pipeline under negotiation, and they will then hopefully turn into firm orders in the coming months.

Final question, if you look at the 8% year-on-year organic growth that you've had in the Services order intake, so can you just give us an understanding of how that was split between the two divisions?

In order intake, order intake of course, the increase was mainly coming from the Minerals Processing side.

First on the cost savings, based on the announcements you have already made, where do you expect the number of employees to land at the end of the year? So what's the number of employees you expect based on what you have announced?

This is very difficult to predict, especially as we have this shutdown type of work, where we temporarily take in a lot of employees to finalize the projects. As stated earlier, the impact - or in the plan for the Metals, Energy & Water was to reduce 200 people.

So is everything else from the previous programs already implemented by the end of Q1? I'm just looking.

At the end of Q1, you had 4,169 employees. And I'm just trying to find a number for the rest of the year, where a number will land.

I think what is also very important to keep in mind is that we have people in so for fixed cost, and we have people in variable cost. And as we get more projects or more shutdown services, more service work and more deliveries, we need more people in those activities, while the main ambition is, of course, to look at the fixed cost side of it and see that that is on the right level.

So I think when it comes to reduction we of course might need - somewhere we might need more people, and then there's other areas in operation where these cost savings will be implemented. So purely looking at headcount and the cost headcount only will not give you a good understanding on savings activity.

And then can you just give me what drives the Metals, Energy & Water really? I can understand that on the Minerals Processing side, replacement is ongoing and that drives demand.

But what's going on, on the MP side? Are your clients expanding their capacity or why do you get orders?

It's coming from different things. It's under the investment reasons are many.

Of course, maybe you are - I don't know if you are referring to know what capacity that we have in some areas. But there is a need to improve efficiencies in many of the operations.

There are regulations that support energy efficiency, lower CO2 emissions. There is regional programs that some areas, some governments, want to have a local industry improved.

And then there's the pure investment needs that are coming from metal consumption increases and the balance between the supply and the demand. And that varies from metal to metal.

And I think what we have also said before is that metals refining and Minerals Processing go in different cycles. So when activity starts in Minerals Processing, traditionally that will result in improvement in activities in metals refining after 18 months to two years.

Just a couple of questions from me, please. I just wanted to clarify on the kind of larger CapEx-light sort of service work that you talked about.

So understanding that it's difficult to know when customers are actually placing orders. But can you give us an idea of whether that environment as a whole is improved?

Are you having more of those types of conversations than you were a year ago? And also, can you actually say whether orders in that area were up or down in Q1, please?

So, excuse me. What was the last sentence you said, or last question?

And just whether orders specifically in the kind of larger maintenance shutdown refurb work; whether the orders were actually up or down in the period.

I think the activity is mostly again related to metals refining, where even on the CapEx side you still have these one-offs orders that there's projects in the pipeline, but the timing of these is very difficult to foresee, and same is valid for these shutdown services or with the larger modifications, where we have a number of projects in the pipeline. But when and if they turn and convert into the firm orders that is difficult to foresee.

But it is a little bit the same behavior than for the CapEx orders, particular on the bigger modifications.

Can I also just ask on the - just talking about - I think you mentioned there's sort of still competitive environment in terms of new orders. Can you just talk about what touched the - sort of the competitive landscape in terms of is it pricing or is it - I think you talked about payment terms not really changing, or it is provisions or warranties?

Can you just give us an idea of kind of what are the sort of metrics that people are competing on?

I think different customers, they value different things. What we have said is that we are not interested in very low margin business.

I think we are more active in projects where we can demonstrate our added value. So we definitely like to protect our pricing, and also through our competence and through our knowledge of our customer's additional value.

And maybe if I just - sorry, just tag on one more question to that. I think - I just really want to clarify that I think you said that the pricing on current work is better than the pricing in the order backlog, and kind of that pressure presumably which is coming through in the margins that will ease as we kind of move through the next 12 to 18 months.

Is that right?

I think we did not express ourselves in that way, or if we did it was a misunderstanding. I think pricing in the project business, every project is an individual.

And there the pricing can vary from project to project a little bit. But generally speaking, we don't - we have not said that we have lower profitability in our portfolio.

Thank you, Operator. Thank you for the presentation and questions, and I would like to remind you that the half year review will be published on July 27, and then the Capital Markets Days will be held on September 21.

So, wishing everyone great breaking news to spring. Thank you.