Metso Corporation Unsponsored ADR

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

Antti Suttelin - Danske Bank Magnus Kruber - UBS Andrew Wilson - JPMorgan Erkki Vesola - Inderes

Thank you, operator, and welcome on our behalf to the half year financial report teleconference. We will hear the presentation from CEO, Markku Teräsvasara and CFO, Jari Älgars and then afterwards, we will take questions from telephone lines.

So please, Markku, go ahead.

Thank you, Rita. And welcome on my behalf as well.

Safety first as always. This is showing our lost time incident rate for the company.

We remain at stable level 2, which is good achievements, but of course we strive to push that down even further and the ultimate target is of course no accidents causing sick leaves. First half of year in a nutshell, I think we can.

It includes for us both joy and satisfaction, but also disappointment. On a positive side, definitely we had again a strong order intake improvement 34%, which came - looking on the first half of the year came basically throughout the businesses including Minerals Processing, Metals, Energy & Water and also Service.

Of course when it comes to Metals, Energy & Water, when we talk about the bigger projects; we had a nice order intake in the first quarter, little bit less in the second quarter, but all in all an improvement from last year. And of course as said already earlier, getting more orders in Metals, Energy & Water is very important for us.

Another positive note definitely, a good performance in Minerals Processing where both our sales, order intake and results improved very well and we are very pleased with that development. And we are also pleased with the development for the service orders, which was good for the first half and accelerating during the second quarter.

Net recovery is an area where we are disappointed. There our call at the end of year - in the beginning of the year, we said that is an important for profitability and our guidance in a way.

When we talked about our guidance, we emphasized that turnaround in Metals, Energy & Water when it comes to order intake and getting orders early in the year has impact in our result and now we know that even though there was improvement, it was not big enough. When it comes to Metals, Energy & Water cost saving activities, we actually have achieved our planned savings, but obviously as more orders have not been coming in, we need further actions to restore segment's profitability.

Another positive thing is that we have - we see the market getting broader. We have earlier said that the Middle East, Russia, South and Central America has been very active for us or have been a very active for us.

Now we see that Australia and Southeast Asia is picking up and even more positive development in Europe. In quarter two, we announced these five orders that are more than €10 million in value.

Two of them on the Metals, Energy & Water side and three in Minerals Processing. And in Metals, Energy & Water side, also including 1 big shutdown service order to a smelter in South America.

Comparing quarter two 2016 and '17, we see that the portion of service orders has increased and we are very satisfied with that development. Seasonality MP, this chart is showing basically the cycle in our 2 businesses indicating of course what we have also witnessed that the Minerals Processing touched a low point in orders first quarter 2016.

Since then, we have had good recovery and also of course as sales is following, it has improved our results. When it comes to Metals, Energy & Water, we touched the low point in orders last quarter 2016.

Now the order intake is above sales. Of course as we said earlier, we like to see even further improvement in our order intake for Metals, Energy & Water.

Looking service business specifically. As indicated, service orders for the first half of the year increased by 15% and in quarter 2 by 17%.

Sales, however, declined by 2% and that was due to a lower order intake in shutdown and upgrade services in 2016. Today service represents 39% of the sales.

And I think on a positive note when we look at the same order intake and safety developments, our order intake in second quarter 2017 was the best quarter or on a best level since third quarter 2015. So, the strongest quarter in service since two years.

Order backlog increased somewhat and we are stable at slightly a bit above €1 billion. Our book to bill rate was above 1 and then roughly €500 million order backlog will be invoiced this year and 23% of that is in service.

And now key financials, Jari, please.

Thank you, Markku. So if we go into the numbers, obviously we have a very polarized picture if we look at Minerals Processing development and Metals, Energy & Water and I will go - go more into this, but first we start on the overall numbers.

Sales was slightly increasing from the previous year's same quarter and all in all, we are a bit ahead of last year. Service sales is more or less flat and the percentage of the share of service in sales is 39% when it was 42% a year ago.

And this obviously has affected a bit the gross margin, but nevertheless, the gross margin was in the quarter quite low with 22% compared to 26% a year ago. I will come more into this later.

And on a half year basis, it's 23% when it was 25% a year ago. Our adjusted EBIT for the quarter was €2 million or 1% and for the half year, €3 million and 1%.

And the result for the period, the quarter was minus €1 million and for the half year minus €4 million. If we go into the next page and look at the margin analysis for the first half of this year.

Last year we had zero result after the first half. Obviously our volume has increased, which we can anticipate that our margins should have increased, but we actually had quite a lot of negative margin impact here during the first half and some of them especially for the second quarter.

One of them is sales mix where we could see already that the CapEx has slightly increased compared to the service, which was flat. We also have seen some cost overruns mainly from new technologies where we have in the startup of certain new projects.

In some projects, we have seen some challenges in finalizing the projects and being able to get them to work finally and this has cost us some costs. And in Metals, Energy & Water, the low sales from the first half of the year and also especially in the second quarter added with workload has impacted the market.

And then also the exchange rates where we can see that the exchange rates show on the gains and losses a positive number, but this is very close to - all of it is lost in the margin. So, we see the same negativity in the margin close to it.

And then we have had the savings on the fixed cost and this is how we end up at €3 million positive result for the first half of the year. If we look at Minerals Processing so in general things look fine.

Order intake has increased by 24% year-on-year from €261 million to €323 million. Sales has increased by 39% from € 232 million to €323 million.

Service sales has also increased by 14% from €125 million to €142 million and adjusted EBIT has increased from €10 million to €26 million or in percentage from 4% to 8%. Obviously thinking about the overall numbers, this means that Metals, Energy & Water has then again gone in the other direction, which you can see here on the other page.

Order intake, which is kind of good number here in the Metals, Energy & Water side is we have been able to increase the order intake from a very low last year by 48% from €190 million to €282 million. But sales due to that we had a very low order intake last year has come down by 21% from €275 million to €217 million.

Likewise has the service sales by 24% from €90 million to €68 million as the service in Metals, Energy & Water is more shutdown services and modernizations and upgrades. So we have seen a negative impact here, which has led to that adjusted EBIT is minus €19 million when it was for the corresponding period last year minus €7 million and the adjusted EBIT percentage is minus 9% when it was last year minus 3%.

And obviously as Markku already stated, this is a clear disappointment. We have gone with our restructuring programs on plan, but still orders have not come in with the same speed.

This quarter we have good order intake, they have come very late in the quarter and we have too little of the big ones. So, we have to continue to do cost saving actions here and obviously we need more orders to be able to turnaround the situation.

So as said, we have a very polarized situation. Minerals Processing is going quite well and we expect it to go well forward also, but Minerals Processing we have not succeeded yet with the turnaround - sorry, Metals, Energy & Water.

If we go into the order backlog and with good mature order backlog and a lower level of advance payments has affected the cash flow. So it has still not turned around, it still continues negative less than in Q1.

Still our anticipation is that this will start to turn on the second half of the year. Liquidity and equity remained solid.

We have quite a good situation in that side so there is now no reason to be worried on this part. Obviously for us it's quite important now we start to turnaround Metals, Energy & Water and that we also are able to turn the cash flow.

These two things are obviously on the top of our agenda going forward.

Okay. Now back to me.

When it comes to market outlook, we see that the market continues stable. When it comes to customers, they continue to focus on profitability and cash flow.

When it comes to new investment, this is still pretty much brownfield where the investment goes into productivity improvements or capacity increase. For smaller equipment orders, they have credit lines.

There is still very little pure greenfield investment, but of course they are coming closer and closer. The market is fairly good throughout the base metals, grains that we have also lead in sulfuric acid and energy prospects.

On energy side, there is a lot of opportunity, but we focus on ways to energy and basically such applications. On the MP side, tighter market will continue - expected to continue.

On service side for the recent quarters, we have seen good development in spare parts, now we see that that there is more opportunities throughout all categories. We have received some shutdown orders and also technical service is developing well.

So, we see that the service is coming in on the wider front. For the Metals, Energy & Water; the situation is we are negotiating in many projects, but the projects are still few and far apart and the timing of these large orders is difficult to foresee exactly when the customers are ready to place the order.

Our financial guidance was changed few days ago. As I'm sure or trust that most of you noticed where the sales is now expected to be approximately €1.1 billion to €1.2 billion and adjusted EBIT is expected to be approximately 3% to 4% and the previous guidance is below.

Our focus areas going forward, we continue to win orders in a competitive landscape. On the Minerals Processing side where the market is stable, we are quite pleased with the rate or the percentage we win the orders.

We have some opportunity, I think we will work actively to get more business in that area. In Metals, Energy & Water side, the projects are still fewer and far apart and there of course every order is important and that is the focus that we are putting forward.

Cost saving activities will continue. As mentioned already earlier in Metals, Energy & Water, we achieved the cost saving target we had initially and yet of course not all of that materialized in second quarter.

We see some more savings kicking in the third quarter and going forward, but we also see that in the absence of more big orders, we need to continue cost saving in Metals, Energy & Water. Strong focus on service will continue.

With the new organization being the first, initial result is encouraging. We have an opportunity through our big installed base to continue to improve service and we work actively now to improve our cost competitiveness of our products.

And tying all that up together and also referring to the first topic of course, strengthen the customer centricity. In the program, we are at the moment actually running a training program in the company for both sales leadership and also sales throughout the organization to make sure that we can address the opportunities on the market in a very good way.

So, that is the presentation from today. Now I think we open for the Q&A session.

I would like to ask about your cost cutting plans and then the cost overruns that you had in Q2 and let me start with cost overruns. How much did you incur cost overruns in Q2, please?

Obviously the number you were looking at what we showed, there was no absolute numbers what we were showing and obviously we have also improved projects at the same time. So, the reasons we were showing up for the cost overruns was as we said; Metals, Energy & Water being - having lower sales, which you could clearly see from the numbers and also that obviously gives a double hit because you also have lower absorption at the same time when you don't get new orders.

On one of the bigger ones, there always the cost overruns from the new technologies. So out of these things that are listed here, that was the one which had most impact, but we have not given out this number exactly as it is.

I can see that these four items in total were about €20 million just visually looking at the picture. Is it fair to say that cost overrun was maybe half of that?

We have not given any guidance, but I would say that cost overruns is the biggest of these. The second biggest one is due to Metals, Energy & Water sales and workload and then more or less the sales mix and FX is about equal size.

And obviously I said there are things also affecting the other way round. So this is the net of the changes.

Okay. And then looking at your EBIT margin side, you put that guidance, any assumption about cost overruns also in the second half not just Q2, but also second half?

Obviously we always have assumed we have certain assumption on how things go forward. We are always analyzing the project and we have done quite a very deep analysis now here in the summer, which is also the reason why you see these margin changes here.

Obviously when we are looking at the new projects, we assume we know where they are going and then we have assumed the cost in those what we think will be the impact for the rest of the year.

So, does it mean that there is some assumption of further cost overruns in the new guidance beyond Q2?

We are in a project business so we always have to assume some costs.

And then on the personnel numbers, your pick of personnel reduction based on the already announced actions in the second half. So if we compare end of the year likely number versus the end of first half number, what would be your best estimate of reduction?

We do not give guidance on the number of employees we will have at the end of the year. But I think what - two things is good to keep in mind when looking at numbers.

In the summer time these numbers include summer trainees as an extra and also the number will go a little bit up and down based on our projects. For example our shutdown projects, the temporary employees that we take in for those projects will be reported in our headcount and when you get the project, you can easily employ 50 to 100 people more, which are there for couple of months and then disappearing again.

So, our headcount will always fluctuate a bit going forward.

And is there any underlying downward trend in number of employees beyond these temporary employees going away?

So, I think that's already visible in our reporting that the trend has been declining. If you take away summer trainees and take away the impact from fluctuating temporary sources, the trend is how it works.

The cost savings obviously will also include persons.

A couple of questions from my side. On the continued actions in Metals, Energy & Water, what will you focus on here?

I think we will focus on reviewing our business, the product line, the opportunities we have, ongoing negotiations and utilization or the workload in different departments. And obviously if we see that the workload is not good enough, then we need to address our cost savings accordingly.

And could you just remind me what was the savings realized from the just closed program? Is it around €12 million, is it fair?

We have not guided for the number. What we said the previous restructuring we did where we were reducing 650 people impacted us by roughly €70 million.

And we said in the last restructuring, it was about 200 people. So, that should give some rough guidelines on impact.

And is redundancy payments included in salaries and other employee benefits in the report?

It is, yes.

And is there anything you can say about fixed cost reduction to the end of the year apart from headcount? I think you had €6 million so far this year?

Yes, obviously we are aiming to continue on that trend. And as Markku already pointed out, we clearly have to continue on the cost savings action, which obviously going forward will be a benefit when the market will turned up.

Obviously we are not - obviously we are not there yet. So, we will have to make ourselves more trim and while waiting for Metals, Energy & Water to turn.

And does it mean that you expect the run rate to increase from Q2 into Q3 and not just the current tailwind that we see at the moment?

With run rate you mean - could you repeat the question?

Yes, I think all order from current actions, you have a certain run rate tailwind from fixed cost reduction, will you step up that into Q3 and take out even more cost incrementally?

This is staying, yes. We already have plans in place and we've already made some decisions so things are moving ahead.

And on Metals, Energy & Water sales I think there were on the lowest level at least since Q1 2014 on the equipment side. Is there any timing issues on project milestones within there that we should be aware off?

No. Things are going forward.

Obviously the main - we expect as you could see from the sales by themself an increase towards the second half of the year in sales. And our main problem is in Metals, Energy & Water and new orders, that is really where our issue is and for that we have to look for more savings.

So, no milestone issues with Q2 in particular on the Metals, Energy & Water?

No. If you look at the Page 6 in our presentation, we briefly show that our order intake is already higher than the sales.

So, of course we expect that to start translating into sales and invoicing going forward.

And just the final one, I think you're talking about the mix impact between service and equipment. Is that a Q1 commentary because it seemed it improved into Q2 from Q1 and also year-over-year?

It's more when we look at the half year commentary, it has not significantly changed in Q2. But yes, you're right, it was more a Q1 comment than Q2 if we were looking at the first half year on that comment.

Yes.

I'm wondering about your confidence in booking orders in Metals, Energy & Water. When you start this new cost cutting now and not one quarter ago, has something changed in your visibility for new orders or just feel that these can slip further and even beyond this year on the Water side when it comes to larger projects?

We see still that we have, we have the same projects in the negotiation. We have many of them at final stage.

But as we have said, when exactly customers are ready to put the ink on a paper, it is very difficult to foresee. But definitely there is more in the pipeline than there was one year ago.

Very important thing for us. Obviously when we look at this year is when you look at the order intake for Metals, Energy & Water last year and where we were at this time, it's obviously where we will end up when this year ends and then obviously that translates to the right size we should have going forward.

So, this is obviously something still which is hard to foresee because these big projects are not very easily to decide and obviously the decision is not on our side. But nothing negative as such, we saw the market improving from 2016 and we still see more activities, but unfortunately the decision making is still very slow.

Do you still believe that this lag of one year kind of stays firm that you said earlier? That the lag from Minerals Processing orders until MEW order should resume?

I think what we have said is that there is roughly 18 months delay based on our experience so we talk about 1.5 year. So, of course that exact timing is difficult to know and obviously which impact us well is that, let's say, the speed with which the new orders turn into revenue is faster in Minerals Processing than they are in Metals, Energy & Water because they take longer.

And then what about provisions? Could you open up how you're not taking any new cost provisions really, but you still comment that you have cost overruns?

I mean is it just a line drawn in the water or how should we see this?

With cost provisions, do you mean projects or restructuring projects? Obviously we are always month-by- month analyzing the projects on how they are progressing and kind of project by project doing it and in some, there may be improvements and in some, there might be deteriorations.

And where we see risk for that, there might be cost overruns we make provisions for it and obviously this is part of what you see here in this red bar, which is called margin deterioration. So, basically cost overruns include both provisions and actual cost that we are chopping and taking.

And how is this problematic projects proceeding? Are there new cost overruns again coming from these?

You took €40 million of provisions in Q4 last year. Is it the same projects that are causing headaches still or an even increased headache or how is it?

No. Let's say there are some projects.

It's not the same projects and there are some projects now where we have new technology where we are maybe. As you know, we are aiming to be the leading in the technology field having the kind of maybe the technology there where you really can have the best yield and let's say biggest capacities et cetera.

Sometimes it means we are stretching the limits of technology boundaries a little bit and sometimes we end up where it does not work out the first time and we have to do some rework and this is what has happened in a few projects. I think we have to just learn from this and see what we can do better going forward.

This is normal that we have included in our business so I think I want to correct or point out that we - that at the moment we don't foresee anything in the magnitude that we experienced last quarter last year, this €40 million provision that we made and there is nothing with that magnitude.

Correct.

And then finally, I would like to know what kind of changes have you really implemented so far in service.

In what?

In service, you are leading your side of the service business so what changes have you implemented so far?

We have basically carved out the organization so that there is a focused team. We are resourcing it as per need is in different market areas and centrally we are just about to finalize our portfolio of work with the service offering and of course with a dedicated organization, you get a lot of focus and I think good activity.

So, we basically can say that we are more systematically approaching our customers and the market when it comes to service offering and more focused as well. Concentrating focus enough on areas where we see that our services are needed and where we can add value rather than trying to do exactly everything for everyone.

I just wanted to - to try and get a general feel for what you're seeing in pricing both in terms of any kind of equipment work that come there, but also of these the shutdown and technical services work that obviously seems like it's improving. Just trying to get a sense of kind of where the pricing dynamic is at the moment versus the pricing in the backlog and if there's an issue with any of the projects, which are in the backlog with regards to the pricing.

Appreciate that's quite a broad question, but just some sort of general sense please on kind of where pricing is?

The pricing for the bigger projects when we get them, we make the full back to back agreements with our suppliers so that we will not be impacted by pricing basis other than what can be transferred to our customers. Well, when it comes to the service business, of course we need to see how is our cost developing and then compensating that with price increases, which we have done already once this year for the service side.

So, I think this adjusting price according to your cost and according to your portfolio is a normal work that we do.

I think it's fair still to say that the competition remains, sadly it's still a buyer's market and only when most of the competitors have a decent backlog will we be able to start to look for price increases on the CapEx side.

And just to kind of follow up on that. Do you feel like the pricing dynamic is dramatically different at the moment than it was 12 months ago or is it just it's hard and it's been hard for some time?

The second one. It's hard and it's been hard for some time.

But I think also it's - you cannot generalize this sort of simply because actually every single project is individually considered and that's why there is definitely no indication that our pricing has lowered. But fact there is heavy competition, I think case by case the margins can vary a little bit going forward and also in the result.

That makes sense, I appreciate it. It's difficult to have a question to answer with just one answer.

In terms of the capital cost question for you, Jari. Just you made a comment around working capital improving in the second half and I appreciate this obviously depends a little bit on orders.

I mean do you think you're going to be able to get to a position where you're sort of working capital neutral sort of year-on-year for the cash flow or is it given the first half, you're expecting that to be an outflow? Just trying to get a sense of sort of how you see that developing.

We have obviously been somewhat also obviously the business is impacting this that when we get the turnaround and start to see more positive results, we will also see a better cash flow obviously. But on top of that, we have been expecting and anticipating that there will be more payments - progress payments and advance payments towards the year end.

We still have a situation now where we have quite a let's say mature backlog, which is pressing us because we have gotten already all the let's say advances we can get and now we are just finalizing the projects. And the more we get the new business, the better the balance gets.

We have less - proportionally less of this mature backlog and then the situation will ease up. So, our anticipation still is that things will start to improve, but with which speed is harder to say.

We still might see quarterly changes due to projects payments either being on one or the other side of the quarter.

So if we expect the cash flow - capital aspect to start to improve more meaningful in '18, that's probably a reasonable best case.

At some point, yes, with this improving situation we have with increasing order intake and that will start with down and progress payments. Yes, we can assume that it will start to improve.

That makes sense. And just final one, perhaps kind of I guess more positively.

I know in the last six months you've managed to win a couple of pieces of work in lithium and just sort of thinking around the whole electric vehicle space and just if you're seeing I guess kind of more interest from potential projects if you think that's going to be a big driver for you? Just try and give us a sense as well as kind of what the competitive landscape looks like.

It seems like you've got certainly very competitive technology and also it feels like an area that might be quite heightened over the next I guess 2, 3 years. Can you just try and help us think about a little bit more, please?

Lithium is of course very hot metal and the best of course at least with big full discussion on electric vehicles. At the end of the day, I think you should not overexaggerate that in the volume.

It is important I think also that has an advantage of over being in a way having the right competence to separate lithium from the ore in a very cost efficient way and that competence we have actually throughout the whole range. So, that is all fitting very well together with our core competence in the company.

Yes, it will have an impact because these projects are still sizable. It will not see a big impact, but if you get projects €20 million to €30 million once or twice a year, of course it will have an impact on our bulk order intake and sales and result.

When you're talking about this new technology, which particular technology or metal is that referring to? The one with the provisions of cost overruns.

I think it came from some new projects where we are introducing new products. Not extraordinary, not big; but we don't normally open up for the individual projects to tell what exactly was the application.

But this is normal technology where we have developed some new applications, new solutions and when selling them first time, there has been a small cost overrun in those projects. But as I said, nothing in the magnitude of what we were witnessing last year fourth quarter.

But it doesn't have anything to do in a specific metal or anything like that?

Nothing to do with anything, any special metal as such.

And just one final one. On salary inflation, what underlying salary inflation do you see at the moment on your permanent staff?

I think we have been in the company, we're being very restrictive with the salary increases this year. So, I think we don't expect too much inflation from the four base markets where we are re obliged to increase salaries somewhat.

But I think in general, Outotec has been very restrictive with that this year.

It's Erkki from Inderes. I have just one question regarding the potential cost saving items that you have in front of you.

You guys have done pretty good job in cutting admin costs in relation to sales, but what catches my eye is that the sales and marketing costs still hover between 10% to 11% of sales on a rolling 12-month basis. Do you see that this level is sustainable considering gross margin around 25%?

Of course it's always optimizing your sales resources amply with the opportunities on the market and trying to be as efficient as possible. So what we see and what we plan for of course when it comes to particularly say is that we can handle more revenue through this organization and the discussion rather goes that when do we have the volume where we need to start employing more people, I think we are not there yet and we can squeeze more volume out of the existing sales organization.

Thank you for participating. There's no more questions from [analysts] either so thank you very much for participation and presentation and your questions.

Thank you.

Thank you very much.