Kendrion N.V.

Good morning, everybody. Welcome to Candrion's Q1 2023 results teleconference. My name is Joep van Beurden, Candrion's CEO, and with me on the call is Jeroen Hemmen, our CFO. I'll start the meeting with some remarks regarding our Q1 results, after which we'll have time for Q&A. We will post a recording of this call and of the Q&A on Candrion's website as soon as is practicable. I'd like to draw your attention to the fact that certain statements contained in my remarks and in the answers to your questions constitute forward-looking statements. These forward-looking statements rely on several assumptions concerning future events and are subject to uncertainties and other factors, many of which are outside the company's control that could cause actual results to differ materially from such statements. Before reviewing our Q1 2023 results, I would like to reflect a little on the current economic and market environment that we are operating in. The positive here is that the overall trading environment was more stable than what we've seen since the onset of the COVID pandemic, now three years ago. The order patterns in automotive became more predictable and helped us in terms of production planning. A second positive is that despite a lot of talk about a recession in the US and Europe, this did not yet materialize. On the negative side, when China abandoned its zero COVID policy late 2022, it triggered a sharp rise in infections, which reduced the overall economic activity significantly in Q1 2023. And this affected China-based revenues in all our business groups. especially IB, our largest group in China by revenue, felt the effect. We expect this effect to be temporary, with order patterns coming back to normal levels as the year goes on. Inflation, too, stayed stubbornly high, and the various central banks have kept on raising interest rates. This puts pressure on our added value margin, especially in automotive. So in summary, a bit of a mixed bag. with on the one hand more stability and a bit of underlying economic growth, and on the other hand persistent inflation and a temporary slowdown in China. And still pervasive talk about a recession around the corner. In this environment, we have delivered a solid first quarter, delivering further growth and record revenues. Group revenue grew by 5% compared to a strong Q1 2022, reaching 136.8 million euro. Our industrial business grew with 3%, somewhat below our expectation, mostly caused by the slower market in China that I just talked about, and compared to a strong Q1 2022. We grew our automotive revenue by 8% relative to Q1 2022, and as mentioned, in a more stable environment than in the past few years. On a normalized basis, our EBITDA was a healthy 15.7 million euro. Q1 represents the 10th consecutive quarter where we report year-over-year revenue growth despite the negative impact from the temporary slowdown in China. It illustrates once more that we have strong growth potential with significant opportunities for our products that help advance the global transition towards electrification and clean energy. We have a balanced product portfolio and are not overly dependent on any specific vertical or market segments. Our product range from brakes for wind power, robotics and automated warehouses to inductive heating technology, circuit breakers for electricity distribution and suspension valves for electrical vehicles. The broad push towards electrification has determined our product development and strategic decisions over the past couple of years and will continue to do so in all our business groups and in China. The new automotive core and E setup, which came into effect at the end of last year, is proving successful. In automotive core, with inflation persistently high, we have increased our sales prices, which we expect will result in improving added value margins in Q2 and the second half of 2023. In automotive E, we want a sizable additional suspension order for China, which is expected to ramp in 2024. The construction of a 28,000 square meter manufacturing facility in Suzhou's renowned industrial park was completed in the first quarter of 2023. Our operational tests are in full flow, and we expect to be ramping the factory in early July of this year. In addition, we plan to start production of six new automotive key projects at our new facility in China during 2023. Jeroen and I will travel to China later this month to officially open the new facility. Let me review our results in a bit more detail. Our revenue in the first three months of the year came in at 136.8 million euro, which is a record, and 5% higher than the 129.9 million euro of the first quarter of 2022. Higher average sales prices added 3.5% to first quarter revenue as inflation continued to affect our supply chain. Currency translation had no impact. All business groups contributed to the revenue growth. Revenue and IB increased by 3% to 38.9 million IAC revenue came in at 33.1 million, an increase of 2%, and both were held back a bit by the temporary slowdown in China. Revenues in the automotive group were 64.8 million euro, of which E was 15.9 million euro and core 48.9 million. On a pro forma basis, E grew with 7% and core with 9%. Around half of the revenue growth in automotive core was driven by higher average sales prices. We do expect that increasing sales prices will continue to positively affect automotive revenue in the remainder of the year. The added value margin for the group ended at 46.4% compared with 49.0% in the first quarter of 2022. several effects contributed to the drop in added value margin. First, the margin dilutes by passing on material price inflation 101 in the sales price. Second, we had lower direct engineering revenues in Q1 2023 compared to Q1 2022, which is in essence a product mix effect. But in the end, the added value margin is best protected by further sales price increases which we continue to pursue with urgency, especially in core. Staff costs in the first quarter included a one-off inflation compensation payment that is part of the wage increase agreement in Germany between the trade unions and the employers association. Kendrion follows these agreements. This one-off payment increased wage costs by 1.3 million euro in Q1. Our normalized operating result before depreciation and amortization was 15.7 million euro, 7% below the comparably strong first quarter of the previous year when it was 16.8 million euro. Depreciation charges increased by 0.4 million to 5.8 million euro in the first quarter of 2023, leading to a normalized EBIT A of 9.9 million euro compared to 11.4 million in the same period last year. The effective tax rate on a normalized income in Q1 was 26.6% compared to 27.3% in Q1 2022. Normalized net finance costs were 2.2 million compared to 1.0 million a year earlier, The increase was mainly caused by realized currency results as a result of the stronger Euro and the increased market interest rates compared to Q1 2022. The normalized net profit before amortization charges arising from acquisition was 5.6 million compared to 7.6 million Euro in Q1 2022. Total net debt, including IFRS 16 lease liabilities, amounted to 147.7 million euro, up from 137 million euro at the end of last year. The debt increase was mainly driven by typical seasonal effects and higher activity level compared to Q4 2022. The leverage ratio based on total net debt divided by 12 months rolling EBITDA was 2.6, up from 2.4 at the end of 2022, and well below our financial covenant of 3.25. Capital investments increased significantly to 10.4 million, compared to 7.4 million in the first quarter of 2022, and of this, 4.3 million euro was related to the finalization of the construction of the new production facility in Suzhou. In the first quarter of the year, we have agreed with our lenders ING Bank and HSBC to use the extension option in the credit facility. This extends the maturity date of the 102.5 million euro facility by one year until April 2026. Other terms remain unchanged. Now, before we go to Q&A, let's talk a bit about our outlook. We expect the economic climate to be unpredictable for the foreseeable future. In China, we expect to return to normal activity levels and the planned ramp up of new production lines in our factory will further support our growth there. Bringing our new factory up to speed is one of the key priorities for this year. We remain positive that our strong position in the growth markets of industrial brakes and selected segments of industrial actuators and controls, automotive and China, will help deliver our medium-term financial targets of an average 5% organic growth per year between 2019 and 2025, an EBITDA of at least 15% in 2025, and an ROI of at least 25% in 2025. I now open the line for your questions.

Thank you. As a reminder to ask a question, you will need to press star 1 and 1 on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star 1 and 1 again. We will take our first question, and the question comes from the line of Frank Klaassen from DeGroof Petercam. Please go ahead, your line is open.

Yes, good morning, gentlemen. Good morning, Klaassen. Good morning, Joep. First of all, on the pricing, if I listen to you, do you think that you can accelerate pricing in the coming quarters? It was 3.5%, but given your announced price increase, do you think that can accelerate? How about the raw materials? Don't you see any relief there? And what could that bring for gross margins? So some words on that, please. And then secondly, working capital was a bit higher than I had expected. But do you think there's room to improve this? And how do you see your working capital development? Thank you.

Thank you, Frank. Let me talk about your pricing question and hand over to Jeroen for the working capital. So on the pricing, the answer, the first and accelerate the price increases, the answer to that is yes, we expect that. It's not necessarily an acceleration of the urgency with which we push this with our customers. But basically, in Q1, we reached a lot of agreements that then start to kick in either towards the end of the quarter or maybe even some cases on April the 1st, for instance. So there is more in the works than what you see in Q1. So now, of course, we will continue to have these discussions. We're by no means done because inflation is still around. But yeah, we do expect the effect of this to be a little bit more pronounced in Q2 and then further in the year. The answer to your raw materials question is also yes. There is indeed, it seems to be calming down a little bit, but it's by no means over. And as you know, and this is one of the issues specifically in automotive, that there is always a delay between the fact that you have to accept in some cases contractually raw material price increases and before you have achieved the same pass on with the customers on the sales side. However, we do expect, as we said, also in our prepared remarks in Q2 and further in the year, that slowly but surely we will see improving added value margins, specifically in automotive, because of all these actions. And then on working capital, Jeroen?

Yeah, so the... The main increase compared to the end of the year really has to do with an increased activity level. primarily driven by the seasonal effect. We have that every year. In December, the plants are basically closed for two weeks, so you empty the inventory pipeline. Receivables are on a quite low level, so that is the main reason for the increase. Also, if you look at the somewhat longer history, then the fact that we have become more industrial helps us in many instances, but not so much in the working capital. The industrial units, especially on inventory, carry somewhat higher inventory levels. Room for improvement. Also on inventory, I still think there is some room for improvement, but then you talk about a couple of million. In Q1, we started to gradually build up buffer stocks in China, and although Also, markets have stabilized compared to the previous quarters. We still are every now and then confronted with some volatility, which leads to having inventory that you would not have expected because you thought you would be able to sell it. Or you need 20 parts, but you only have 19, and therefore you cannot yet produce it. So it has improved, but it still has some impact. So, yeah, improvements are possible, but then you talk about maybe half a percent of revenue or something.

Okay. Thank you for helpful comments. Thank you.

Thank you. Thank you. We will take our next question. Please stand by. Your next question comes from the line of Tim Ellis from Capital Chevrolet. Please go ahead. Your line is open.

Yes, good morning everyone. I've got a few questions regarding automotive. So for E you stated that you've seen 7% revenue growth versus the 11.4% you had last year for E. What's the reason for the drop in growth momentum there? Is that mainly China or are there some other reasons for it?

Okay, no, I may say that, I mean, we're looking at one quarter, so this is typically, you get quarterly gyrations on this, so it's very difficult to extrapolate the 7% or the 11.4% if you like. I will say, you heard me talk, Tim, earlier about we have, in China alone, six more projects starting in the second half of the year. That's all E. We talked about a substantial suspension order we won in Q1 that will ramp in 2024. So through the quarters, we do expect that 7% of E to go up quite substantially. But I always try to urge people not to read too much into a quarterly number. which can also be sometimes too high. And in this case, it's 7%. Please do not extrapolate that. Over the next couple of quarters, this will accelerate. Okay, fair. Thanks.

And then could you maybe give some updates on the products within E? Are there any, let's say, major developments

regarding the direction we're headed to so you had the big suspension project in China so how's the sound system going any updates there or no I mean I'd say so we have you know of course we talked for many quarters now about the three main products on E so suspension sound and sensor cleaning sometimes we also call that smart actuation All three are modular products, and the big change compared to what we used to do, compared to the products in core, that effectively these are modular products, meaning that we sell any of these products to different customers. They're only marginally different. As an example, the order we just won for the suspension valve in China, ramps in 2024, that's only possible because the product is essentially already designed. And it means that, of course, there are certain tweaks necessary for this specific China-based customer, but they're minimal. And that means two things. One, far less investment for us, scaling possibilities on the production line, and of course, a quicker time to market for the Chinese customer that we sold this product to. And for your information, We started discussing with this customer in earnest, basically at the end of 2022. These are timelines that three, four, five years ago in the traditional automotive world were unheard of. Also, that part of the automotive industry is changing. We're very pleased with those three modular products on the east side that we have. to be able to cater to these types of opportunities. So on all three, we're making good progress. We're still investing quite a bit specifically on the sound side, the software and electronics. That also, we expect that the investment intensity there to come down a little bit as we're nearing the end of some of the bigger developments on the software side. Of course, that's also highly modular and scalable. So, yeah, we're feeling good about the state of affairs in E and the traction that we're having in the market.

Okay, thanks. Then going to industrial, a little bit similar question to my question regarding E. So obviously the 3% is not the same level as industrial used to be before. And again, I mean, it's Q1, don't want to jump to any early conclusions. But is the main driver behind it, again, China? And do you expect it to... go up to similar levels that we've experienced the last two years? Or do you see, let's say, a more normalization of growth there also considering that the acquisitions normalize?

A couple of points. First, the need of 3% was a little bit below our expectations and also what I said earlier in my remarks and in the press release. specifically on IB, there was definitely some impact of that temporary slowdown in China, which is a large part of the market for us. That's point one. Point number two is what we've seen in 21 and 22 on industrial is basically growth rates in high, you know, between sometimes north of 15% year over year for a sustained period of time. that we do not expect and nor have we ever mentioned that that will be sort of the through the cycle growth opportunity. So you definitely can expect that we're coming off a little bit of these numbers, but they're still, through the cycle, a very good growth opportunity. I am pointing to the electrification that we mention every quarter. That trend will not stop. Of course, you have to deal with the comparables on a quarter-by-quarter basis. Q1 last year was particularly strong. So I would say don't model out anything between 15% and 20% on a constant basis. But there is very good growth opportunity in industrial, and we expect to make full use of that in the coming years.

Okay, clear. And then one last question to wrap it up regarding the divisional margins. Were there any new developments there? So did you see an improvement in core now that revenues further increased, so maybe some operational leverage there that improved the margins and the EBITDA or the margin in industry? Were you able to maintain the really good margins of last year for now?

On the growth margin side, yes. So the main impact on EBITDA compared to last year are the mentioned one-off type of wage inflation. If you look at the product margins in industrial debt, they remained on a high level. In core, we have realized, sorry, substantial price increases in Q1, but we do expect, as you've mentioned already, debt to accelerate in the remainder of the year.

Okay, clear. Thanks a lot. That's it from me.

Thank you, Tim.

Thank you. We will take our next question. Please stand by. Your next question comes from the line of Martin Dendriver from ABN AMBRO. Please go ahead. Your line is open.

Yes, good morning, gentlemen. You mentioned a one-off in the wage cost, but Can you remind us, please, about the labor agreement, so the collective labor agreement wage increases that we should take into account in 2023? And in relation to that, when do you have your normal salary raise round? Is that in March, April? Was that in March or is that in April, May? Just to get a bit of a sense of what we should expect in wage costs in the remainder of the year. That's question one.

Okay, so obviously every country has its own dynamics there, and even within the country sometimes that can be the case. So on average, the wage inflation, and we had mentioned that last year for 2023, we expect to be around 5%, slightly more than 5%. Because of the particular agreement in Germany, which is our most important country related to it, so most of our wages come from there, So the agreement there consists of a percentage, which will be applicable mainly from the 1st of June, plus a one-off payment of the €1,500 per employee. So round numbers, if you then look at the phasing, So the 5% will end up at roughly 8 million in a year. But if you then look at the quarterly phasing because of this 1,500 euros, then in Q1, you end up roughly at 2.8. Then in Q2, it drops down to 1.5, 1.6. And then in Q3, Q4, it goes slightly up again to around 1.8. Again, round numbers because there's a lot of dynamics there. But I think that answers your question.

So it is indeed a bit lumpy and phased differently than what you would expect if you simply have a percentage increase per, let's say, April 1st or May 1st.

Oh, and by the way, for SODIS 1500 euros, that will be one time, also because the labor agreement is two years, so also in 2024, in the first quarter, that will be an item. But it's purely a phasing topic, so it's not an increase per se.

but this is the labor agreements but on top of that you obviously have normal uh promotions and stuff okay that's clear um the second question revolves around the new plan in china could you perhaps uh at least refresh my memory uh what's the revenue level of that plant when fully up to uh up and running uh and second to that if you look at the contracts that you have today in your backlog, and so signed contracts. What type of utilization level should we then expect based on those contracts going forward? Yeah.

The second question. So in China currently the current situation is we have two factories, one in Suzhou and one in Shanghai, and they're both almost full. And then as we show, we will open in a week and a half our new facility. Now, what we will do is, the first step is we will, these two other factories are leased. The new factory is owned. We will move the production from these two factories into the new one. And that means, so currently revenue levels of China, again, round numbers, roughly 10% of the group. So let's call that 50 million, a little bit more. So that basically takes up half the capacity that we have in that facility. Now then, if you're looking at the product pipeline, we have talked about the six projects in automotive that are starting in the second half or starting to beginning to ramp in the second half of 23. I just mentioned this new other automotive suspension project we want, which will then add to this in 24. In industrial, it's not these big, big projects that you can individually name, but there's a lot of traction there as well. But our goal and our expectation there is over the next couple of years, so let's say in 25, 26, that this factory is going to be full, and that will mean around 100 million, again, round numbers of revenue in China. And the vast majority of that is visible in our current backlog. We also have the opportunity to invest in a stage two, which will add another building on the same plot that we are now occupying with this factory. That stage two will give us another, say, 50 million in capacity. Obviously, a bit early to think about that while we're still moving into the first phase. But that is for after that. That would mean if we see further growth, which we do expect. That's not yet in the backlog. that Phase 2 would cater for another 50 million of revenue in China.

Okay, that's clear. And in relation to these investments, 10 million of capex in the first quarter, but there was completion capex of the new plant in China, 4 million, so 10 minus 4 gives 6, 6 times 4 is 24, plus the 40 already spent in China, is roughly 30 million. And I seem to remember that the guidance for 2023 was 40 million. So can you please perhaps update us on the capex guidance?

The guidance for 23 was not 40. So we have said that after the finalization of the China building, that investments will go back to slightly above depreciation, but not increasing as a percentage of revenue. So for this year, let's say a bit more than 30, is at this moment what we see.

That's perfectly. And then my final question, it's a slightly different tactic than Frank tried with the working capital. Should I read it right that, in fact, as a percentage of sales, you're aiming for 0.5% improvement in 2023 over 2022? Would that be the correct way to think about net working capital as a percentage of sales in 2023?

That is what I think, that improvement is, I think, in the numbers. So yes, we are targeting for that. If we can do better, we can do better. But also that is not, so from quarter to quarter, it can obviously deviate a bit. Does the large customer pay on the 30th or on the 1st? Stuff like that. But on average, yes.

Great. Thank you very much, gentlemen.

Thank you, Martin. Thank you. We will take our next question. Please stand by. Your next question comes from the line of Johan van den Heuven from Edison Group. Please go ahead. Your line is open.

Good morning, Joep and Jeroen. It's Johan from Edison Group. A few questions. Good morning. Can you provide us an update about your planned cost savings for the year? There were two buckets of cost savings, both 4 million, Austria and the split in corn. Can you give us an update about the progress and about the timing for the year, for quarter, please?

Yeah, so they're both realized, as mentioned. So the plan in Austria is... is closed. The only thing which is still there is building, which we are trying to sell at the moment. And also the restructuring mainly in core has also been completed. So as from the 1st of January, those cost savings are effective. You also see, for example, in the FTE numbers in automotive, On the indirect side, there were around 50 less than last year. And other savings are obviously also in other operating expenses and in direct employees as we moved some production from Austria to a cheaper location in Romania. If you look at the total cost, then part of that is especially in Q1 offset by the 1.3 billion, one of wage inflation that was mentioned. And also, as flagged last year, we do have temporary high external R&D efforts in automotive, as you've also mentioned, which we expect to tail off in the coming quarters.

Okay, thank you so much. That's clear. Another question is, I think last year you gave sort of a number of of the revenue impacts of, well, COVID in China, I think about 3.5 million euros revenues, which is sort of missed in the first half. Can you give us a number now because you say, well, especially industrial is growing a bit less than anticipated. Can you give a sort of number on the impact or in euros or percentage, both are fine?

Yeah, I would say compared to our expectation, the numbers that you mentioned is roughly what I would quote here as well, Johan. It's of course difficult to know because you get the revenue that you have, but I would say that order of magnitude sounds fair to me. But I think the important point to make is that this is temporary. We did see a significant spike in infections, and not just us, obviously, everywhere. That's now behind us. And I expect the Chinese operation and the Chinese economy to revert back to normal levels.

Okay. But can we assume there's still a little bit of a small effort in Q2 and back to normal in the second half?

No. I wouldn't put too fine a point on it. That's all within. Even we can't really say that. There's, of course, always normal gyrations that you have within your customer base, timing of certain orders for when they fall. I would say, for all practical purposes, we're sitting here in the beginning of May, that this effect is behind us.

Okay, that's clear. Another question you mentioned, especially in automotive, more stable market environment, have you noticed any difference from that in your order intake? And perhaps it differs from different segments.

So in our ordering what? I missed that. Order intake, if that sort of increased the appetite in the order intake. Well, we saw in Q1, I'd say, a modest growth in terms of the market. We're nowhere near the levels we were used to before COVID, as you well know. I think that stability is a bit more confidence in the market that allows you, and that also has to do with the absence, I'd say, of the massive supply chain shortages that we saw. If people are worried there is something isn't available, they're going to over-order. because they say, you know, there's an allocation coming, let me order 20% more, because if they then cut me to cut 20%, then I still have what I want. Everybody does that, you know, the dynamics there. So that seems to be behind us. So I would still say the market, the automotive market is still well below pre-COVID levels, as we all know, but at least, Once the order is in, you can actually trust that you can deliver it. And that helps, of course, in all sorts of operational processes, including production planning and working capital as well.

Okay, my last question is about gross margin, which was lower in the quarter for obvious reasons. You also said in your comments that you expect to continue with the price increases, which might be a bit higher than Q1. What is sort of the indication of gross margin for the full year, which is achievable? Is it halfway 46, 49?

I don't want to be pinpointed on that because the For example, the impact of the margin dilution of the one-on-one price increases is, for example, on the Q1 margin, it's a full 2%. So it is not only... it does not only depend on the sales price increases, it also depends on purchase price developments. And that seems to be cooling off a bit. So we have been indeed also confronted with some suppliers that are offering now some spare capacity. Well, that did not happen in the last two years. So that could be some relief of pressure there. So, yeah, on the overall margin, I would say half to 1% of revenue contribution in the remainder of the year as a net effect of price increases and purchase price increases. Does that answer the question?

Yeah. Thanks very much.

Thank you, Johan.

Thank you. We will take our next question. The next question comes from the line of Martin Verbeek from The Idea. Please go ahead, your line is open.

Good morning, it's Martin Verbeek of The Idea. Firstly, could you inform us about the cash flow we have seen in the Q1 and are you also willing to make some kind of projection for a full year 23?

The cash flow was minus 6.5 million. And for the year, no, we don't give guidance, but we reiterate what we have said, that in Q1 and in the first half year, so the net debt will increase, first of all, because of the completion of the China building, putting pressure on the investments. So after May, I think two days from now, when the dividend is being paid out, So the operational cash flow will remain within the company and then we expect to deliver it. So potentially higher than last year, but I would like to leave it at that.

Okay, thank you. And then secondly, you just touched upon the China facility will start six new products in the course of this year. Could you inform us about the annualized revenue of those six projects?

Well, we don't break that out because, as you know, every year when we do full-year results, we disclose the nominations that we won of the year for the total lifetime revenue for those projects. We've done that as well, as you know, in February. You saw that the vast majority of the wins that we had were on E, Do you remember? I haven't got the number here. How much e-nominations did we win in 2022? 206 million, I think. 206 million, so well above, of course, the current run rate revenue. The six projects are part of that, but I don't want to break them out specifically. The project that I earlier talked about that we won recently also for China, ramping in 2024, is not part of that, so that's an additional one. And we'll talk about the nominations again next year in February when we report 2023.

Okay, but you mentioned our nomination. I'm now talking about the revenue, the spin-off of those nominations. But then I have to look at the number between 10 and 20 million of annual contribution of annualized revenues of those six projects.

A bit more than that, so a bit north of 20, but note that I think you realize that projects, they ramp. So revenue in the first year is always less than the peak revenue. Okay, thanks very much.

Thank you. Once again, if you wish to ask a question, please press star 1 and 1 on your telephone. There seems to be no further questions at this time. I'd like to hand back for any closing remarks.

OK, well, thank you very much all for your attention and your questions. If you have any follow up, then you know where to find us. Thank you very much.