Osram's (OSAGF) CEO Olaf Berlien on Q3 2016 Results - Earnings Call Transcript

| About: Osram Licht (OSAGF)

OSRAM Licht AG (OTCPK:OSAGF) Q3 2016 Results Earnings Conference Call July 27, 2016 8:00 AM ET

Executives

Boris Tramm - Head, IR

Olaf Berlien - CEO

Stefan Kampmann - CTO

Analysts

Andreas Willi - JP Morgan

Sven Weier - UBS

Uwe Schupp - Deutsche Bank

David Vos - Barclays

Peter Reilly - Jefferies

Lucie Carrier - Morgan Stanley

Peter Olofsen - Kepler Cheuvreux

Alok Katre - Societe Generale

Operator

Dear ladies and gentlemen, welcome to the Osram Analyst Call. At our customer’s request, this conference will be recorded. As a reminder, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]

May I now hand you over to Mr. Tramm, who will lead you through this conference. Please go ahead, sir.

Boris Tramm

Ladies and gentlemen, welcome to our Q3 conference call. Regarding forward-looking statements, I would like to draw your attention to the safe harbor statement on page two of the presentation, which is available for download on our website. Olaf Berlien, our CEO will now make his opening comments. Afterwards, we will take you through the -- after this, we will be happy to take your questions. Olaf?

Olaf Berlien

Thank you, Boris. Ladies and gentlemen, a warm welcome from me as well. And thank you for joining our conference call today. Before talking through our recent M&A announcements and the Q3 financials, I would like to welcome my new colleague, Stefan Kampmann, and give him the opportunity to briefly introduce himself. Stefan?

Stefan Kampmann

Thank you very much, Olaf. Ladies and gentlemen, a warm welcome also from my side to today’s telephone conference, the new kid on the block. As you know, I became CTO of Osram just some weeks ago and would now like to give you some details about myself. I studied physics and started my career actually in laser diagnostics and semiconductors. Then for more than 20 years, I have worked for Robert Bosch, where I was responsible for product development and industrialization. And in the beginning and especially in regards of power-train.

Within the first 12 years, I spent more than six years in manufacturing; I learned how important is for business success to bring sales, engineering and manufacturing together on a simultaneous engineering approach and moreover I acted as board member for automotive electronics and gasoline systems, which is why I’m quite familiar with semiconductors and sensors for the automotive, but also for the consumer electronic market and especially also with topics such as industry transformation.

But let’s now come to what brought me to Osram. First of all, I see a huge potential in the lighting industry on its way to smart and intelligent lighting. And therefore, I was attracted by Osram with its strong product and technologies for lighting solutions and the strong knowhow in photonics and optics. Secondly, I’m indeed I’m thrilled by the dynamic transformation in the industry and the need for change. And thirdly, it is a strong brand reputation of Osram in the market, which has to launch and especially establish new solutions.

Now, during my first days, I started visiting our plants in Germany, namely [indiscernible] were including the green room which was very impressive for me. In all these locations, I met highly motivated people with a strong drive for innovative solutions. For the upcoming weeks, I will visit our other plants, R&D sites and customers in Germany, United States and in Asia, and really looking forward to be a part of the Osram team in the future.

With that in mind, I would like to handover to Olaf again who will give you a run through of the third quarter performance, to my mind, a very good quarter that perfectly underlines the potential of Osram for the future. Thank you very much.

Olaf Berlien

Thank you, Stefan. And I must say, I am really happy to have you on board here, and I’m looking really forward to work with you together.

Before we dig into the numbers, I would first like to say a few words around the important steps we have made in our three-pillar strategy. The first is the agreement to sell to Ledvance which we announced yesterday evening. It was only in July last year when I declared the intension to exit the lamps business. Today only 12 months later, we have delivered on our objective. We have walked the talk. During that time, we had undertaken the enormous task of separating out what was historically the very heart of Osram.

Please do not underestimate the scale of the challenge we have overcome. For the IT system separation alone, we did it in one week, what others have taken many months to achieve. We went for big bang option rather than the long draw out alternative. And today, I am extremely happy to announce that we have agreed to find a new owner for the lamps business, which will trade under the brand name Ledvance to the investors MLS backed by two financial strong covenants for over €400 million. On top on this, Ledvance will pay Osram a high single-digit million euro amount each year for the next 10 years and brand licensing fees. We expect the deal to close in the next financial year.

The business of Ledvance and MLS are highly complementary, and those will be significantly enhanced by the deal. Their regional exposure and product portfolio dovetail nicely. Through MLS, Ledvance will gain much improved access to the high growth Chinese market while MLS gains access to Ledvance and extensive and long list distribution network in the America and Europe.

The product overlap is extremely limited, giving rise to significant cross-selling opportunities but besides the strategic rationale, it is important that we have found a better owner who will take care for the Ledvance employees. With the new owners, we have found a buyer who has made commitment to protect the Ledvance employees. Existing agreements with the workers council and the workers union will be upheld and the headquarters will remain in Garching in Germany.

To make a long story short, Ledvance and MLS together are stronger geographically, stronger in their product offering, stronger in scale and stronger in the cost position. They will now be a truly global player with a great offering for their customers. Osram in turn can now look forward as a more digital, hi-tech company as I said, which is both growing and delivering solid double-digit margins.

Secondly, Osram’s Opto has entered into a strategic supplier with MLS, this means that once our Kulim plant is up and running, MLS intends to stretch its LED chip and packaged chips from Opto over the three-year period. This further strengths our strategy providing base load for Kulim. Now also the carve-out and sale might appear to have taken center stage in the recent months, we have also been working hard on the rest of the business, a great example is the recent acquisition of Novita Technologies.

We told you at the Analyst Day back in January that as a part of our SP strategy, we would expand our position in LED modules and focus on more forward integration, and Novita very much plays in this scene. They are a U.S. manufacturer and supplier of innovative automotive LED modules and are highly complementary to our SP module business. The deal has strengthened our North American footprint and enhances our low cost design and capabilities.

From the financial point of view, it is also worth highlighting that Novita’s margin is immediately accretive to the SP margin, and has been enjoying very high growth rates, both today and in recent years. These are a few examples in how we are working hard every single day to execute our strategy.

Now, let’s go down to the financials on page number six. We ended the quarter with 10.5 comparable growth, around €70 million of sales were pulled forward from Q4 to Q3 because of the IT carve-out impact we previously communicated. Excluding this effect, underlying growth was still roughly 5% and that’s up from Q2 and the highest comparable sales growth in 22 quarters; I repeat it, highest comparable growth in 22 quarters. It demonstrates solid underlying performance from all segments, in particular LSS and Opto Semiconductors stand out with strong underlying growth rate. From the regional perspective, the Americas were the key driver of growth. Here, comparable growth over 13% was driven primarily by LSS and SP. The LED share has now crossed the 50% mark and continues to grow at a double-digit pace.

Let’s move now to page number seven. And now we come to the adjusted EBITDA. I would like to highlight that while Q3 is usually the seasonally weakest quarter for Osram, the carve-out impact means that Q4 will be the weakest quarter this year. The carve-out resulted not only in higher volumes but also a better mix in the effective segments. Notably, LSS reached breakeven in the quarter, while SP saw ongoing dilutive impact from the growing share of LED and innovation topics. Opto which was not affected by the carve-out, maintained a solid level of profitability. There was no material impact from currency exchange but the margin did benefit from €118 million of Push savings.

If you take a look to special items on page seven, special items in this quarter amounted of €84 million, the largest portion relating to lamps carve-out charges. For the full year, we expect around €120 million of carve-out costs and a double-digit figure for the disposal of the asset. As we communicated previously, transformation costs will be below €100 million.

So, now, let’s go into the segments and I move to page number eight. I start with Opto, which was the only segment which was unaffected by the carve-out. Here, we saw a step up in sales growth to the double-digit level. You see the 12.8%, a level we strive to remain at over the mid-term. Growth was driven by both, our premium and SSL business. And unlike the previous quarter, the currency exchange impact on the adjusted EBITDA margin was limited. License income was slightly above the prior year. And as we communicated on the last quarter, Opto’s margin excluding FX and license income remains to the 18% to 20% corridor.

I think let’s go to free cash flow on the same page. As you can see, free cash flow was positive but significantly down year-over-year, reflecting the ramp up of Kulim investment.

I move now to page number nine, moving to SP where we had around €35 million sales impact from the carve-out like in Q1 and Q2, there continues to be around 2 percentage-point positive sales impact from the reallocation of customers from Opto industry to SP automotive. I think we talk about quite often about that. Underlying growth was broad-based across all region and technology. The LED share reached 41%, up from 36% in the prior year quarter with an ongoing sharp growth in LED modules.

Looking to the adjusted EBITDA margin on page number nine, dilution from the growth in LED component is ongoing. The drop through the additional pull-forward sales force was also offset by ramp up costs for the new technology in car lighting.

I move now to page 10, at LSS even taking into account €12 million pull-forward effect on revenue, underlying growth was solid driven by indoor luminaires service and LED driver. The LED share has now reached 70%, which we believe is the best in class among our peers. And higher volumes from the pull-forward effect helped bring LSS up to the breakeven level in the quarter. However, even excluding this impact, we continue to see a clear year-over-year operational improvement in both our systems and luminaire business.

I move to page number 11. At lamps, we saw over 3% growth in Q3, I think it’s excellent driven by halogen and LED lamps with a €22 million impact from the carve-out. The adjusted EBITDA margin was broadly stable year-over-year, despite dilution from higher LED sales and cost for establishing the Ledvance branding.

Let’s go to page number 12. Looking at cash flow and assets, I think you can see a step up in CapEx in line with our previous communication that CapEx in the second half of the year will be around double the level of the first half year. This is mainly due to the ramp up in Kulim investment; I think we talk about that, and support our previous guidance for the full year CapEx. To remind you, the full year figure should be around 50% higher than the prior year.

If you go on the free cash flow right side on working capital, maybe you see we are happy to report our turn rate has improved year-on-year, previously it was 4.9. However, we saw a €124 million outflow on reported free cash flow. And this is due to €158 million of extraordinary pension funding, in line with our previous communication. Remind you we sold the Felco shares and we said that we would put this money in the pension funding and in this quarter, it was €158 million. And in addition, we had the higher push and carve-out cash effect compared to the prior year.

So, let’s move to page number 13, the net liquidity bridge. I think you can see the impact of these factors on a quarter-over-quarter basis. On top of this negative free cash flow in the quarter, the ongoing share buyback further reduced the Group net cash position to I think a remarkable €582 million net liquidity. You see it in the middle, pension funding is €158 million; you see the CapEx number I was explained was €104 million; and you see the share buyback by €85 million on the right side. And as you know, the share buyback and the Kulim investments will result further reduction on our net cash position in the coming quarter.

Let’s move to the key financial metrics on page number 14. The high quarterly tax rate of 42% was due to one-time effects. However, we still expect the full year tax rate to be around 25%. Again, the full year tax rate will be around 25%, similar to the tax rate last year; and corporate items in Q3 are on a similar level to previous quarters and we still expect to see around €18 million of the corporate cost for the full year.

Finally, before coming to your questions, coming to our full year guidance. We make no changes to our expectations of positive comparable sales growth on an adjusted EBITDA margin of above 10%. Now, we have three quarters under our belt. We believe that we are in a position to be slightly above the prior year level, and remind, last year was a record year with 10.2%, and we will be slightly above the prior year level. So, I expect another very good year.

In light of this statement, I would like to remind you that Q4 will be weak, again the IT carve-out, worldwide we stopped production and logistic chain in the first days of July and Q4 will be weaker and largely because of the carve-out effect and certainly below the margin level of the Q4 last year. Please be in mind that we expect to disclose lamps as a discontinued operations in quarter four. We will provide you with historical financials for the last seven quarters before our full year results.

So, with that in mind, I will open the floor for questions. Boris, it’s on you to coordinate.

Boris Tramm

Thank you. Operator, please open the Q&A session.

Question-and-Answer Session

Operator

Thank you. We will now begin in Q&A session. [Operator Instructions] First question is from Andreas Willi, JP Morgan. Your line is now open. Please go ahead.

Andreas Willi

My first question is on SP and the margin development. You talked about the ramp-up of investments and costs for the auto lighting business. Is that from a sequential basis continue to ramp-up or is the current level something we should kind of carry forward for the next few quarters? And the second question I have is on the balance sheet, it’s obviously in very good shape. Do you expect to make any further pension contributions going forward, and at what point in time would you consider distributing some additional excess cash potentially post the buyback?

Olaf Berlien

I think the SP and margin development, what I said that there is a lot of one-time impact behind it. So, we made some recruits for laser and for OLED. And so, the traditional business and the aftermarket business is very strong still in U.S. and was good margins. But, in this quarter, we had some one-time impacts from this laser and OLED, and we had some one-time impact from Russia and from Argentina that means we had the currency impact in SP was by €8 million, and in this case, on the Group level, currency was neutral, but SP had some impact in this case. That was first question. And second question, you are absolutely right. I think our balance sheet is quite healthy. So really, if you put in your mind we have a capital base by 54%, very stable; we have no debt; we have around €600 million cash on hand. And as I said, and we decided it last year to put the price for the Felco shares on our pension funding, we put this €158 million now in the third quarter and I remind I think now we are absolutely funded, that means the worldwide funding level of our pension is around 95% and that’s an average percentage. That means in some countries I have over 100, in some others, we have 93%. But to be honest, I think this is really a benchmark to have 95% of all the pensions out funding, though in this case this is now finished, and in this case, we have really a very good shaped balance sheet. Excess cash is stable. And as we said, we are in the program to buy the share buyback program. I think we announced that we reached the three percentage base last month. And the bank is fully independent to buy shares and they are on the way to run up to this €500 million as we communicated.

Operator

The next question is from Sven Weier, UBS. Your line is open. Please go ahead.

Sven Weier

Three questions please from my side. The first one is a bit of a technical question on your chip agreement with MLS, how does it work in more detail? I guess you said it’s like €100 million each year for three years. So, the question would be, why is there a limit to three years and wouldn’t €100 million mean that these guys take quite a lot of your initial capacity in the factory? The second question is just thinking more strategically of what this disposal means for what remains of Osram. I mean, I guess you now had a fair chance also to look at how this year looks at acquisitions. And do you see yourselves as well protected on that as Lumileds or what is your general view on your protection against the takeover, now that lamps is going to go? And the last question is you mentioned obviously the working day effect by pulling forward sales, was there also a positive working day effect on top of that because of the timing of those public holidays that was at work in Q1-- or let’s say in the March quarter that is?

Olaf Berlien

So, let’s come to the chip agreement, first of all, it was our wish and intention and with MLS together to have these strategic purchase agreements. We waited for three years. Of course, we can make five years, but it was -- first of all that we said let’s have for three years, let the time talk about because as you know, the Kulim factory is not there. So,. we are talking a time up to 2020. I think from today it’s a good view to have security for a base load for our Kulim factory. And we know and I realize that there were some critics in the market. We are able to fill up the factory and let me say two years before we are coming in production we have a base load. So that’s the reason put it on three years and I put it €100 million each year as well and that combined you asking what does it mean, is it capacity for Kulim. The capacity for Kulim is much higher, but you have to put in your mind, Kulim is a chip factory and we have a packaging in Wuxi. So, it’s not only a contract for Kulim, it’s a contract, if you buy packaged LEDs, it’s a combination for our current factory in Wuxi as well.

And your second question about the CBUs; we checked that. I think it’s a totally different situation to the GO Scale part. GO Scale was on the way to buy our Opto, that means the LED business, the chip business from Lumileds and we’re talking about here our traditional business of lamps and there’s no high-technology and there is no military business and there is no government business. So in this case we checked it with some legal advisors and we don’t see any issues from the CBU’s point of view. So. as I said, it’s a totally different story.

Sven Weier

If I may interrupt, it was not with regarding to your disposal of Ledvance, but if Ledvance is going to go away, what could that mean for what is left over for Osram, right, your Opto business, I mean do you see yourself as well protected as Lumileds?

Olaf Berlien

We are a company on the stock market, we are open for every shareholder. So, whatever mean protected. So, I think we are a high-tech company, I think now it’s clear, and before we had 18,000 patents. And I cannot talk for the CBUs but with 18,000 patents on hand, maybe you would define Osram now a high-tech company. Again -- so I’m not worrying about that. I’m really not worrying about that. I think we have to go a long way. And coming to your last question, the working days impact as I said, that was really an unusual situation that means really that we put turnover what we usually would have in Q4 in July. We ask all our customer and clients please, please order in June, because we did not know how long does it take this IP separation. And again, this is really to make it clear, it was, if I talked to SAP and IBM, and they told me Olaf, this is really not benchmark, we’re talking Champions League and then best in class. Because usually if you have an IP separation, you switch off system-by-system and transfer in the new legal entity. And that takes usually between 1.5 years and 2 years and there are a lot of examples in the market, and I think you can read it in the Phillips, it took Philips 18 months.

So, we did it in one week and you can do it only if you switch off your company that meaning, really that you stop production, stop delivering, send everybody in vacation, and the advantage is after six days you switch on the machines and we did it very professional. And so that’s the reason we made these IP separation in this short period of time was as I call big bang. But the only disadvantage is, I have a change from turnover from Q4 to Q3. I think we explained it to you and to the market that we will have a stronger Q3 than usually and we will have a weaker Q4 than usually. And that’s what I said and Boris as well.

Boris Tramm

Sven, regarding more working days for the quarter besides pull over, there was no meaningful impact at all.

Sven Weier

If I just can follow-up on your first point, I mean I think that was a clarification that you also say the packages. But, could you quantify this purchasing agreement to how many wafers this would correspond, so that we could get an idea what kind of baseloads you really have from this agreement?

Olaf Berlien

I know that you are looking for this but I have to tell you that all my colleagues will come on board and will explain it later on maybe in detail, not today. But, it’s a question of chips size, what kind of chips you are ordering in the year 2018. Now, we are talking about a product in 2018, 2019 and 2020, so you cannot -- I cannot tell you what kind of chip mix you will order in the year 2019. What we would like to give the market in June to give you the feeling that we are right on track as the one of the biggest LED producers for lens in China, this is MLS, he is looking to work with a premium supplier like Osram and on the opposite, I have a base load for Kulim as well. And to make it clear and I am sure this question would come up in this call. It is our absolute intention to produce as much as we can premium chips that means maybe you can call it niche, but we would like to produce as much as we can premium chips. And what’s the difference between the two is, in the first stage of the production the epitaxy is the same and in later stage of the production, you have then a split between chips for general lighting, or chips maybe for the premium or niche business and we are looking for an healthy mix for niche, I call the premium and not niche because that’s our major turnover, and the general lighting.

Operator

The next question is from Uwe Schupp. Please go ahead.

Uwe Schupp

Two questions please. Firstly, just really following up on what you just said, I thought it was quite an interesting point, you have not missed one opportunity to talk very highly about your niche business. You showed another 22% margin last quarter, at the same time you have actually changed the risk assessment, right, very officially in your last half-year report where you say that the risk for the general lighting market has actually increased because the market is not improving as you may have hoped for. So the question would be, can you give us a guideline, because I guess previously we all thought that the Kulim CapEx program will be 100% general lighting or something very close to 100%, could it be 30% niche, and only 70% general lighting, or is this kind in the floor so to speak? Secondly, do you see the SP margin stabilizing anytime soon or is there a risk of sustainably falling below 10% even before the one-off items that you had this quarter, i.e., could the increasing share of LED products lead to a sustainably falling margin possibly below 10% [indiscernible] a natural flow that you would guide us to any time soon. Thank you.

Olaf Berlien

Maybe really I tried to explain it, but that’s always maybe my not 100% correct explanation, I was always it was our intention to have not 100% in the Kulim factory as I said to be and that’s what I said, today we have 85% of our turnover is in the niche, I call it premium product because if you have €1.2 billion turnover it’s not a niche, but nevertheless, if you have 85% of the turnover of Opto is in the premium product, to stay with this high level of margin as we did and you correctly said, we had the flying level at this quarter by 22% to stay in this range, and as I said the range is from the 18% to 20%. I need a very cost effective base and that’s what Kulim is doing. I have the factor cost in Kulim and you know the currency in this base helped me much more than we ever expected and as I said the search process of a wafer is the same, so that means the epitaxy and the first steps in a wafer if you bring it then in later stage to a premium product or to the general lighting product it’s the same, so I have a cost base in Kulim that helps me to stay with an high level of EBITDA margin for Opto, and it was always our intention to have the highest rate of premium products coming out of Kulim.

So to give you an answer, yes it is the clearly intention to have this 70%, 30% range between premium and general lighting and to be honest in the later stage I hope it will be increased and I tell you with our innovation initiatives what we have in Opto on-site I am really, really confident and Stefan would put a lot of pressure on these guys that they will come up with a nice premium product. So again, the guideline is to make it clear, Kulim is not 100% general lighting, it will be a nice part of premium one and for this reason I would like to say on a high margin level.

Your second question that’s not so easy to give an answer, we have so many impacts. On one hand, we have a very stable halogen aftermarket business worldwide. As I explained, we have over 871 million cars outside on the road with halogen, so we have a stable aftermarket business. On the other hand, we have been increasing LED light, and as we explained the LED had a margin dilution in SP, between Opto and SP there is a dilution, so that’s pressure on the margin, that’s for sure. They have pressure on the margin and for this reason, we have pressure on the SP margin. And we have a decreasing business for HID, the Xenon light, this is decreasing as well and will be compensated from an higher sale in LED. So as you said, you said give me a range. Boris, can I do this?

Boris Tramm

I think you can.

Olaf Berlien

The intention is really to stay clearly in this 10% range, that’s a long-term, it should beat that. Okay fine on it. Okay, everybody said yes they are fine so that’s clearly what I see in the combination of all these impacts. So there’s no cliff event, it’s a combination between increasing and decreasing.

Operator

The next question is from David Vos, Barclays. Your line is open. Please go ahead.

David Vos

The first one I have to go back to the Kulim off-take agreement for a moment there. Can you just help us understand the risks here, because it sounds like it’s still fairly up in the air what the customer is going to order or is it actually the case that they have a takeoff agreement whereby they are committed to a certain dollar amount or a volume amount and there’s really not much risk to that picture there. And then, the second question is also going back to the SP business there, can you elaborate a little bit on the bargaining power between yourself and the OEMs and what I’m referring to is that these laser and OLED products that you’re introducing they help sell quite expensive options on very expensive cars? And I just wonder, why is it not possible to kind of recoup a bit more of the heavy investments that you’re doing around those products from those OEMs. I mean why does it have to be all borne by Osram if in the end of the day it’s the OEMs who are benefiting from this most? Thank you.

Olaf Berlien

Let’s come to the Kulim one. I think, again and that’s what I explained this morning. The purchase agreement with Chairman Sun what we signed yesterday night or yesterday evening is a nice signal that we are on a right track. And I don’t see any risk, it’s a low risk, of course every customer can walk away. So I cannot talk about to guarantee that no customer of Osram will walk away in every division.

So on the other hand, if you would, I’m sure you will concentrate on MLS a little bit, they have heavy investment in new factories. So he had the huge hunger for LED chips and what we said on our Analyst Day in January, [indiscernible] explained that so many smaller LED chip producer will die, they will die. To be honest, we had a statistic that 70% of all Chinese chip producers will die in the next year. And for this reason, they will concentrate on bigger chip producer and that was one of the strategic rationale really to invest as well. So that means, the companies like MLS as a market leader, they have really an interest to have the QT for the delivery of the chips. And of course, it is a question of the market price, that’s the next question you will come up. But as I said, the advantage of Kulim is that we have the best factor cost in Asia, better than in China, better than in Korea, better than in Taiwan. So the combination of the IP rights and the technology of Osram, the cheapest factor cost, the best chip size and chip performance that brings out the best chip price for me as well.

So I have a good chance to come up with to beat the best price with the best chip performance and for this reason, I’m quite confident that we have a low risk for all our potential that we would like to produce in Kulim. And I hope it explained a little bit more what you asked for. SP, laser and OLED, this is really a niche and I think this is really a niche and that’s the reason I’m talking with chips from premium products and not from niche. Laser and OLED is today in premium cars. Today we have it in a BMW-7 series, and you know it will come up in another German car soon, but will be a premium car as well. So it is a niche product and we have to see how is the rate to the next level of cars. So will it come up in the mid-class cars, maybe later but not fast. And the same is the OLED. The OLED is really something special, and I’m sure it will be something special. And to bring and to make profit in this area, we have to make some huge investments in a new OLED factory and this is still open if we should do it and it must be calculated and as you said, before we go this way, we need a clearer commitment from the OEMs, if this is the right path and do we have a guarantee for a demanding product for OLED. So it is a little bit too early, David, to give you a clearer view about the OLED ways, but the niche out will be a mass production.

Operator

Next question is from Peter Reilly, Jefferies. Your line is open. Please go ahead.

Peter Reilly

Good afternoon. I’ve got two questions please. Firstly, can you help us understand more what’s happening with the organic growth at the LSS business. Fantastic growth rate even if you back out the working day adjustment, it still is like you’re doing 12%, sorry not working day the IT adjustment, it still like is 12% organic growth, second quarter in a row with very strong growth after a long period of very weak results. Is this a number of big projects coming through or is this something more sustainable? Because you’ve actually got the business back on track there.

And then secondly, looking further at with your new fab investment, clearly one of your aims at the time was to scare some of the smaller players from making investments, because with the biggest and lowest cost fab it’s going to be quite difficult for a small player to compete with. I just wonder if you are seeing anything in the marketplace about other companies following your example and announcing very major fab investments and is there a risk of some sort of arms race as other people follow your example, so if you could update on what you see happening in the CapEx of your competitors, that would be great.

Olaf Berlien

Okay. Thank you, Peter. You’re right. I was really, really proud about this 16% increase in LSS in comparison to last year. As I said, some of this percentage came up from the turnover what we moved as I explained from Q4 to Q3. But nevertheless, that is very healthy growth, very healthy growth. And as we explained, I think the LSS team is right on track. We make a break even as we said that we would do it in the Q3. And from my point of view, they have a stable order entry book; I don’t see any slowdown. We have a strong demand in Europe. And in this case, I think LSS is really on a good track, as we explained on our Analyst Day and my road shows in London.

Boris Tramm

Looking for Q4, so don’t expect the same growth rate of course in Q4 due to the pullovers, but of course the next quarters also looking into the next year in fact nice growth rate for this business.

Olaf Berlien

Coming to your second question, I know a lot of people were surprised that we came up in November with our three pillar strategy and to invest in Opto. But I think we did it on a right side, some of them said your competition will invest as well. Nobody is there. To be honest, today, we are the only company they announced these investments. So, minimum we are one year ahead whatever will happen, if somebody will come. Do I see any investments coming up? As I said, you cannot survive if you stay in the 2-inch or 4-inch technology, so you have to invest and that’s the reason that the statistic, it’s not from my statistic, statistics shows that most of the smaller Chinese chip producer cannot survive and you see it really in the result. There are only three companies, they have a margin between 18% and 20%, then you have five companies with a margin between 5% and 7% and then you have 40 companies they are underwater, they will all die, they will all die. And as I said, I don’t see anything in the air.

Peter Reilly

I have a quick follow-up on just LSS and this might be an impossible question to answer, but the growth rate is coming is it new products that are driving it or re-establishing sales channels or re-engaging with certain customers because it’s a quite dramatic turnaround, just trying to understand a bit more, what’s happening?

Boris Tramm

Actually it’s two fold, it’s of course new product. We saw the investment in R&D pipeline pay off and then it’s also especially on the luminaires side that we see that the new sales force is really working and hitting the ground. It’s really also the feet on the street.

Olaf Berlien

We have to make a lot of homework. So we will have up and downs. I’m quite happy to have this breakeven now, but as you said it’s a long way to go.

Operator

The next question is from Lucie Carrier, Morgan Stanley. Your line is open. Please go ahead.

Lucie Carrier

Hi, good afternoon everyone. Thank you for taking my question. I had a couple of follow-up questions, the first one on your agreement with MLS. Is this agreement in any way or form conditional in terms of pricing levels?

Olaf Berlien

Yes, as I said it must be on market price. If you talk about the year 2018, 2019 and 2020, it must be clear that you have to deliver on market price and to reach this market price as I said, I’m quite confident with the best factor cost and the best place with the best technology I’m able to beat this.

Lucie Carrier

Okay, okay because we’ve had some feedback from MLS that the agreement was conditional on obviously, quality, of course, but also for similar quality and lower price in the market. So this is what you’re expecting to deliver, i.e. sell them at a lower price than the market for similar quality.

Olaf Berlien

I cannot confirm this, I have the same contract in front of me and I don’t have anything about quality, it’s as I said chips and market conditions and the volume is €100 million.

Lucie Carrier

Okay and just also on, you were talking about the Wuxi factory and the package. From your press release though, you were talking only of this agreement being on the Kulim factory and on the chips and not on the package, so is that also including the package now?

Olaf Berlien

As I said the combination, Lucie is, I kept both of those, we don’t know how is the exact demand in the year 2019 or 2018. So, usually you have a combination between the chip coming from Kulim, and we have packaging factory in Wuxi. So the mixture what is pure chips and what is chips plus packaging, I cannot tell you today. And that’s the reason Chairman Sun and me said let’s put the volume, it means the €100 million inside and the split will be then in the year prior to that.

Lucie Carrier

Okay so it could be that the €100 million BSK between Kulim and Wuxi or that it could be more skewed to Wuxi, it’s not necessarily going to be and that will be few instruments how much baseload you have out of Kulim to make the €100 million.

Olaf Berlien

Correct.

Lucie Carrier

Okay. No, no, the reason I’m asking is because MLS obviously they have their own packaging facility and from the press release it was really only saying the agreement was on the LED chip plant in Malaysia, so this is why I just wanted to double check. Another follow-up on the Malaysian plant. If I understood you well, but I’m not sure you were saying that the Kulim factory would be aiming at 70% premium and 30% general lighting. Is that correct?

Boris Tramm

I think Lucie, this split -- don’t take this split written in stone, so it was to give you a hint that Kulim did not only 100% on general illumination, it will be also kind of premium product. But the split is flexible, so don’t put it in stone please. And regarding time limitation, please review to the last question please, because we still have a couple of questioners.

Lucie Carrier

No, I understand but I think it is important for us to understand whether most of the Kulim manufacturing is going to be on the premium side or whether this is going to be on the general lighting side, and if I looked at a comment from Aldo in November, he was saying this investment was clearly geared to the general lighting market. So I’m just trying to get a sense of how we should model Kulim in terms of our earnings?

Olaf Berlien

But as I said, Uwe said 100% and I said this is not true and then he recommended is it 70%, 30% I said that is our intention, it was always our clear maybe while we’re not proper in our announcement, it was always to have the maximum as we can get in premium because very simple, we make more margin premiums.

Boris Tramm

And Lucie also you are totally correct it’s important for your model but I mean, Kulim is more premium products is a clear upside potential for us. And of course, the guidance which we gave for 2020 may include even lower premium loads for Kulim as we see today. Okay.

Lucie Carrier

Okay. And just maybe my last question on the LSS business. Of course, this is a positive we have seen it kind of coming to breakeven. But obviously, the organic growth is very high, and the business is still not profitable. So what do you need for that business to become, I would say, properly profitable.

Olaf Berlien

I think what you need is always a combination of so many things. First of all you need the right product portfolio and that’s what we explained, that we are coming up now with a number of new products for the market. Second one is, you need the right sales force, and I think one of the mistake in the path was that we used the lens sales force to sell our luminaire and what we did this last year, that we started to have our own LSS sales force and they are concentrated really on projects and we see it now as the first fruits that we have now a better sales. So we have some sunshine, but I don’t want to talk about the summer but I see that we get the first results of our intention to coming up with an own sales force and that’s the combination and product portfolio, the sales force.

Boris Tramm

Okay, Lucie. Due to the time limitations, we can just answer two more questions. I’m sorry for that. The next question please.

Operator

The next question is from Peter Olofsen, Kepler Cheuvreux. Your line is open. Please go ahead.

Peter Olofsen

I had two questions on OS. On the 12% comparable sales growth, what was the contribution from SSL sales and how are SSL sales tracking relative to your expectations? And then on the earlier remark that some 70% of Chinese players may eventually disappear, what proportion of global industry capacity do these something like 40 players represent? And then on the earlier comment on OLED, I understand you are considering to make an investment there, what would be the size of the investment?

Olaf Berlien

Okay, let’s start with the last one, as I said we are thinking about, it’s not that no decision to invest in an OLED factory. I said if this product will move from niche premium to a more mass one then I need more capacity and this is a question I have to discuss with my customer, the OEMs, will it stay as a niche product then the capacity is fine, I have today already, if it moved to a more mid-sized product in cars then I need more capacity on that and then we have to invest. But it’s really quite too early to talk about that. I would say in the end of the year I have a better view and in close contact with all of the OEMs worldwide. The 70%, as I said, that’s not my statistic. I expect that in the year 2020 we have lack of capacity so that’s what the statistics shows us, HIS, that latest in 2020 maybe the demand is higher than the current capacity in this case as I said it’s helpful to have up to running factory in Kulim.

Boris Tramm

On your sales split, so SSL is still in Q3 between 10%, 15%, it’s slightly behind our initial expectations but nothing much really worrisome.

Peter Olofsen

May be one follow up on pensions. On your balance sheet you have this €291 million liability, what proportion of that is linked to the lens business? Because I assume that it will go to the new owner.

Olaf Berlien

Yeah, very easy €292 million we have today and €47 million will move to the new owner. So the new owner and €290 million minus €50 million.

Boris Tramm

So we now come to the last question.

Operator

The last question is from Alok Katre, Societe Generale. Your line is open. Please go ahead.

Alok Katre

Yeah, hi thanks for my questions. Just one question, really just going back again to the MLS and I sort of want to beat this one to death, but just if you could clarify, you talked about at the press call about €100 million per annum and actually equate to about 20% of the capacity and I presume you referred to 20% of the initial sort of capacity because clearly if I look at your 2020 plan then the target was around 15% of your revenues coming from general lighting SSL products, even including merchandising then the €100 million wouldn’t equate to 20% capacity and then just in that context following up on Lucie’s question, is there therefore reflective of some sort of pricing concessions because they give you the base load.

Olaf Berlien

No, they had no pricing concession, as I said it’s a complex one. I don’t know the mix between pure chips per packaging. So the €100 million will be a split in this year, and as I said, and that’s for him the same, if you beat, if you come with the best chip, with best chip size, and chip performance on market price, then you are like my major competitor, you can sell us like hell. So in this case, it’s not a question that we made any price concession, that was not really the task and the question. Again, it’s a nice and good signal that we are on the right track and both parties are happy to have security for the delivery and I have a base load.

Alok Katre

And so if I can just have a follow-up, is there any contingent liabilities with regard to either OSRAM Push or any plant closures or ownership or any commitments towards MLS that would give them a bit of recourse to Osram with respect to the Ledvance sale, or is this just about completely severing ties with Ledvance from a financial and operational perspective once the deal is closed?

Olaf Berlien

Completely separate, nothing to do. So, on my table, Mr. Vos [ph] is here, our Head of M&A. You can give the answer, yes or no.

Olaf Berlien

Customary condition what you will see in our normal purchase agreement.

Olaf Berlien

Thank you very much.

Boris Tramm

Perfect. So, we will now close the call. Thanks for joining us today, and we are looking forward to hear you in November on our Q4 numbers. Bye.

Operator

Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may now disconnect.

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