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Ladies and gentlemen, thank you for standing by. My name is Jasmine, your Chorus Call operator. Welcome, and thank you for joining the OSRAM Licht AG Conference Call on the First Quarter 2018. [Operator Instructions] I would now like to turn the conference over to Andreas Spitzauer, please go ahead.
Good afternoon as well as good morning, ladies and gentlemen. My name is Andreas Spitzauer, Head of Investor Relations of OSRAM, and I want to welcome you to OSRAM's Conference Call for our Q1 2018 Results. As a reminder, the conference call will be recorded and is available on our homepage www.osram-group/investorrelations.com. You can find today's presentation there as well. It is now my pleasure to turn over the call to Dr. Olaf Berlien, the CEO; and Ingo Bank, the CFO of OSRAM. Please go ahead, Olaf.
Yes, thank you very much, Andreas. Ladies and gentlemen, warm welcome from my side as well. Let me start with an overview and the financial highlights of our first quarter. My colleague Ingo will then provide a more detailed explanation of the financial figures, of course followed by the Q&A session. Looking at Slide #3, you can see that we had a solid start into the fiscal year 2018. As already indicated in our outlook, investments in our future as well as headwinds from currency trends are dominant factors in '18. Nevertheless, we managed to grow while remaining highly profitable. From today's perspective, we expect to gain more speed in the second half of the ongoing fiscal year. On Slide #4, you can see that revenue in the first quarter rose on a comparable basis by 5%. At the same time, our adjusted margin stayed on a high level of almost 17%. This was mainly due to our strong operational performance and to a minor effect by divestment. At the same time, the ramp-up costs for the new LED capacities peaked in the first quarter. Like-for-like as you see on this graph, 2 effects R&D and ramp-up sums up EUR 18 million more than a year ago. Furthermore, we saw a currency burden on our EBITDA of EUR 22 million in total. Without the mentioned effects, the adjusted EBITDA would have been closer to EUR 200 million. And as planned, free cash flow turned negative due to our high CapEx, which by the way rose then EUR 100 million. To cut the long story short, operational performance remained strong. Well, let me talk a little bit more about markets and this takes me to Slide #5. The situation on the -- of the construction industry in North America remains difficult. Also, our customers such as Acuity or Eaton, for example, have officially stated to suffer from this situation. They expect some improvement in the second half of this calendar year, and this might positively impact our LSS business. Also in Europe, we see a challenging market for luminaires. If I'm looking at the global car production, we see a mixed picture. In China, growth rate came down over the last quarter. This is partly due to the expiring subsidies. And in line with that our Korean automotive customers were impacted by trade limitations with China. But nevertheless, our view on the automotive market has not changed since Q4. In total, we see further growth even though on a lower level. In parallel, LED penetration in vehicles continues. As a market leader, of course, we are benefiting from this long-term trend. Moving to Page #6. At the Consumer Electronic Show, CES, a few weeks ago, we were presenting intelligent headlights that the uprising Chinese carmaker Byton, which you see on this chart on the right side, is using by the way. In Las Vegas, we provided a wide range of technologies and with our [ new claim ] OSRAM is lighting the way to the future of driving, we were turning invisible lights into visible benefits. And what kind of example, for example, lasers that play a key role in LIDAR, which enables autonomous driving or infrared LED, that supports driver assistance, such as lane departure warnings. At the CES, we also demonstrated technologies to enable smart headlights. They can inform drivers about obstacles in the road, for example. For instance, if someone is crossing the road in a difficult driving environment. And in Las Vegas, we were the first to present LED and laser light sources that are suitable for both light and simple protection on the road. Imagine a motorcycle is overtaking a turning car at night. He gets not only the warning by indicator lights, he sees also an arrow on the road that shows in which direction the car is driving. To be honest, this is really, really impressive because technologies like these can make our life and your life safer and smarter and of course more enjoyable. And they also can translate into future growth. Coming to growth, our new site in Kulim, which opened last year November is ramping up as planned. We are very happy with the yields, we already have achieved there now in the last weeks. Currently, the first chips from Kulim are reviewed by our customers. We expect to start selling the first chips in the course of the third quarter. Ladies and gentlemen, let me summarize briefly. We are growing on a profitable basis despite unfavorable currency developments. At the same time, we are investing in new and innovative products. We continue to build a solid foundation, which will position OSRAM towards digitalization trends in promising industries, and the long-term trends are working in our favor. Therefore, we are positive about the second half of the fiscal year, during which we expect to pick up further momentum. Our strategy is paying off ladies and gentlemen. And with that, I would like to hand over to my colleague Ingo. Thank you very much.
Thank you, Olaf, and also good morning, good afternoon to all of you on the first call for our fiscal year '18. Let me start by providing you with more details on our first quarter results. Before I conclude my prepared remarks with an outline of what is expected to shape our outlook for the balance of the fiscal year 2018.
Moving to Slide 7 now. The start into '18 was solid, despite significant headwind from foreign exchange, comparable growth came in at around 5% and growth continued, largely driven by Opto and the aftermarket business in SP. As expected, the market environment for LSS did not improve compared to prior quarters. Adjusted EBITDA at 16.7% was strongly impacted by the strengthening euro driving, by and large, the 130 basis point differences in profitability compared to last year. CapEx was EUR 201 million in the quarter, reflecting the ramp-up of capacity in Malaysia, Germany and China for Opto. And as a result, our free cash flow in the quarter was negative with EUR 119 million. Reported EPS was at EUR 0.71 lower than prior year by EUR 0.21 due to the impact of foreign exchange and prior year special items. Adjusted EPS was EUR 0.84 very close to the level in the prior year quarter. Let's take a closer look at the revenue growth picture for Q1 '18, on Slide 8. The weakening of the dollar against the euro clearly took its toll on our nominal sales and growth rates in the quarter for all of our reporting segments. At group level, the 10% year-over-year appreciation of the euro versus the dollar had a substantial negative effect of 610 basis points or around EUR 61 million. At the same time, we saw positive contributions from recent acquisitions largely being Digital Lumens. The total benefit from changes in our portfolio contributed 450 basis points to the year-over-year growth. If we stay with revenue growth a bit longer on the same slide, looking at the geographies at the lower right of the chart, we can see that EMEA growth in Europe and Middle East, growth was challenged by a difficult market environment for our LSS business. At the same time, Opto saw good growth in general lighting in this region. SP faced a decline in its traditional light sources business. APAC growth was driven by Opto and LSS. In LSS, we saw a good performance in our dynamic lighting business, driven by a solid pipeline of City beautification project. Growth in the Americas was fueled by a strong quarter for our aftermarket business in SP. Our LS service business saw some improvement to prior-year, as we were able to move forward with a few bigger projects. Overall, however, the U.S. market continues to lack momentum for both businesses reflected in our LSS reporting segment. Moving on to profitability in Q1 of '18 on Slide #9. OSRAM's adjusted EBITDA margin for the quarter came in at 130 basis points lower compared to the same quarter a year ago. The drop in profitability is almost entirely related to the negative impact from developments in foreign exchange rates, particularly the strengthening of the euro. As you can see in the bridge to the upper right of the slide, foreign exchange had a substantial negative absolute impact of EUR 22 million net in the quarter. As previously communicated, a [ EUR 0.1 ] change in the euro-dollar exchange rate approximately has a EUR 9 million impact on EBITDA per annum. Based on the current exchange rate trading, this headwind is picking up momentum beyond what was reflected in our Q1 financials, putting pressure on profitability and earnings. At a margin of 16.7%, we delivered EUR 172 million in absolute adjusted EBITDA. Volume growth and the proceeds from the divestment of a small nonstrategic business in our Specialty Lighting portfolio were able to offset the substantial impact of foreign exchange just discussed. At the same time, ramp-up and R&D expenses were higher than last year, but in line with our plan and largely related to our growth engine Opto. Adjusted EBITDA in corporate items was negative at EUR 23 million similar to the same quarter a year ago. Special items this quarter amounted to EUR 15 million. Moving on to Slide 10. Opto's revenue growth performance was almost equally distributed across the 3 regions. Growth was particularly strong with general lighting as we continue to build out our customer and product portfolio. In the automotive business of Opto, some of our clients reduced inventory levels in connection with their fiscal year-end reporting. Growth for infrared products continued, but at a lower clip due to capacity limitations. We expect Opto to increase its growth momentum in the second half of our fiscal year as capacity expansion investments start coming on stream. Opto's adjusted EBITDA profitability was impacted by the stronger euro, higher ramp-up costs, and increased R&D spends. In absolute adjusted EBITDA terms, Opto was able to compensate for these negative impacts through volume growth and ongoing productivity programs. As a result, absolute adjusted EBITDA was at the same level as in Q1 fiscal year '17. SP finished Q1 fiscal year '18 with modest growth. Our aftermarket performance was good and in line with seasonality overall. At the same time, we saw a low double-digit decline in our OEM channel with traditional light sources, which was offset by growth in LED components and modules. SP's adjusted EBITDA included a one-time EUR 15 million gain from a divestment of a small nonstrategic part of our Specialty Lighting portfolio. This helps to offset the significant impact of foreign exchange pointed out to earlier on Slide #9. And finally, LSS growth continued to be challenged by weak U.S. market, and an accelerated volume decline in traditional ballasts in both the U.S. as well as Europe. Our LSS service business in the U.S. picked up some growth, as some bigger project went into the execution stage. Underlying market expectations in the U.S. have, however not changed meaningfully when compared to the end of our fiscal year '17. We've also seen this reflected in the public comments by some of our luminaire customers in the U.S. Overall, lower volumes and a stronger price decline turned adjusted EBITDA negative in LSS, when compared to prior year. Compared to prior quarter, however, we saw some improvement in our overall profitability. We recorded approximately EUR 9 million special items for LSS in Q1 '18 largely related to restructuring and transformation charges to improve our cost base. Moving on to cash flow on Slide 11. Free cash flow in the quarter came in as expected, and was largely a function of a higher capital expenditure spend of EUR 201 million, approximately 90% of which is related to Opto. As Olaf said we are on track with our capacity ramp in Kulim and are also making progress as planned in Regensburg, Penang and Wuxi. We believe that the Q1 '18 CapEx level presented the peak spend for the current fiscal year. For the full fiscal year '18, we continue to expect approximately EUR 600 million in CapEx, no changes here. Working capital performance continued to be excellent with days outstanding stable at 48 days. Let me now turn to earnings per share on Slide #12. Reported diluted EPS in Q1 '18 was EUR 0.71, down compared to Q1 '17 largely due to the negative impact of foreign exchange and higher special items. Adjusted EPS for the quarter was EUR 0.03 lower, coming in EUR 0.84, compared to EUR 0.87 in Q1 '17. Our corporate income tax rate was approximately 28%. Overall, the U.S. tax reform is slightly favorable for OSRAM on a net basis and already reflected in our tax rate accounting. Let me now take a look forward -- and look at some of the key financial performance drivers and how they might shape the balance of our fiscal year 2018. Firstly, the U.S. market environment continued to lack momentum for our LSS business in Q1. Current market indicators do not point to a substantial rebound soon. This overall assessment is still in line with what we said back in November '17. The second important KPI for us is the vehicle production growth, which Olaf already covered in the beginning on Slide #5. In our first quarter of 2018, car production and sales overall were in line with our expectations and the outlook for the remainder of the fiscal year has not changed materially. This still means that we expect production in car sales to grow, albeit at a lower clip when compared to '17, and with different geographic dynamics particularly for China. The same is true when looking at the ramp-up cost expected for the further expansion of the industrial footprint of Opto. Q1 '18 was in line with EUR 9 million and the outlook for '18 is unchanged, we still expect to incur between EUR 40 million to EUR 60 million higher ramp-up costs compared to prior year. And lastly, foreign exchange. As discussed the appreciation of the euro, particularly against the dollar had a visible impact on our revenue and profitability in Q1 '18. With the average rate at $1.19 in Q1, we saw the impact we largely expected and reflected into our planning and guidance for fiscal year '18. However, when looking at the current exchange rate movements, especially the euro-dollar now trading between $1.23 and $1.25, we see substantial pressure on our profitability and net income. We have started some of the cost efficiency measures to try to compensate for this headwind. Nevertheless, our profitability and earnings guidance is now more ambitious when compared back to November 2017, but still in line with the lower end of the range implied for adjusted EBITDA and EPS. Thank you for your attention, and Olaf and myself are now looking forward to your questions.
[Operator Instructions]. The first question comes from the line of Sven Weier of UBS.
Three questions please maybe, we can go through one by one. The first question is relating to the like-for-like growth in Opto. I think last year you were pretty confident to achieve kind of a mid-teen like-for-like growth rate in Opto, Q1 was a bit below, but you mentioned some of the headwinds on destocking and not the available capacities, so cut a long story short, are you still confident to achieve that run rate by the end of the year because of the second half? That's my first question.
Sven, it's Olaf. I think we do it together with Ingo. Yes, we are quite confident that we speed up in the second half of the year. As we explained, we ramp-up now Kulim and Kulim is coming up online in April, so that -- as I said in the second half of the year for us. And we had -- as Ingo said, we had in the beginning of this year and the end of the last year some destocking of our customers. So we don't see any issues in a row and for this we are quite confident that we do the growth rate.
Okay, so 14%, 15% like-for-like for the year is still fine. Second question on LSS, with LS in particular regarding your strategic review could you be a bit more specific on when you plan to give us an update, is that rather something for really the year end -- the fiscal year end or could there be also an updates earlier than that?
Yes, as I said, in the end of the year '17 in our Q4 and our guidance call, LSS is -- LS is under review and I've said, we are coming to a decision in '18 and to be fair. We are in the beginning of '18 and end of January, beginning of February. So it takes a little bit more time to run through all of the options. But in the meantime, we are working on additional actions, so we reduced our workforce in the German headquarter in [indiscernible] area by 30%, that's really a lot. So we bring down the fixed costs. We made an additional decision 2 weeks ago that we would concentrate our production on one site in Europe. Today we have 2 plants, one in Europe -- one in Germany and one in Eastern Europe. We will have production in the future only in one plant. So we are preparing everything to be more successful. And if we would come to a decision in one of these option, I think it's good to be prepared with only one factory instead of a more complexity of 2 factories. So we are good on track. And as I said, it's not only to announce an option, it is to do our homework to bring down the cost.
And the last question would be just on technology. I think in November 2016, you announced the prototype for LIDAR with Infineon. And I think back then Mr. Kampmann said, it's going to be kind of mass-market ready in 2 years. I was just wondering where you stand on that if you had any design insights by the OEMs. Maybe you could give us an update on that end?
I think the CES was also a very-very exciting show, was in regards of LIDAR, where the LIDAR companies basically use the advantage to showcase their current status. We had our boost not only the company, where we invested in LeddarTech, we had also other companies who basically showed their modules with our products. And our product means in this case that we were providing the laser diode. I also explained last time that we are basically expanding our activities in LIDAR are coming from being a component supplier into the system level causing this dynamic innovation phase of LIDAR, we see indeed that we have an early access to development in the system level to get in a very early stage the future requirements for our future component product. And that's I think where we have currently a very good footstep. We have -- let us take a good insight into another system architecture, which are out there and we are currently also evaluating a second company, which is taking advantage of different system architecture for safe sensing laser system, also a kind of new LIDAR technology, which basically will expand our scope into other system topology to be prepared also with our components with these use cases. So currently, we feel very comfortable in our position. There is still a strong demand from all the suppliers, LIDAR suppliers, in regards of emitters means laser diode from us and with our system levels. I think we have a very good position to understand where are the current developments, in which directions the current developments go and what will be the future of high volume systems which we will see on the road.
And what is the -- Mr. Kampmann, what is your take on the announcement from AMS, which has said they have a design in for VCSEL based LIDAR system. I mean, does that enhance your effort also to offer a VCSEL-based solution going forward?
We are currently evaluating that all the different application fields for LIDAR, so LIDAR for automotive, LIDAR for more smart companions like smartphones where we use basically time of light or structured light applications and we have to make up our mind. If it goes stronger in the direction of VCSELs or if we provide VCSEL based systems where we basically take a small segment VCSELs from suppliers.
The next question comes from the line of Peter Reilly of Jefferies.
I have got 3 questions as well please. If I can start just by asking about the growth dynamics in the specialty, you've got some very different trends there, you got the inventory adjustment, LED penetration is still rising, you've got halogen and xenon in decline. Can you help us understand a bit more, what's going on and I'm especially interested in the rate of decline for the halogen and xenon, whether you see that in an accelerating decline phase? And then secondly, I wanted to ask about what you're seeing at Kulim in terms of the cost and the manufacturing efficiency. You're obviously very pleased with the technical progress and productivity, but is it too early or are you also starting to see that it's going to be materially lower cost facility than your current installations? And I will save the third question until afterwards.
So I thought it was the Kulim one and then maybe Ingo and me we are talking about the LED penetration and your first question about gross dynamic. I think we are really quite happy about what we see in Kulim. So that means the first chips, the quality of the chips, the performance of the chips are excellent. They are so excellent that we are really surprised about the performance and what we do in the meantime now is that we are sending these chips to our customer that they make a view about that. So what we see is a very good technology progress and we see that the ramp-up is moving much smoother than we expected. And we are now -- then in the next phase, we would qualify the chips, and as we talked in Kulim, the third step will be then the qualification for chips for the automotive industry as well. So today what we see, we have an excellent start and I see no issues and no problems today with Kulim.
Maybe to come back to your question around specialty or basically you asked about auto I think. So yes, we had some dynamics around inventory management at some of our clients. We also saw that some of the OEM manufacturers took an extended furlough for a couple of days before Christmas, unlike it was a year ago. And we believe that had to do with them sort of ramping down production, making sure that dealer's inventory levels gets down a little bit and that's what we saw particularly also in our halogen and HID business, which was at low double-digit decline. We still grew in LED components, maybe at a lower clip than we used to in the quarters before, but that also had to do with some of the inventory corrections, but still -- irrespective of that we still saw growth in LED components. So from going forward, we do expect a decline in traditional light sources, but that's also something we expected for the full year. We don't believe it's going to be at the same rate as the decline that we witnessed in the first quarter given the circumstances that I just explained. We also see that the penetration growth in LED front lights especially is continuing as we expected, so no changes there. And against that backdrop, we are quite hopeful for the second half of the year and also more capacity in Opto will come on-stream.
And when you talk about the more capacity, I guess the infrared capacity isn't this year, it's next year when Regensburg comes on stream. So are you also having for the whole this year a growth constraint where you'd like to supply more infrared chips but you are unable to do so?
Yes, that's true. We cannot deliver, we still have a capacity limitations. We are coming online with Regensburg in November 2018, and since November, we have capacity concerns for infrared.
And the third question, I wanted to ask, just on digital systems. You've been -- you talked previously about being very enthusiastic about the potential for that business. We've seen very different numbers coming out so far, Philips Lighting and Acuity and Asian, maybe you can give us an update on whether you are still bullish about that business medium term or whether you think that some of the news play from industry makes you a bit less optimistic about the potential for digital systems?
No, it didn't make me pessimistic for the potential. What's true is in that, what I said in the beginning of my remarks for this call we have a downturn in North America. So the construction industry in North America had a decrease and for this reason my major customer it is Eaton and Equity, both reported as you said, a decline in their sales. So as the market leader and also in America with the digital systems we had an impact. So for this reason, you see these results in our Q1 and that will be weaker [ at ] the year for DS in total. But for the potential and that's what I talked about Peter in our outlook is if you are thinking about really a smart building and the smart city, it is clearly -- everybody -- we are talking about very fancy cellular phone to mobile, but the smartness in the building is low. So really today we are switching on light, on and off, that's most what we are doing. So more smart technology will come in buildings, in rooms and of course in the city. And then this case from the potential point of view, there is a huge potential for the next decade -- and talking about that we have a potential for smart buildings and smart cities for the future. So in a long-range, I'm optimistic. In a short range, yes, we have a downturn in one major market and that's North America, and that's what we see --.
I think if we look in the future for digital systems, we have a very strong position in the market with our electronics and we clear the need for this market for our customers to be prepared for future functionalities in regards of connectivity, we see with light systems based on our electronics. Central systems being incorporated and for this purpose we will launch basically on our big fair in March, light and building in Frankfurt, a light platform which will -- basically in April, our customers who are using our electronics from DS to connect basically their luminaires into a platform to bring them into the cloud and based on that they can establish new functionalities. And I think it's very important because, these customers of DS are [indiscernible] companies, companies which have a clear focus on the design of this luminaires, but do not have too much resources to work on these functionalities for the cloud and we will provide these additional services with DS and I think we would be very attractive. And I'm not promising too much. We will see on the fair, already the first customers of DS, which will go on to this platform and they would announce it. So I think we are very positive to provide for the market for our customers new functionalities with DS, based on our current market channel, based on our electronics.
Maybe Peter, just to finalize DS in this regard, I think if you look at the comments made by others about it, for us largely also that refers to one part of the business, which I pointed out also traditional ballasts, yes, where we're seeing double-digit declines not just in this quarter, but also in the last 2 quarter of '17 and some price erosion that is higher than normal in this segment, that was to be expected at some point in time. At the same time, we also continued to see double-digit growth in LED-based drivers as well. So there is a classical replacement market that is now ongoing and we are well presented there. As Olaf said we're #1, in the U.S. We are a good #2 or #3 here in Europe. And obviously, we participate on both ends on the declining part, but also on the growth part. So that is for us still in line with what we would expect and the key now is basically a step to leverage. Investors like Digital Lumens on the market and the access we have to digital systems into places like U.S. and Europe.
And that means really we have an interest. We have an organic and inorganic growth. So I'm quite sure that you will see some good things in the future.
Next question comes from the line of James Moore from RedBurn.
Maybe I could just start off with the currency and the guidance. Just to be clear, I mean in print, in black and white, you talked about the [ 1.0 -- 1.08 ] euro rate. And obviously we are at $1.24, so EUR 50 million, EUR 60 million worth. Basically, are you comfortable even though it's tougher to achieve? Are you comfortable with [ 700 ] at current currency rates? And can you remind us what percentage of sales and costs in dollars and euros and what the export is? I asked because a few years ago, they would talk about a 10% export, now the talk is more over 20% export? It would just be helpful to get some clarity on this topic. That's the first one.
Ingo will give you the answer James, but in our presentation you have a little bit to bridge. We tried to explain from the year-over-year and like-for-like and you see our currency impact of the U.S. dollar in the Q1. But Ingo, you can go --
So James, so generally speaking, of course, when we look at the guidance, which we also did of course before we came out with the numbers this quarter. We try to factor in opportunities and risks, possible upsides and downsides and the same is true with the guidance given for '18. So back then, we therefore provided the range of adjusted EBITDA as expressed with the use of [indiscernible] and the EPS range of EUR 2.40 to EUR 2.60 that we gave. Obviously. the current trading of the euro-dollar at $1.23 -- $1.24, which is different to the $1.18 we factored in back then, it's something we're looking at and as a result of the guidance that we've given, and we are now giving is more ambitious, no doubt about it. But we're now looking more to the lower end of the guidance range, but we are still within the range provided. So that's the way we approach the guidance on the basis of current trading. If you look at the math, I mean, we've indicated that back in November that roughly 48% of our revenue base is in dollars -- are dollar based, and that approximately EUR 0.01 of the euro-dollar exchange is EUR 9 million. Let me remind you that the first quarter was [ 1.19 ]. We've recorded our results on the basis of [ 1.19 ]. So that's in the back and that was pretty much expected. So what you have to think about is the rest of the year and not the first quarter.
And secondly could ask a little bit about Kulim. Great to hear, you're ramping up as planned. I wonder if you could share some color on production and revenues and mix, just so I understand? Can you say a little bit about how many wafer starts were achieved in production in the first quarter and what you expect in the second? And can you talk about the mix of what you're currently making, producing in terms of UX: 3 and Sapphire and I just want to be clear, are we talking zero Kulim invoice revenues in the first half? Can you in any way say what the second half looks like?
Yes, for that question is yes, it's 0, in the first half and some in the second half. We said that we would try to ramp up somewhere between 4,000 to 5,000 wafer starts a week at the balance of the year, so towards the end of the year and we also said that roughly 1/3 of that would be for more premium type of products, as you referred to UX: 3 and the balance for general lighting or other Sapphire-based type of product. That's unchanged, that's in line with what we said early in November, we are on track with that as Olaf said. And therefore, as we said, we don't expect any meaningful impact in our revenue or growth for Opto before the second half, when we see some of that capacity probably feeding into our revenue base. That is unchanged, to me there is nothing different than what we said in November.
Can you say how many you produced in the quarter?
Well, Olaf said in his prepared remarks that we were -- we have shipped some samples to customers to test, which I think gives you an idea where we are and given the size of the site, we didn't have any plans to basically ramp fast or certain production capacity. Our focus was more on stabilizing processes, stabilizing quality, getting good samples to our customers. We were not driving the facility for the first quarter towards a certain production output that could be invoiced, that was never our intention. And that's typically also how we would ramp facility of this size.
Very helpful and finally, could you perhaps help us a little bit with the growth dynamics. If Opto is growing at 11 between different technologies, I get the sense there all bottlenecks in certain areas, but is there a significant difference in growth rate between LED, infrared, any of the laser dynamics?
Yes, there are of course growth dynamics. As we said, at this point we are bit handicapped as far infrared is concerned, so that's -- obviously, we knew that when we entered the year. Where we were growing at -- last year, we were growing at very high clip with infrared, also with the support of the S8 phone with Samsung and coming into '18 we knew that given the capacity limitations that growth would come down for us in infrared, still at the -- sort of absolute same level, but from a growth rate perspective, certainly not as exciting as it was last year. For the first quarter, as I said for the LED components parts for auto, we saw growth, but at a lower clip given the inventory corrections that I was pointing to. And also if you look at generally at car production growth overall in the quarter, it was lower than previous quarters and we saw some of that as well, but going forward, we would expect that to pick up. Again in general lighting, had its strongest growth in the quarter, very significant, but again that was not based on the Kulim capacity that we have. We're building the channels and right now we're largely still buying chips from third parties, doing a little bit of packaging and then reselling that to customers to test the channels, to test what the products need to be like, so that we can sort of switch them from outsourcing to insourcing when Kulim goes live with meaningful capacity, probably starting in the third quarter. So those are the dynamics that we're seeing right now.
Next question comes from the line of Lucie Carrier of Morgan Stanley.
Actually, I have a couple of follow-up, I'll have 3 questions. But the first one I wanted to ask was around initiative that you can take to offset some of the FX headwind. I mean, I appreciate this is not anything operational from your side, but you may continue. You've spoken about some savings initiatives, I was wondering if you could give us some color there? And also when considering some of the end markets you are serving where you are clearly market leaders where capacity are said to be constrained, isn't there any opportunities around price initiatives as we see sometimes with -- at other company in terms of offsetting the FX headwinds? So that's question #1.
Okay, I think we'll do it together, Ingo. As I said, we are -- in the meantime, we are working on a lot of -- and many initiatives in all the business units working, let me say again the cost impact from currency, for example. So in LSS as I said we used fixed cost. We do the same in SP. We run a lean Headquarter, lean SP project to be faster and leaner in this area and the same is on corporate level that we started with the project, we call it Lean Headquarter, that means really to bring cost down and to have the reserves and the potential to meet the targets. Ingo?
I think, Lucie, your second question on pricing was that obviously all of our competitors are by and large also impacted by these movements some more than others. Some of our competitors are based in somewhat different jurisdictions, but they have a similar issue with the dollar devaluating against their respective currencies. So we haven't seen really pricing become an issue in terms of price erosion increasing in the year. At the same time we also don't believe that by either lowering prices or increasing prices, we will sort of meaningfully change current demand or market dynamics in that regard. Where we can, we will definitely do that. Where we do projects for instance that is easier to do, and we're looking into that right now and other areas that will become a bit more difficult, also based on competitive dynamics.
So just a follow-up on that maybe, I hadn't asked my question well. I was not expecting you to kind of lower the prices specifically considering the FX moves you're seeing, but considering the level of consolidation in the industry, the fact that as you said all your competitors are impacted by the FX move, and the fact that some of the businesses operate at CLE constrained capacity. Isn't there scope actually to increase prices to offset some of these FX moves and across the industry, I mean you and of course your competitors, which are being impacted?
I think, Lucie, I understand where you are coming from. I was trying to explain, on projects, you can do that. There is a possibility to do that. On running projects, it's a bit more difficult. If you start quoting for new projects, et cetera, it always depends on who you are competing with and in some areas you also see behavior, our competitors are trying to enter our arena. So we're very careful not to open the door too much here. So it's not going to be that straightforward to pass on the exchange rate movements through pricing to our customers. We will -- of course, we look into it where we can, but I don't want to give you the impression that it's going to be something that would be logical for everybody to do at this point in time.
And my second question was around the mix in -- follow-up on the mix of Kulim. You've mentioned that in the quarter you had the strongest segment in OS was general Illumination, most of it is still kind of a being outsourced. I was wondering when you kind of fully up and running in Kulim, so when we reach the end of the year, does that mean that this outsourced kind of production would be fully covered by Kulim and what I'm trying to get a sense on is, whether Kulim will cover this in full and offer further opportunities for growth or how should we think about that?
Yes, so obviously we are supplying of a wide array of different chips, high-power, low-power, and mid-power. So with that said, we do not expect that we will have completely in-sourced everything that we've outsourced by now, but a larger degree, also again depending on some of the product levels; some of the products, we can already do in-house today, not through Kulim, but through other facilities we have in Penang. But in general, of course, the idea is that we can load Kulim as fast as possible and cut down on the in-sourcing. I mean we said before that for the year, if you look at Kulim and the ramp-up that we will see some contribution of course by Kulim from a revenue perspective, but you cannot take the full wafer starts per week that we put in place by the end of the year and assume it's going to be completely incremental revenue to OSRAM. Some of it will be incremental, some of it will just be substitution of insource -- where we just internalize then the margin that today maybe our supplier gets.
But just maybe to understand a little bit better, kind of the capacity you have at Kulim or that you plan at Kulim for general illumination, I mean how are your sales in general illumination today versus what you're kind of targeting long term and especially coming out of Kulim, which I believe would be the main facility because I think it's difficult for us to -- considering we have partial information on the mix and the prices level across different category to see that?
I think last year when we guided for the first time for '18, we also -- Olaf gave an update on where we are with our strategy, and there we've also indicated where in [ 2016 ], let's just say we were with --
LED for GI.
LED for GI, so that [ 16% ] is something that I think you can work with. And as I said a portion of that will be in-sourced and a portion of it still have to be outsourced because we will not have all the product diversity in Kulim right from the get-go, and we will obviously start with those where we believe we can be much more cost effective and with better quality even to some of our customers. It's important for us now to build customer channels and there's a lot of interest for us, especially from a lot of the U.S. and European-based companies to work with us in the general illumination space. We're extremely excited about that opportunity. But again, not all of it will be done through Kulim, some of it will be done through external. We will also do some more commoditized products still this year in sort of more in the areas where we supply some chips into the LED retrofit arena, but those will be largely from outsourcing, and not too so much in-sourcing because we're trying to focus more on the more profitable segments which will be produced in Kulim.
And just the last question, it would be very short. Considering the U.S. tax reform, are you able to guide us for 2018 effective tax rate you're expecting in your P&L? I mean last year you were 29.1%, I think, where should we go from there?
Well, you should expect that for this year, we would end up roughly at 28%, which is also reflected already in our tax accounting this quarter. So that's kind of the rate you should expect for '18.
The next question comes from the line of David Vos of Barclays.
My question would be on the China impact, you flagged that up, China traditional headlamps being quite important. Could you help us sort of frame that in both revenue terms and whether that's -- you know if any notable mix impact as well? Thank you.
Yes, there was a downturn in China, I showed you this on our graph as I was talking about markets. As you know in China, the subsidies for cars are stopped. So for this reason, the market had a little bit of slowdown. And on a second topic, what I explained in my remarks, was that there was a trade limitation for Korean car producer. I think you maybe you have seen that in the press, that Korea had 1 million cars less produced in 2017 than they expected and that came -- this car mainly where -- shipped -- should be shipped to China. So on one hand, we had an impact on our Korean customer and on the other hand, we had little bit slowdown in the Chinese market. Nevertheless, halogen was strong. So still most of the cars that are produced in China -- brand new cars equipped with halogen products and we are at a good position in that, but in comparison to the year before we had a slowdown.
Could you help us frame it sort of in quantitative terms, how much of your SP business is generated in China and then is that lower or higher than the average SP margin?
I don't think we ever really guided for how much business we do in China, let alone how much margin we make. The only thing I would say is that China as a market is still obviously younger than the European and U.S. market. Therefore, China in terms of contribution from a revenue perspective to SP, it's kind of reflected in that. In other words, Americas and EMEA is still bigger than China overall. China has as Olaf said, a little bit of a different mix than some of the other regions. The U.S. market is a market with a different type of OEM channel and very profitable aftermarket business. The European part is strong OEM and also strong aftermarket. And in China, the aftermarket business is still growing, given the fact that the market is still relatively young and there's not too much out there yet from an aftermarket perspective. So maybe that gives you kind of an idea how this will split within the company.
Next question comes from the line of Sebastian Growe of Commerzbank. Please go ahead.
The status on Opto, and we can start with Kulim and on the mix -- think you have the necessities clearly there to finalize the planning for the second module and given that you do see a strong pull from premium product, 4 premium products? Could module 2 look very different from module 1 and if so would this have any big impact on the CapEx spend? And then secondly on infrared, it is a more clarification question, to be honest. I think on the Q2, 2017 conference call, you said that the first output could come online in the second quarter of 2018, now you're guiding to November, is there any delay in the process or what is behind that? And may we take these questions first and then I would have some more on the specialties?
As of my point of view, we are still absolutely in our original plan. I know that I cut the ribbon in November, that's really -- I was asked by [indiscernible] if I'm available in mid of November, cut the ribbon in the new factory. So there is no delay in our production, definitely not because we -- to the original plan we are little bit faster and because we are working now in 3 shifts. So I'm wondering, that you think that we are coming up in the second or third quarter, we'd definitely start in the end of '18. So I'm wondering.
No, I don't think we ever have said anything, Sebastian to be honest. I believe Olaf said that we would come on-stream with this in the beginning of fiscal year '19 and that hasn't changed from original plan. And to your first question on the second module in Kulim, also there we are still on plan with looking into that probably in the summer-time of this year, depending also how demand develops in the second quarter, we've seen, as you know, in the last 3, 4 months from announcements from others put capacity in place, we're weighing all these factors in before we make that decision, but at this point in time we've not taken any decision whether module 2 will look different to module 1. Indeed, it will then also depends a little bit on the mix. And whether we will also implement some of the higher share of UX: 3 in module 2 really depends on how the volume on that side of the house will develop, but that's too early days to say anything at this point in time.
Quick follow-up to that comment, is there any structural difference in the CapEx need that is related to UX: 3 compared to the Sapphire?
No. Not really, UX: 3 basically means that you have to deposit a few more layers. I mean if you think about like I do it from a layman terms, it's a few more layers so you run a couple of extra rounds in the factory around similar equipment. It does of course increase a bit the complexity on the front end of a facility rather than a facility that just runs one process that's clear, but other than that from a CapEx need perspective there is not much different, no.
Okay, fine. So then let's move onto to specialty and just quickly on the EBITDA margin, if I do unwind the divestment gain, so then I think the margin -- EBITDA margin will sit around 14.4%, so 200 basis points down year-on-year. You made also the comment that you do expect I think a better traditional product contribution I think over the rest of the year then. So it would be fair to say that the EBITDA margin in Q1 was abnormally low or normally very-very extremely strong quarter 1? And along those lines, can you just remind us of what the margin level for LED product already is at?
Yes, indeed we had a decline in the -- so if you take out the EUR 50 million obviously then we saw decline in the margin. A, remember there is a big impact from foreign exchange in that. It's roughly 150 basis points or so for SP [ auto memory ], which explains a big part of the 200 basis points you are mentioning. And then if you remember, I said that we saw a low double-digit decline in the traditional light sources business of SP, which obviously carries a very high margin and that you see immediately reflected in the numbers. So to the extent that we will still have some aftermarket business obviously now in the running quarter. So the second quarter of this year as well as somewhat of a recovery from a traditional we saw some, we should see some positive impact from that. But again, if you look at the exchange rates that I believe will probably not go away. So that kind of will balance the picture probably certainly on the short term also for SP.
I would have one question on joint venture with Conti, but will stick eventually with currencies first. So if I just look and compare the Q4 -- calendar Q4 2016 currency rate compared to Q4, 2017 currency and that's $1.08 compared to $1.18, in other words, it's [ $0.10 ] build up, which triggered the EUR 20 million -- EUR 22 million headwinds on the EBITDA in the quarter one. So if you could just walk through the year and look at what is coming up and Q2 '17 compared to than Q2 '18 and so on and so forth, this delta shouldn't really move much even if we pencil in current exchange rates of $1.23, $1.24. So what I just want to ask with this is, isn't really say EUR 18 million EBITDA [ drag ] really the most current exchange rates, if we just look at how the year overall quarter-by-quarter played out in 2017?
I think you will find that the year-over-year dynamics on a quarterly basis will be different and these will be more pronounced in the first half where we still had a rather low euro-dollar or a very strong dollar relative to where it is today. If you remember well in '17 we saw in the middle of the year, starting with the end of our third quarter I believe how the euro started to appreciate quickly and significantly against the dollar and therefore third and fourth quarter will see somewhat of the bit of a difference. But again if you think about the average -- the average for the year for us last year was still $1.08, and in that sense, if you look at $1.18 -- $1.19, now in the quarter, we look even higher, still for the balance of the year, I think that at least you will find the range that we provided where we updated the guidance from an exchange rate perspective, probably even more in the numbers. So I don't think, even though the quarters will look differently, the impact for the year will differ from what we said earlier.
Maybe we'll take that offline afterwards. Last one then on the JV with Conti. I think at the conference in New York that you hosted in January, you said that by April 2018, you will finally have that JV up and running. Along that announcement date, would it be fair to assume that you will also provide -- mark with some strategic targets that you say, where you want to take the revenues eventually by 2020 or so or how should we think simply about that event?
The original plan is that we sign -- that we have signing in our second quarter. That means we are working very hard now with the due diligence and with the legal part, so I'm quite confident in both sides had the willingness to sign in the next few weeks. And then we have to wait to get some approvals. As you know, we have the antitrust approval from different countries, we try to do it only in [ Brazil ], instead of seeing improvements and so we expect to be up to running between July and September. So that's the range we have, the positive part to close. Then that means as we always said we will start in the [ mid 3-digit millions ] in turnover. So maybe Stefan, what you can tell us about the addition on that?
I think we are very good -- on track on that [indiscernible] German companies put their heads together and we had already a lot of work done and content in the term sheet, which [ have certain ] or basically is to go along our initial plans. All the due diligence are on track, so the work and the contracts are finalized in time and there is nothing like…
There is no red flags today.
Time line. The [indiscernible] are on track. We have set some from both sides, so everything is on track and green.
What did you mean with external growth, what you mean that we -- some M&A parts or what's your question behind it?
No, the question was simply, if you are willing and considering to feed the market with some ideas and targets where you want to take that combined entity either OSRAM and Conti acting in concert, it's i.e., starting from EUR 400 million [ before take ], I think that was the initial number that you provided the market with. But I guess everybody is knowing that this market segment is growing at 20% plus eventually, so if you just do the math then that would mean by 2020 or so, EUR 600 million in revenue, roughly speaking. And I'm just curious if you are planning to also come up with sort of an official target where you would like to see that business in terms of revenues, EBITDA, whatever by [ 2000 x ]?
Yes, we have it, but we don't want to talk it about today. What we will do -- definitely do is we will have a capital market day. If we have the timing about that, we are coming to some more details about this joint venture. But first of all, let us sign it, let us come up to running and then we will talk about really margin, target and potential. I think, give us a little bit more time.
Yes, let's put ink on the contract first and then we can talk about numbers.
Give us a little bit more time. But we will come up with details.
Next question comes from the line of Alexander Virgo of BAML.
I have a couple of quick ones, I guess. Just looking at the R&D year-on-year, it looks like there was about EUR 10 million headwind in the quarter. I'm just wondering if that's a number we should annualize and how we should think about that over the next couple of years. And then second question, if I look at your progress on gross margin over the last 4 quarters I guess, it's been about 200 bps or so erosion in your gross margin on a quarterly basis and now nearly 300 bps. I'm just wondering if you could break that out for us, I guess, some of it will be FX, but if you can talk a little bit about what's driving that that would be very helpful? Thank you.
Yes, about R&D, Stefan will talk a little bit.
Yes, I think you saw that basically we spent a little bit more in R&D than we initially had planned, but there is proper reason mainly, at least all of that in OS, and we have, let's say the opportunity at Opto Semiconductors to invest a little bit more in R&D into new functionalities and in opportunities which we see from the market. So I think that R&D is generating a future revenue potential, and therefore, we are very happy with this decision. It's not the case that we have to catch up in original plans through some additional R&D, these are basically in future opportunities.
Yes, if you look at the full year because you are also asking whether you can sort of use this as run rate. When we gave guidance last year, I think Olaf showed that we would intend to spend a bit more on R&D, so that is still the case and the number that we provided originally in that regard where we said EUR 30 million to EUR 40 million has not changed. So maybe different in the first quarter bit more than in the other, so -- but overall it's the same guidance, so that's still intact. On the gross margin, largely that is foreign exchange that we have, but also, of course, the ramp-up costs that we have in the various facilities that we build up, both particularly in Kulim, but also in Regensburg are feeding into -- negatively into the gross margin without any revenue against it. And then for -- particularly if you look at SP for instance, you would see that with the lower share of traditional light sources in the mix in that quarter, also gross margin is somewhat lower, those are the main reasons.
So I guess it should be stabilizing from the about quarter 2, 3 maybe?
Well, yes, of course, I can't really predict what exchange rates will do, but from an operational perspective somewhat -- again please also don't forget that we are not completely finished with our ramp-up. What we saw in the first quarter will definitely also continue into the second quarter and beyond. So we will see some ups and downs with very special reasons that we already sort of communicated in November.
Next question comes from the line of John Quealy of Canaccord Genuity Incorporation.
Just a quick one from me, back to LSS, as we wait for your review on what to do with that business, shall we expect the adjusted EBITDA to base out here or should until we make this decision, continued losses and perhaps maybe accelerating into that decision? Thank you, guys.
So I think if you look at LSS right now, I mean we're quite happy with the fact that we improved somewhat with similar revenue levels in Q1 when compared to Q4 of '17 from a profitability perspective. I would not like to guide for that this is specifically as Olaf said we're working on a number of measures to get the cost structure, more in line with its revenue base and with our longer-term profitability targets that we want to carry, and it will still take a while before that fully feeds through in the bottom line. So I don't really want to guide, but I also don't want to give too much of the enthusiastic picture here on the profitability of LSS.
But we had a good first quarter. So a good start, very good start. So I'm optimistic that we have a new CEO on board for LS, and I think together with the team and the measurements and the cost restructuring, it looks really good. So I'm happy with the progress of the business.
Thank you very much for your participation. We wish you a great rest of the day, and if there are further questions then [indiscernible] happy that to call Investor Relation of OSRAM. Bye.
Thank you, guys. Bye.
Bye-bye.
Ladies and gentlemen, the conference is now concluded and you may disconnect your telephone. Thank you for joining and have a pleasant day. Goodbye.