Strong organic order growth and profitability increase

Strong order growth

Order intake of CHF 1’801.4 million increased by 11.6% compared with the same period last year. Organic growth of 6.5% and CHF 82.3 million in orders from acquisitions drove this upsurge. Order intake gross margin decreased nominally by 0.4 percentage points to 33.8% because of business mix and price pressure in the energy markets.

Sulzer delivered solid growth and profitability increase despite price erosion in the energy markets.

Jill Lee Chief Financial Officer

Order intake in the Pumps Equipment division increased significantly by 21.3%. The increase stems from 12.1% organic growth, particularly in the oil and gas market, and the JWC Environmental, LLC (JWC) acquisition. Order intake in the Rotating Equipment Services division grew by 6.5% as a result of organic growth of 3.1% and acquisitions. The Chemtech division grew by 5.0% driven by Europe, the Middle East and Africa (EMEA) and Latin America. Order intake in the Applicator Systems division increased by 6.3% driven by the acquisition of Transcodent as well as 1.3% organic growth.

Sulzer recorded growth in all market segments except the power segment, which declined by 9.5%. Orders in the water segment grew by 23.9%, as a result of organic growth and the JWC acquisition. Oil and gas orders grew by 18.9% on the back of good bookings both in up- and downstream. Orders in the general industry segment grew by 8.3% mainly as a result of the Transcodent acquisition. Orders grew across all regions and were most pronounced in the Americas (20.1%).

As of June 30, 2018, the order backlog had increased by approximately CHF 210 million to CHF 1’807.2 million from CHF 1’593.5 million on December 31, 2017.

Strong sales growth

Sales amounted to CHF 1’600.3 million — an increase of 10.5%. This rise was driven by 5.4% organic growth and CHF 73.2 million from acquisitions.

Sales grew in all market segments except the power segment which remained flat and declined organically. Sales in the oil and gas segment grew by 9.9% based on the higher order backlog at the beginning of the year. Water sales increased by 38.3%, as a result of organic growth and the JWC acquisition. Sales in the general industry segment grew by 6.6% due to organic growth and the Transcodent acquisition.

Sales increased strongly in Asia-Pacific and in the Americas, and remained stable in EMEA. The share of sales in emerging markets increased from 40% in the first half of 2017 to 43% in the first half of 2018.

Lower gross margin due to mix and price pressure

Gross margin decreased to 30.2% compared with 31.3% in the same period last year. This drop was due to a larger share of lower-margin new equipment business and price erosion effects in the energy markets. Total gross profit increased to CHF 483.7 million (first half of 2017: CHF 446.7 million) as a result of the higher sales volume.

Operational return on sales increased to 8.5%

Operational EBITA (opEBITA) amounted to CHF 135.7 million compared with CHF 106.1 million in the first half of 2017, an increase of 27.0%. Savings of CHF 25 million from SFP and the contribution of acquisitions more than offset the above-mentioned mix and price erosion effects on gross profit. OpEBITA increased organically by 16.8%.

Operating expenses excluding amortization, impairment on property, plant and equipment, restructuring expenses and other non-operational items increased by 2.6% because SFP savings were exceeded by the operational expenses of the companies acquired.

Operational return on sales (opROSA) increased to 8.5% compared with 7.4% in the first half year of 2017.

Bridge from EBIT to operational EBITA (January 1 – June 30)

SFP costs impacted operating income

As part of the SFP program, Sulzer has continued to adapt its global manufacturing capacities and streamline its organizational setup. Restructuring expenses remained broadly stable compared with the first half of 2017. In 2018, restructuring expenses were mainly associated with measures taken in Germany, Belgium, Brazil and Switzerland. Adjustments for other non-operational items increased by CHF 10.7 million from last year. This increase was largely from SFP-related costs including factory footprint optimization and related implementation costs.

Consequently, EBIT amounted to CHF 78.0 million, an increase of 43.8% compared with CHF 55.3 million in the first half of 2017. Return on sales (ROS) was 4.9% compared with 3.9% in the first half of 2017.

Stable financial expenses and profit from associates

Total financial expenses amounted to CHF 4.9 million, compared with CHF 4.9 million in the first half of 2017. Higher interest expenses were offset by currency exchange gains. A positive income from associates of CHF 0.7 million (2017: CHF –0.4 million) was recorded from a joint venture in Asia.

Lower effective tax rate

Income tax expenses increased to CHF 17.1 million (2017: CHF 12.4 million) mainly as a consequence of higher pretax income. The effective tax rate for the first half of 2018 decreased to 23.2% compared with 24.8% in the first half of 2017, mainly due to the change in profitability of the group’s entities in the respective countries.

Higher core net income

In the first half of 2018, net income amounted to CHF 56.6 million compared with CHF 37.6 million in the previous year. Core net income, which excludes the tax-adjusted effects of non-operational items, totaled CHF 101.0 million, compared with CHF 75.9 million in the first half of 2017. Basic earnings per share increased from CHF 1.08 in the first half of 2017 to CHF 1.71 in the first half of 2018, primarily due to higher profit. In addition, the purchase of 15.24% of Sulzer shares on April 12, 2018, reduced the number of shares outstanding which positively impacted basic earnings per share by CHF 0.11.

Key balance sheet positions

Total assets as of June 30, 2018, amounted to CHF 4’246.8 million, which is an increase of CHF 129.5 million from December 31, 2017. Non-current assets increased nominally by CHF 133.9 million. Two factors contributed significantly: higher goodwill (CHF 78.2 million) and higher other intangibles (CHF 48.4 million) mainly as a result of the JWC acquisition. Current assets remained broadly unchanged. Inventories (CHF 86.9 million) and supplier advances (CHF 13.3 million) grew as a result of the approx. CHF 210 million order backlog increase since the end of last year. Trade accounts receivables increased by CHF 16.1 million due to the sales growth. Cash and cash equivalents decreased by CHF 129.7 million.

Total liabilities nominally increased by CHF 765.2 million to CHF 3’180.1 million as of June 30, 2018. The main reason was the CHF 546.0 million liability related to the purchase of Sulzer shares from the former majority shareholder Renova as well as CHF 76.0 million of outstanding dividend payments to Renova. Current borrowings increased by CHF 167.8 million to fund the JWC acquisition.

Equity decreased nominally by CHF 635.8 million to CHF 1’066.6 million, mainly as a result of the above-mentioned effects.

Free cash flow impacted by volume-driven inventory buildup

Sulzer’s free cash flow generation is usually back-end loaded. Free cash flow amounted to CHF –29.8 million compared with CHF –2.5 million reported in the first half of 2017. In the first half of 2018, free cash flow was mainly impacted by net working capital. The increase in order backlog of approx. CHF 210 million since the end of last year led to the inventory buildup and resulted in this net working capital increase.

Cash flow from investing activities totaled CHF –242.5 million compared with CHF –111.2 million in the first half of 2017. In the first half of 2018, cash flow from investing activities was driven by CHF 209.2 million for the acquisition of JWC, and CHF 42.4 million for purchases of property, plant and equipment. In the first half of 2017, cash flow from investing activities was driven by CHF 84.2 million of acquisition-related payments and CHF 34.1 million in purchases of property, plant and equipment.

Cash flow from financing activities totaled CHF 118.1 million compared with CHF 11.7 million in the first half of 2017. In the first half of 2018, Sulzer increased current borrowings to finance the JWC acquisition. The net change in cash since January 1, 2018, amounted to CHF –129.7 million, including exchange losses on cash and cash equivalents of CHF 8.3 million.

Outlook 2018

Sulzer expects that the oil and gas market, which accounts for approximately 40% of its sales, will continue to recover gradually and that this will translate into a commercial rebound that will be mostly visible in 2019. The power market is expected to decline, while all other Sulzer markets are expected to continue on their current growth path in 2018. This should lead to a slight increase in organic order level for the company, supplemented by additional volume from newly acquired businesses.

At half-year 2018, Sulzer has already achieved its incremental full-year savings target of CHF 25 million, as a result of timing of initiatives. The company is raising its 2018 incremental savings target to CHF 35 million to reach a cumulative CHF 220 million. This will help to compensate continuing margin pressure in the energy markets. Sulzer confirms its overall SFP run rate savings target of CHF 230 million from 2019 onwards.

For the full year 2018, Sulzer is updating its guidance. Including acquisitions and adjusted for currency effects, order intake is expected to grow by 7 to 10% (previously 5 to 7%) and sales to grow by 6 to 8% (previously 4 to 6%). The company confirms its guidance for the operational EBITA margin (opEBITA in percent of sales) to be around 9.5%.

Impact of IFRS 15

Sulzer has adapted its reporting to reflect the application of IFRS 15 “Revenue from Contracts with Customersˮ. It replaced IAS 18 “Revenueˮ, and IAS 11 “Construction Contractsˮ. IFRS 15 determines whether, how much and when to recognize sales from contracts with customers. In the first half of 2018, IFRS 15 had a positive effect on sales (CHF 3.9 million) and opEBITA (CHF 12.5 million). Consequently, the application of IFRS 15 increased opROSA by 0.7 percentage points. These differences are related to projects where sales, cost and profit were recognized over time according to the previous accounting standards. According to IFRS 15, sales, cost and profit of these projects are recognized later at a certain point in time.

The information presented for 2017 has not been restated. For transparency, we are showing the figures for the first half of 2018 according to both the new and the old methods in the business reviews. The changes in percent shown in the tables and mentioned in the text compare 2018 figures according to the old method with 2017 figures as previously reported. In the interim consolidated financial statements (note 13), a table summarizes the impact of the new accounting standards on the financial statements.

Abbreviations

EBIT: Operating income
ROS: Return on sales (EBIT/sales)
opEBITA: Operating income before restructuring, amortization, impairments and non-operational items
opROSA: Return on sales before restructuring, amortization, impairments and non-operational items (opEBITA/sales)