GEA Group Aktiengesellschaft GEAGF CEO Stefan Klebert on Q4 2019 Results

Ladies and gentlemen, thank you for standing by and welcome to the GEA Group full year 2019 conference call. At this time, all participants are in listen-only mode. After the speaker presentation, there will be a question-and-answer session. If you wish to ask a question during the session, please press star 1 on your telephone. Also, please be advised that the call is being recorded today, Tuesday the 17th of March 2020. And without any further delay, I'd like to hand the call over to your first speaker today, Oliver Luckenbach. Thank you.

Good afternoon ladies and gentlemen, and thanks for joining us today for our full year and Q4 2019 conference call. My name is Oliver Luckenbach, and I'm the new head of Investor Relations at GEA. I joined two weeks ago, and I am together with my team very much looking forward to having a very successful relationship with you. With me on the call today are Stefan Klebert, our CEO, and Markus Ketta, our CFO. Stefan will begin today's call with the highlights in 2019, and Markus will then cover the financials before Stefan takes over again for the outlook 2020 and our key priorities. Afterwards, we open up the call for the Q&A session. I would like to start the call today by drawing your attention to the cautionary language that is included in our safe harbor statement as in the material that we have distributed today. And with that, I will hand it over to you, Stefan. The floor is yours.

Thank you, Stefan, and also a warm welcome from my side. Let's continue on page eight with some more details on our intake, sales, and book-to-bill ratio. Order intake in Q4 2019 increased by 9% to 1.34 billion, which represents a new record volume in the fourth quarter. The growth came from business area equipment, where base and medium-sized orders were higher than in Q4 2018. Also, our intake at business area solutions developed nicely. Here, the driver was large orders. Service sales declined by 2.4% while service sales continued to grow. New machine sales were down by 4.6% year-over-year. The weakness of new machine sales came from both business areas. At business area equipment, mostly dairy farming with difficult market conditions in the US was the reason. At business area solutions, new machines were almost flat. Strong growth in beverage and utilities was compensated by a negative impact in food, chemical, and others. Service sales grew by 2.5%, with business area solutions growing a bit stronger as price increases at business area solutions were carried out a bit later during the year. To sum it up, order intake was very solid in Q4 2019. Growth was driven by the service business while new machine sales growth... Now I'd like to draw your attention to page 9, the development of our service business. In Q4 2019, service business grew by 2.5% to a new record level in the quarter. Service sales accounted for 32.7% of total sales, which compares to 31.1% in last year's reported period. As in the prior quarters, pricing contributed to the sales growth in Q4 2019. The effect from pricing was around 2.5%. To sum it up, our high-margin service business continued to grow. Let's go to page 10 with EBITDA, EBIT, and ROCE. As you are well aware, from 2019 onwards IFRS 16 is having an impacting EBITDA and EBIT. In Q4, EBITDA came to 150 million euros, down from 157 million last year. As in the prior quarter, there were the following effects. First, in Q4 2019, there was an IFRS 16 effect of 18 million which did not exist in Q4 2018. Second, there was the headwind of special effects of 16 million net expenses. These two effects netted to only 2 million euros. EBIT declined from 97 to 93 million euros. The decline was not as pronounced as at EBITDA level, mainly due to expiring purchase price allocation expenses on a year-over-year basis. ROCE started to slightly improve quarter-over-quarter, but the year-over-year development is still down due to a decrease in last 12 months EBIT and an increase in last four quarters capital employed figure under phasing in of IFRS 16 right-of-use assets. To sum up, EBITDA and EBIT were year-over-year lower due to a very strong Q4 2018. ROCE was lower year-over-year but slightly improved quarter-over-quarter. Please follow me now on page 11 to the full year EBITDA bridge. Our starting point here is 539 million euros, and it's calculated from the old definition as follows. Starting at an operating EBITDA of 518 million euros for 2018, we deduct 42 million strategic project costs and add back 67 million IFRS 16 impact as well as 5 million from a revaluation of inventory. This brings us to the number 479 for 2019. Volume contributed positively in 2019 with 27 million euros, while new machines contributed 43 million negatively, but the service business with 53 million euros positive overcompensated that effect. Also, margin mix at the service business was the clear driver. The development at business area solutions with new machines contributing negatively by 17 million euros has to be seen on the back of the cost of 21 million euros associated with the backlog review we conducted in 2019. Without this effect, the margin development would have been positive. Regarding R&D expenses, the driver here was increasing personnel expenses. Same counts for SG&A. Personnel expenses increased by 44 million and were only partly compensated by cost reductions in other SG&A costs. This shows the necessity of our program to reduce headcount by 800 FTEs in total. FX was a tailwind in the entire fiscal year, predominantly from movements of the US dollar. This in total brings us to an EBITDA of 479 million. So summing up, in 2019, eliminating all special items of 41 million expenses and 20 million of FX gains, one could say underlying EBITDA was 501 million. Additionally, one needs to consider positive special effects of 23 million in the year 2018. Thus, operationally the gap was only 15 million euros year-over-year. Let's proceed on page 12 to the net working capital development. Year-over-year, net working capital improved by 65 million and the ratio stands now at 14.0%, down 155 basis points. Net working capital in business area equipment now stands at 621 million euros, and at business area solutions the year-over-year improvement was mainly a result of the following factors: net trade and other receivables declined by 19 and 27 million respectively, trade payables increased by 18 million euros, inventories remained flat year-over-year. We are now already at the upper end of the targeted range for our net working capital ratio. Does this mean that we are done with our aimed net working capital improvement? Certainly not. The reduction in net working capital is one of our top priorities as we have outlined in the last conference call. You will see further improvements already this year, however there will be seasonal fluctuations between quarters. To sum it up, reaching 14% net working capital over sales already at the end of 2019 shows our capability to reduce net working capital. Now, coming to net working capital to cash flow on the next slide. Starting from an EBITDA of 150 million euros, the improvement of net working capital in Q4 2019 contributed 250 million euros in cash. The improvement came from a reduction of inventories of 168 million as well as an increase in payables by 132 million euros. Receivables increased however by just 51 million euros. Cash out for restructuring was 30 million euros and resulted from the initiatives which were announced and implemented earlier in 2019. The category others was positive for 50 million and included pension-related cash outflows of 9 million euros and effects from the net effect of the investments of 16 million euros. This gets us to an operating cash flow of 372 million euros. CapEx of 59 million euros is about the same level as last year, and with other cash this led to a free cash flow in Q4 2019 of 308 million euros. Taking into account repayment according to IFRS 16 of 16 million euros and interest payments of 5 million euros, our self-defined net cash flow came to plus 287 million euros. As a result of the positive net cash flow development, net financial debt of 263 million euros at the end of Q3 reversed to a net cash position of 28 million euros at the end of Q4. To sum up, free cash flow came in strong with 308 million euros. We were able to close the year with a net cash position of 28 million euros. Both results are driven by an improvement of our net working capital. Now coming to financing and liquidity on page 14. As always, starting on the left side of the slide, GEA is solidly funded on a diversified financing structure. The numbers have slightly changed compared to Q3 2019. The solid cash generation in the fourth quarter has led to a lower utilization of the bilateral credit lines of 167 million quarter-over-quarter. Please follow me now to the right side of the slide. The decline of the equity position is predominantly explained by a negative net income of 171 million euros caused by high restructuring costs and the goodwill impairment at Pavan of 248 million euros. The rating leverage stands at 2.9 times according to Moody's consideration at the end of September 2019, and it has deteriorated compared to Q4 2018 but improved sequentially from 3.1 times according to Moody's consideration as of June 2019. The financial liquidity, long-term financing instruments, and the net cash position are providing sufficient comfort in terms of liquidity. We are committed to our investment grade rating and our clear target is to maintain this going forward. Thus, there is currently very limited headroom for further leverage. To sum it up, GEA remains in a solid financial situation regarding financial structure and liquidity. And now back to Stefan.

Thank you very much, Stefan and Markus, for the prepared remarks. We will now start the Q&A. Operator, please open the line.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Again, as a reminder, if you wish to ask a question, please press star 1 on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Once again, star 1 if you wish to ask a question. Our first question is from the line of Claus Berg.

Thank you. Yes, hi Stefan, Markus. It's Claus Berg. So a couple for me please. First of all, in your guidance of a slight revenue decline, how much of this is protected by the backlog in solutions versus the order book in equipment? Equipment is obviously much shorter lead times. I'm interested in your lower end scenario of 430 million EBITDA. If new orders stop from March onwards, that seems difficult to achieve your lower end. So I'll start there.

Okay, 770 million for invoicing in equipment, and is that roughly six months? Should we expect about six months of that backlog to be converted? And Markus, little bit the duration of the shorter backlog? You like? Yes, yes, absolutely six months, okay, good.

Okay, good. Then my second one is on your savings of 25 million for 2020. I get to that if I back out the 25 million and I assume revenues will fall slightly, which I think in your language is 3%, let me get the operational gearing underlying to be around 3-4%, but I know there are many moving parts, insurance and everything. But the 3-4% is not that different versus your gross margin, so shall we assume that you haven't taken any price pressure in your guidance at this stage, thinking more now about the second half rather than the first?

I think when we met back in November, you and I, we were talking about the majority of the service business today is still spare parts. So could you help us, Markus, in terms of how much is service contract so we could model that there could be delays both on volume and price from people not being able to travel, etc.

When looking at our all service figures, it's about 50% is spare parts. But of course they need to be built in, it's not just selling them over the counter. Usually we have to implement them in the machinery and equipment there. And service contract is around 20% below okay.

Okay, okay good. And then I just had one quick one. We talked about the 25 million here from previous announcement. How much is procurement and supply chain versus the tail end of the 800 FTEs coming through? We know that 400 people had left, and I'm trying to understand the 25 million better and what the gearing is on the upside.

Our assumption for this year is that we're going to have a full year effect of 600 FTEs in 2020. And of course there's some phasing, we might be able to do more in the first half of the year. But I think that's a pretty fair assumption when we say 400 by the end of last year and another 400 this year, to say there's a 200 FTE full-year effect.

Okay cool. Very quick one, probably the last one. The footprint in Europe, could you help us with where you're more exposed other than Germany, exactly where is your footprint? We're getting a lot of questions about France closing, etc. I don't know if you can rank them by country, talk a little bit more about your exposure in Europe, Stefan?

All right, thank you.

Next question is from the line of Lucy Carrier.

Thank you. Good afternoon gentlemen. I have a couple of questions, I'll throw one at a time. The first one was around dividend. Maybe if you could give us some indication in terms of your status regarding AGM and if we are potentially facing a risk of any delay considering what we see on COVID-19. The reason I'm asking is because we are seeing several announcements at this time on that front, and it would be great for us to understand what you have in mind or what is possible within your articles of association.

Okay, thank you. And do you have... (question cut off)

Okay, thank you very much. Just to confirm also what you were telling earlier to Claus, saying all of your factories in Italy are currently running, is it the case also across Europe despite what we hear in terms of confinement measures and so on?

Thank you. And just the last question, maybe moving away a little bit from the coronavirus situation. Can you comment maybe on the latest trends you've seen in your key markets before this outbreak and what you are seeing now in terms of level of demand from your customers? Do you see a lot of delays in terms of decision-making or maybe not so much? Just what you think in current trading, thank you.

Thank you. The next question is from the line of Felix Bismark.

Thank you very much. Good afternoon. Thank you very much. I have a couple of questions. The first one, could you give us any indication of what your underlying assumption is for European growth or global growth under your guidance, or is that really just the impact of people being disturbed by the way the supply chain situation?

We said that this year it's going to be slightly lower revenue compared to last year. We currently globally can tell you that we expect with the coronavirus there will be a slowdown. As Stefan said, our end markets are in general intact. Nevertheless, there will be some impact this year. That's why we said slightly lower. We think that going forward in the next years, assuming then when the coronavirus has settled, we will see at least a growth of 3% as we set out in our market guidance.

Is it reasonable to assume you made like a 500 basis points cut to your growth function? So if you say percent normally... No, no, we have not specified this in any direction. Totally, we are monitoring this right now.

We are slightly more, we are monitoring this right now.

Okay. And on your current trading, did I understand correctly that you haven't even seen any impact in February order intake numbers from this? No, not yet.

Okay. And then one more, can you confirm that your debt covenants are only based on your financial debt, not on your pension or other liabilities? And what about the authorized capital measures that you have from the AGM last year? Do you think it's a good idea to maybe increase those?

Yes, the covenants are only based on financial debt. And regarding authorized capital, we will come with the AGM invitation where you will see that everything which expires will be renewed. That will be our proposal for the AGM.

Thank you.

Thank you. Next question is from the line of Sebastian Grow.

Yes, good afternoon. Thanks for taking my questions. The first one is around your guidance and particularly around the bridge. You indicated in your prepared remarks that you had the 40 million non-recurring, so the starting point is rather 520 for the EBITDA. So my interest is focusing on what you have been assuming so far and the potential decline in service revenue to get a better sense of the overall sensitivity to those very high margin business contributions, and also what have you baked in in terms of headwind from wage inflation for 2020. Then moving on to portfolio, you had the impairment charge for Pavan. My question is what are you doing to tackle the margin decline there, which has been freefall since the acquisition, and would that suggest we should be prepared for further layoffs? And then final one on services, you indicated in the prepared remarks that you came in rather late in the quarter with the price hikes if I understood correctly for the solutions. Can you just give us the general price escalation that you have planned for 2020 and how this is going with customers as we speak?

Okay, now, first one about the EBITDA bridge from 2019 to 2020. We had 479 with restructuring. As I said in my prepared remarks, we had special items of 41 million. We don't expect to get in 2020 another 41 million one-time effect. Of course every year there are one-time effects, but by far we do not expect to see that amount. And then we said 26 million euros in procurement savings from our capital markets day, and that's also our expectation. And with the 600 FTEs, we also think that there should be across levels around 25 million from that. However, on the other side, we had last year positive FX effects of 20 million euros, so you need to deduct those. We expect to see a salary increase in total of around 26 million. And then of course we have a corona effect which we estimated in different scenarios and also some additional risk buffer. So when I take both into account, we end up with our guidance with a midpoint of 455. If we can have all the price increases which we usually assume, I end up at the upper end, and if corona is getting really worse and negotiations are getting tougher and all service business is affected, from today's point of view it might bring us down to the lower end. It's pretty much influx, as you can imagine, what's going to be the effect of the coronavirus.

That makes sense. Specifically on the service element, can you give us a sense of what your planning assumption is? Are we looking service revenues down this year, flat, or what?

We don't have any working assumptions right now for the service side. We expected actually to have steady prices in our planning plus normal inflation adjustments. If we can have more, we're going to try, but the corona virus issue might hold us back to be able to do price increases in service this year. I think I actually forgot to mention wage inflation, that was around 26 million in total.

Then on Pavan, the margin needs to be improved. We fully agree. We are working on this and there have been some layoffs also as part of the headcount 800 program which we announced, so it will bring some efficiency into Pavan as part of this program. But that's it for the time being. Can you remind us of what potential further provisions you might take for the year 2020?

We're going to have restructuring charges of around 50 to 60 million. There's no such thing as something really big at Pavan. We'll bring down the number of employees, bring more efficiency in, and it's still a workable company. We just need to focus now on the margin, and that's what we're doing right now.

Okay, fine. Thank you.

The next question is from the line of Sebastian Zuber.

Yes, good afternoon. Many questions have been answered, but one is still left. Maybe an update on the current situation in Germany now that schools have been closed. How does your blue-collar workforce come to work as they need to care for kids? How do you manage this process and what could be potentially seen as an impact to your productivity or to your top line? Thank you.

Okay. And there may be one follow-up question also with regards to the new structure of your organization. Will we get some additional data such as backlog, EBITDA by division? That would be quite helpful. Share of service probably not, but...

Okay, thank you.

Next question is from the line of Akash Gupta.

Hi, good morning everybody. Thanks for your time. I have two questions please. My first question is regarding the project business. Can you talk about risk of liquidated damages or penalties from customers in case you have delays in finishing projects?

Thank you. And I have a follow-up on your IT investments this year. Can you talk about what sort of flexibility do you have on both CapEx and IT investment? And if the current situation and uncertainty continue, do you have room to delay some of these investments into next year and beyond?

We don't see that we have to delay any investment right now. At the end of last year, we bought the necessary SAP licenses. This year it's going to be not that much capital expenditure for programming and setting up the processes for the new SAP template. Other IT projects are actually on their way. We don't have any liquidity shortage right now. We don't see any material revenue deviation currently. So we don't see the need to postpone. On the other hand, we are watching that situation closely, preserving liquidity. But we will be executing right now on our IT strategy.

Thank you again.

For those participants who wish to ask questions, please press star 1. Our next question is from the line of Lars Larsen.

Thank you very much. Hi Stefan, I'm Marcus? I've got a few if I can take them one by one. Following up on the service operations, Stefan, the challenges of getting service technicians on site. I appreciate we are in uncharted territory, but in light of these lockdowns and limitation of movements, I wonder whether there is some way for you to help us understand and quantify the impact. For example, if you look at the number of service visits in Italy over the last couple of weeks, what does that look like relative to the same period last year?

Understood. And I'm going to try another maybe slightly unfair question around the COVID-19 impact on your guidance. I applaud you for at least attempting to come up with some guidance. Most other industrial companies don't. But what you're doing in your sensitivity table in page 153 of the annual report, where you try to gauge specific scenarios and the associated EBITDA impact, you're obviously categorizing COVID-19 as a moderate risk and you pinned it at 22 to 70 million impact. I would have thought it needs to be right up in the right-hand corner of your matrix at least 120 million impact for 2020. Maybe to ask a little bit differently, if you think back to months ago as you started to think about the 2020 guidance, can you give us a sense of what you were thinking pre-COVID-19?

This is Marcus. Let me answer this question. Before COVID-19, of course we would have expected that revenue would be up and we would have higher guidance for EBITDA and for ROCE. If we take a look at what the effect is, if we take what you suggested on the upper right corner, the financial effect would be above 120 million. But we don't see this at this point in time. We see that there probably will be an effect, and that's why we chose the range with a midpoint of 455 million. That's why we have it classified as we did. But as I said earlier, we are monitoring the situation closely and let's see how businesses around the world will be affected.

Understood. If I can try a third one, just around working capital. You've done well in Q4 2019 to manage working capital issues. You laid out your corporate-wide program in August last year. Specifically, if I can ask about some of the smaller end markets like oil and gas and marine and shipping, although they are very small for you, are you seeing stress among customers and are you doing anything differently from a working capital standpoint in terms of collecting receivables or otherwise?

So far we have not seen anything like that. But it takes a bit more time for it to come to a liquidity situation unless they have a product which they sell cash-and-carry, which is not the case with oil and gas and shipping. So there might be some lag. So far we have not seen any constraints, but we are monitoring these customers very closely. I would not exclude that there will be some effect in the future, but we have not seen any yet.

Understood. Thank you.

The last question is from the line of Felix Bismark.

Thank you very much. I have two more questions. The first one is, is it fair to assume that you are pursuing your divestments that you have announced? I ask because you could get right now an exceeding bid is either side now it's more difficult to find. And the second question would be, have you baked into your assumption any recovery in Q3 or Q4, or is the assumed impact going to be negative for the entire year?

We are still going forward with our divestments. However, we are monitoring the situation closely. We have got feedback from private equity companies that they are monitoring right now full focus on their portfolio companies. So whenever there is private equity involved, we need to see if they are still in acquisition mode. So far we are pursuing our divestments as planned, but with that caveat. Regarding recovery, we have not baked in any recovery yet. But as I said, there is a range. If there is recovery, we can have price increases, the range goes up to like 480. If it gets worse, our range is currently going down to like 430. That's the best we can do right now.

Do you have a similar range for the revenue as well? No, we don't have a similar range for revenue. As you said, slightly there is a zero to five percent range in that context. Let's see if we get the revenue at the higher end at five. We don't know yet either.

Okay, thank you very much.

There are no further questions. Please continue.

Okay, if there are no further questions, let me make some final remarks. I think what is important to mention is that 2019 was a strong year for GEA, where we really could change many things which put a lot of stress to the organization during the last years. We established a completely new organization, we changed a lot of people in the management team, we are really now in a setup which allows us to steer and control the company much better. And above all, as Stefan said, whether there is Corona or not, people need to eat and drink. And this is our business. We are producing the machinery, the processes, the equipment for our customers who are producing food, beverages, and pharmaceuticals. So the long-term trend for our industry is brilliant, I would say. And that's why we are in the medium to long term still very optimistic. We will use the time to do our homework. We now have to manage the corona crisis, this is what we do. We will protect our people, we will do everything to keep our good and qualified people. And at the same time, we are with our intention to limit of course the negative impact on our organization. But medium to long term, this is an excellent market in which we are in, and therefore we remain very optimistic. That concludes our call today. Thank you very much for participating. And if you have further questions, please come back to the IR team. Thank you very much and talk to you soon. Bye bye.

This concludes our conference for today. Thank you all for participating. You may all disconnect.