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FLSmidth & Co A/S
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Ladies and gentlemen, welcome to the FLSmidth Third Quarter Interim Report for 2019. Today, I am pleased to present the CEO, Thomas Schulz; and the group CFO, Lars Vestergaard. For the first part of this call, all participants will be in listen-only mode and afterwards, there will be a question-and-answer session. As a reminder, this call is being recorded. Speakers, please begin.
Hello, everybody. I wish a warm welcome to all who listen in to our Quarter 3 2019 report. At first, to the key highlights. Positive free cash flow in the quarter, lower capital order intake, record-high service order intake, revenue increased as expected, and the EBITDA margin declined to 8.0%. We had, on the 11th of October, guidance change from lower end of 9% to 10%, what we communicated at the end of Quarter 2 to around 8% for the full year, and we will come in the presentation, of course, for the root cause for that and what we are doing about it. Then to the market outlook, we are still, in Mining, in a growth cycle. We have a good momentum in the service, but on capital, it's a cautious outlook for the time being. In Cement, a stable market, especially on the aftermarket, too. So now in the reasons of what happened with the guidance change on the 11th of October. And this is divided in 3 pieces here, which goes actually over the year. The first part is the business mix. We expected a higher share of service business in the year, which didn't pay off versus the capital, and in the Minerals business, actually, our material handling business performed more than we believed or than we saw coming versus the mineral processing. The material handling is a little bit lower in profitability. The other part is what we actually call internal sit and wait. We have an increase since the second half of the year, delay of customer decisions. What is it? It has to do that we see on one side, challenges on the license to operate. We had actually several mine sites losing their license without pre-warning, where we were operating and working on it. And we see that normally, the activity where we get engineering orders on big mine sites or Mining operations and then fairly short after the capital order that this didn't happen. There is no order cancellation. It is simply from a timing. It's like, we call it, sit and wait. That means customers will definitely do it. The demand, the need is there, but it takes more time, and that is for us, disruptive workflow where we have all the experts in and have to see when the capital order come. The last part is that in the final stage of some of the projects, we saw that we were definitely too ambitious in the time line, and that created less profitability than anticipated. It's not about loss-making, it's about lower profitability levels than anticipated. All of that, that trigger that we accelerate the business improvement initiatives, what we actually had in a vast majority already planned with the reorg last year to implement over several years. That will get shortened dramatically. If we then go to these mitigating activities. On one side, if it comes to Mining, we have a reassessment of the profitability of the mining projects, and we see definitely a higher level of contingency. What we can read out of it and what you should read out of it is that the profitability on Mining capital business in that what we have in the backlog compared to the run rate before the Q3 is roughly DKK 30 million lower per quarter than anticipated before. On the other side, the accelerated business improvements, we will consolidate on the mining project execution and significant fewer centers to get absorption as well as the hit rate of capital orders more into these centers. And with that, a better follow-up on the time line. So about the footprint optimization like in procurement, Cement and the Mining and in the group functions, as we had planned with the reorg, will get a completely different time line, which means faster. This EBITA improvement program has a [ cost ] of DKK 100 million, where we will have a run rate of DKK 25 million at the end of '19 and DKK 100 million at the end of 2020. The cost is, in total, DKK 150 million, where DKK 75 million will be this year and another DKK 75 million next year. So when we look here on the guidance, we had an initial guidance on the EBITA, 9% to 10%, with revenue 19% to 21%, where we lowered the guidance at the Quarter 2 into the lower end of the 9% to 10% and the higher end of the revenue guidance.When you look into the realized figures, Q1 to Q3, you see that with the EBITA margin performed up to now, the 9% is really out of range. So we guide new on the around 8% for the full year and stick with the 20% to 21%, which means the higher part of the revenue guidance. From that, we end the market outlook, let me start to Cement, where, of course, we have to explain more about the order intake and the level of order intake. We have an unchanged activity level in the cement industry. The big orders are lumpy, which means they are not coming regularly. They are very difficult to predict. And there is, since several years, no change in that. Not a big demand for big orders out in the market. We have a big interest for sustainability-related solutions where we can offer customers where the market demand to have more support to fulfill environmental requests. So the level of small and mid-sized opportunities with upgrade retrofit is actually quite good. If we then look into Mining, in Mining, we're still in the growth cycle. And yes, we were in the middle of 2017, more ambitious on the growth than we are today, and that is what we communicated already before, but we are still in a growth cycle. The service has a very good momentum, but we have a cautious behavior on the capital business. And one big part of that is, of course, with the sustainability and partly the uncertainty out of the macroeconomics that some of our clients, actually, the majority are more pausing on that, what they have to do, the demand, the need is there. The interest in anything with the sustainability and productivity improvement is quite high. It's not only the tailings management. For both industries, the productivity focus is very high. And any offering in the productivity improvement is like to be seen. Now into the order intake. Order intake declined quite strong versus a very strong Quarter 3 2018, which was one of the highest for the company. let me start with the big figure. Here on the right side, the Cement capital is 83% down, down to a little bit more than DKK 500 million. That is when you look into it, not satisfying, but fact is that we didn't have any larger order in that quarter, where we compare with a very strong large order quarter, but the pipeline didn't change. The activity level is the same as before. So we are not concerned about that. The only thing what we have is, we see clearly the time line, not helping us in the quarter 3. If we then look into the service, service, again, is growing here in Cement too, which is actually a result, the same as we see in Mining, with good 19% growth in service that we have with the reorg quite a good strong structure now to cover our customers in the front line better. The capital mining business went down in line with that, what I said with the more cautious capital approach, what we are faced with. On the right side, you see order intake for service as well as for capital and it's easy to see that we are coming since quarter 3 2018, slightly up or quite up in the order intake for total service. When we then look into the dark blue bar, this is when we have like in quarter 3 last year, the long [ stake ], that means large capital orders that were not in for the quarter. So out of that, that makes that bar, that makes the capital part smaller than before. Then we look into the revenue split. You see on the left side, that Mining stands for 60% of the business and Cement 40%. We had only 9.2% EBITA for Mining in the quarter versus a good 5.8%, which comes up quite significantly from last year on the cement part. The cement part with the strategy, profit over growth, what we partly see in the order intake. Here, we see it really full that we performed quite well on that. Then if it comes to capital versus service, we had exactly the same ratio, 43% capital versus 57% service like in quarter 3, 2018. And with that, I would like to give to Lars.
Yes. And today, I'll focus mainly on explaining the quarter 3 variances we had compared to the plans we've had. And I'll also try to give some clarity on the implications going forward from what we saw in in the third quarter. And in particular, focus on how the performance is in the various parts of our business. When you look at the key figures here on this chart, you can see that the order intake was down, as Thomas mentioned, and it is the absence of large order that drives this. In particular, we have a lower backlog in Cement as we didn't get the larger orders. And that may lead to pressure on revenue as we move into next year. But again, as Thomas mentioned, there is the same pipeline as we've seen before. It's a timing thing. So it is still early days in terms of what we see into next year.We also had 2 cancellations in the backlog in the Mining segment. They have been on -- not been moving for quite a long time. So in our planning, they will have very little impact on revenue this year or next year. But sometimes -- one of them, a customer was in bankruptcy, and we had expected the customer to come out of bankruptcy -- decides to come out of bankruptcy, but that didn't happen. So that sometimes happens in our business. If you look at revenue, we are up 9%. Gross margin, I'll touch more about that later on, is down 2.2%. Our cost level SG&A ratio is at a healthy 14.1%. EBITA is up 8%, and profit for the group is up 17%. If we then look into revenue, it is progressing as per plan. We see that the revenue in Mining service is up. We also see that Mining capital is up, and when we say that we see delays, it is not really impacting revenue that much. It's mainly in the final stages where we're not generating a lot of revenue that we see the delays, so it's not that visible on revenue. If you look into Cement, we're down in Cement service and slightly down on the capital part in Cement revenue. If you look at the whole group, you can see the chart on the right-hand side that we are up 9% compared to the same period last year. And unfortunately, our order intake is lower than the revenue in this quarter, where we didn't see a lot of big orders in neither Cement nor Mining. If we look at gross profit, as I mentioned before, we're down 2.2% compared to the comparison period at a group level, when you look to the right-hand side, you can see the drop in Mining, where we went from 31.7% last year to 25.2%. It looks dramatic. It is a lot less dramatic than what this picture shows because the comparison period is extremely strong. And as a footnote, we have shown here what is the average gross margin we have in the Mining business. So a more relevant comparison figure would be 27.6%. So we are roughly 2.4% down compared to the same period last year. The cost overruns and the effect from the Mining business is roughly DKK 70 million in the third quarter, and that is what has caused the challenges we have in this quarter. If you look into our Cement business, or maybe I should just touch -- the service margin in Mining is as per plan. So it is really a capital challenge we have in terms of profitability. If we look at Cement, we see a good performance in terms of margin in both service, and in capital we increased the margins by 1.6%. And we really see the effects of the initiatives that we did last year in the -- towards the end of the third quarter, as well as executing a stronger backlog. So good progress in terms of profitability in the Cement segment. If we look at our SG&A ratio, where you can see we are down to 14.1%. So we are slightly down compared to last year. It's worth to mention that as part of the lower profit expectations, we have revised some of our incentive pay. And that has had a positive impact on the SG&A ratio as we produce some accruals in this area. So the run rate we have in Q3 is lower than what it would be if we had not changed the expectations for the incentive space. If you strip out the IFRS and this change in accruals, you would see that our underlying SG&A cost is slightly up compared to last year. This is as per plan. It's more investments in the digital area where we are continuing to see good momentum in moving this area of our business. Yes. And to the EBITDA bridge, I'll start from the beginning of the year, so we get all the components in. We started with an initial guidance of 9% to 10%. If we take the midpoint of that, that would be 9.5%. In the middle of the year, we said we would end up in the lower end of the guided range, and that was very much related to the mix we have between service and capital, where we planned with a higher service share than we ended up with. So that drove the change to the lower end of the guidance, and if we then explain how we went from 9% to 8%. We have the cost overruns in the third quarter, and that also has an implication going forward as we have reduced the expected margins on certain projects that would generate the revenue going forward, so DKK 70 million impact in the quarter. And as you saw, we did not get all the capital orders that we had expected, and we do see some delays in terms of decision-making, and that is expected to lead to under absorption and related costs of roughly DKK 25 million in the second half. If we then look into the fourth quarter. What is the impact of of what we saw in quarter 3 and the change in the order intake we've had, then we will see DKK 30 million lower profitability on the Mining CapEx part, and this is, as also Thomas has mentioned, the result out of a different mix in the backlog as well as we have reduced profitability expectations on certain mining projects. If we then look into the last part, that's DKK 75 million. That is -- we are going to accelerate some of the initiatives to increase our underlying profitability, and that will cost us DKK 75 million this year, and that all leads to 8%. Where the DKK 30 million is a number that you have to remember for next year because we do see that the backlog is impacted, and therefore, this will impact most likely all 4 quarters next year, so that the run rate profitability on Mining CapEx will be lower than the average of quarter 1 and 2, which would be the old level. But again, the third quarter is expected to be the low point in terms of Mining CapEx. If we look into working capital, it goes up slightly in the quarter. We have a large part of our working capital in [ Polysius ]. And that, of course, increases the absolute reported level. We also see that we did not make as much progress on certain mining projects, and that leads to us not being able to invoice and collect some of the trade receivables, and therefore, the improvements in working capital is delayed as a consequence of this. Apart from that, we see -- we still believe we can reduce the working capital in the remainder of the year. It will be a challenge to reach the 10% as we see these delays and that has implications on receivables and bid performance. And if we do not see some of the bigger capital orders that will also put pressure on the prepayments. So it will be slightly more difficult to reach the 10%, towards the end of the year as we had. That is our ambition and we've communicated that earlier on. If we look at the discontinued activities. I'll keep it short this time because there's really not a lot of news to say in it. The progress on the various projects are as per planned. We spent DKK 40 million in cash flow in the quarter. So no changes to the forecast of what it will cost to finalize facilities where we are. So if you look into cash flow for the group. The first thing I'd like to say is that we have -- if you look at year-to-date, we are at DKK 621 million, where we, in the same period last year were at DKK 288 million. So a good improvement compared to last year. If you look at continuing activities, we had an EBITDA of DKK 475 million. We did see a higher amount of used provisions in the period, and that led to the DKK 79 million of cash out, a slight increase in working capital and all these leads to a CFFO of DKK 285 million. The free cash flow for the group was DKK 139 million, where we last year had DKK 213 million. The capital structure is in line on both numbers. And not a lot to say there. We saw a slight reduction in net debt as a consequence of the free cash flow. And with that, over to you, Thomas.
Yes. Thanks a lot. Then forward-looking. If we look into that, where we are, we have a strong progress in service. We see the Cement capital margin improving quite a lot. We see an increased cash flow from operating activities, and we see significant more opportunities with sustainable solutions than we had a year ago. On the more negative, downside is we have a lower backlog in Cement, yes, it's the timing of large orders, but we have to look into detail into it, how that works out for next year. And we have a lower margin in the Mining capital business out of the backlog and what we see. The management focus is these business improvement initiatives, which we are at the vast majority already planned, as I said during the reorganization to implement over several years, step-by-step, we'll get from a timing point of view, significant shortened, and that creates, of course, the savings quite quicker, as well of course, some costs with it. We have to focus on, and we do that on the backlog conversion, with a solid execution on it. And of course, the reduction of net working capital, and we've set all the cash flow improvement. Long term, I normally start with sustainability, and I'll start again here because that is the main thing what we get asked and discuss with customers. There we have to offer a lot in all areas, and that's based on the business model. But it clearly shows that what we had in the quarter 3, and with the profitability, standardization, modernization, project execution is an area with ongoing efforts to improve efficiency. Out of that, into the sustainability overview. As you know, we are focused on 3 out of the 17 sustainability development goals, which clean water, climate change or climate action as well as responsible production, especially, that is where we can contribute the most. And we could contribute significantly more from a technology point of view, and we see out of that area, as I said several times now, quite a big business opportunity. Our safety track record stayed on 1.7, as before roughly, well below the target what we have, and our carbon footprint, again, improved from 3.2%, down to 2.4%, which shows that not only what we offer to the customers is important from a sustainability point of view, we would like to be, as a company, role model too. And with that into innovation. This time, it's about a special technology for flotation, it's the mixedROW Flotation, which is actually 2 different systems combining into one, with a clear benefit on energy consumption, up to 40%, what we worked up to now on it and up to 5% improved recovery rates. It's another example of a sustainable productivity improvement for our clients this time in Mining. So to combine and to give a key overview about the quarter 3, positive free cash flow. Our revenue increased, we had a lower Mining margin than we wished for. We had a higher Cement margin as expected, but still well done. We had the absence of real larger orders, especially in Cement, and we had quite a high Service order intake. With the outlook, we are stable in the activity level on Cement, and we are more cautious on the Mining capital. And of course, we revised the guidance on the 11th of October, from lower end of 9% to 8% or around 8% for 2019, on the EBITA line. Last but not least, we have a Capital Market Day. It will be on the 6th of November, that means in a few days here in Valby in Denmark and Copenhagen and the theme is driving sustainable productivity improvement. And with that, I would like to go into the Q&A.
[Operators Instructions] Our first question comes from the line of Kristian Johansen of Danske Bank. Please go ahead.
So first question is regarding this contract change where you state that you are awarded contracts with defined milestones with this stop-or-go mechanism to a high degree. And the same time, we see that you had to cancel 2 mining orders. So I guess what I'm asking is that this delay and stopping up we are seeing, what is the risk of that turning into actual cancellations going forward?
The -- at first, if it comes to that stop and go. What we call sit and wait more. The demand is there, the need is there, everything is actually clarified, but then when the next "go" should come, we saw in the mining industry that a lot of boards put a little bit foot on the break, which means comments we get like, "please wait another quarter, a few months, and on top of it," we saw in several mines, and it's actually public knowledge, cancellation of the permits to operate, the license to operate. They are not withdrawn forever. They are only taken temporarily until it's clarified which kind of environmental footprint is requested and how to deliver it. So this is for the time being, that's the things why we call it, as our mining customers, call it, actually, that is where we have it from, sit and wait until it goes further. But it hits, of course, our 2019. Lars, if you would like to comment.
We have -- the 2 cancellations we have. I would not really call them sort of like something that relates to this, they have -- both of them their own story. One of them is a customer that went into bankruptcy, and we could not -- and we try to keep the contract alive because when somebody buys that site out of bankruptcy, then the likelihood that the project would restart was quite high. It didn't materialize. So that one we have to cancel. And the business case for the other project simply didn't take off for the cost anymore. So it is quite unrelated to the -- so what you can say, the stop and go that we talk about and the delays on mining projects. And maybe I should just mention, we had of course, a slight impact when the customer went into bankruptcy, but it had -- did not have any P&L impact when they were canceled. So it's not a negative hit in this area.
And it's not a picture, what we see in the industry that cancellations are now happening out of ongoing projects. Absolutely not.
Okay, that's quite clear. Then a question on the slide you have a mitigating initiatives. So you flag this new run rate of DKK 30 million, which we should incorporate. In terms of the improvement effect, what is going to be the full year effect of the 2019?
So the initiatives that we will be implementing quite shortly, will have an effect from 1st of January of around DKK 25 million. And then what we've said is that we have DKK 100 million. That is the full year effect from 2020. So we may get a little bit more in 2020, but I would not -- I would use the DKK 25 million because some of these initiatives takes a little bit of time before they are fully implemented.
Okay. So the full year effect for 2020 will not be much more than the DKK 25 million?
No. Of course, if we can accelerate, we will do that and give clarity on that, but there are some things that takes a little bit of time to implement in these initiatives.
Okay. Fair enough. And then my last question, obviously, given the weakness we see in your capital order intake and the comment you made, especially in the beginning of the year with this more unfavorable mix on -- between capital and service, should we expect that to reverse then going into next year with a high proportion of service revenue?
Yes. That is, of course, not only clear out of the figure, based on the fact that it's a business sentiment behind, based on the fact that the miners are very much investing and looking into it to improve their productivity. Their agility to cope with very volatile market, gives us a lot of opportunities, and that is what we see in the service. And that will go on and when you then look into the order backlog, if you look into what we had service order intake versus revenue, you'll see that we actually build up quite a service backlog, and that will get released more and more. And it is with mining -- with the mining industry, as with other industries, If there is no allowance to spend more money or the money in capital orders or capital business, as the technical people in the mining industry wanted to have, then of course, they focus more on the spend and the OpEx to make their systems, their solutions more productive.
Our next question comes from the line of Magnus Kruber of UBS.
Thomas, it's Magnus from UBS. A couple from me as well. So the first question, I mean, this DKK 30 million headwind on the capital side on Mining, I guess, will that effectively exit the books in -- or the run rate will be normalized as of Q2 next year, so no more incremental step-up there headwind for Q3, Q4 2020?
I mean, that is what we see in the backlog and the -- so that would hit more or less all quarters next year based on what we have in backlog right now. And then, of course, changes can come from whatever order intake we may take, but that is what we see in the backlog in the capital business. So that will be all quarter next year.
Okay, great, great. And then could you quantify a bit about how much is DKK 30 million in basis points on the effective projects?
Sorry, the line broke up. Could you repeat, please?
Yes. How much is this DKK 30 million in terms of basis points for the affected part for the capital business and the margins for those projects?
Yes. I mean, I think you can take the DKK 30 million and you can even compare that with the capital revenue we have per quarter, which is -- then you can see how it impacts our business. I think it -- that is probably the easiest way to make that calculation.
Okay. So I should apply it to...
Yes. So I mean, it's on the whole portfolio. So it's the average on the portfolio where we have -- what we have in revenue per quarter, and then you can basically divide these 2 with each other and then you can see what the impact is.
Okay, got it.
Roughly, it is roughly 2.5% on the Mining capital and roughly 1% of the Mining revenue.
Okay. And in terms of the DKK 25 million under absorption you saw in the second half. Do you think you will see a corresponding run rate through the first half of next year as well?
Can you repeat? The line is really bad. What was under absorption? Can you please...
Yes, you had a DKK 25 million under absorption from this stop-and-go effect, I think you mentioned. So do you expect that run rate to continue through the first half of next year?
No. So that is one where we will address that with the business improvement initiatives to ensure that, that is not continuing into next year.
With the reduction into fewer centers, we actually reflect the workload and the dragging out of timing on projects, which means in fewer centers, we will be able to absorb and to manage the existing cost structure more efficiently. We were a little bit too bullish on the outlook on capital business in Mining. Actually, as we communicated, I said that before, in the mid of '17, end of '17, we gave an outlook that we are back on growth. But we still are, but on a lower growth rate than we communicated, end of '17. And that is negative effect out of it, what we will rectify now.
Perfect. And the final one on a bit more positive note. Could you expand a bit on the global framework agreement you signed with the Rio?
Yes. It is always in our interest to have long-term agreements with very important technology-leading companies. Why? Because it makes it easier to negotiate, and it makes it easier to deliver and fulfilling all the milestones. So it's easier to predict and actually from forecast to cash, as we call it, that is quite a good system. The customer benefits because he doesn't need to put so much effort in it and we benefit out of it. What is very important here, it is a very unique contract. Rio Tinto is a market-leading company in the mining sector. It has, of course, an impact and sends a clear message that we are very well at partner in technical solutions, sustainable solutions for the mining industry.
Our next question comes from the line of Claus Almer of Nordea.
Also a few questions from my side. The first question is about this DKK 70 million in cost overruns. Is this specifically due to poor execution? Or have you just been too optimistic when you price the project? And if it's the latter part, going forward, will you then be able to get the right pricing or should we just expect lower margins? That will be the first question.
Yes, I can make it like that. There is definitely pure execution in it. I have to say that loud and clear, and you know us, we are quite honest and direct in it. But the bigger part is actually we were -- when we booked the orders, we were too ambitious on the time line how to realize it. With that related is, of course, the cost. If you stay longer on the mine side than you intend to do, then you have higher cost. Yes, we can invoice these costs later on, but not this year, and we have to see how long these projects are ongoing because that is normally what we call the claim discussion with the customer at the end of the project. And that creates these cost overruns. One word with it. It is definitely not loss-making contracts, what we talk here. It's simply lower profitability. And for that, we put a higher contingency in the future into that business.
So just to be sure. So you're saying this DKK 70 million cost overrun should be reversed next year?
It will be reversed over the time when we finalize these projects partly. But as I said, some part is not good execution.
Okay. Then my second question goes to the provisions in the quarter. We have seen that the level of additions and usage in Q3 is higher than we've seen in most quarters in the past. Is this also a reflection of issues with your delivery model, then you just saw included in the profit warning? Or it's more a quarterly variation?
So first of all, we do see large quarterly variations in terms of -- in particular, reversals and usage, where the addition line is really very much related to the activity level we have in that particular quarter. So the addition line should work more stable from quarter-to-quarter, where -- when you look into, as an example, the usage comes very much from it. We have any warranty claims, as an example, in that period that we have to pay off, or did we have any tax cases or so. So the usage can be a little bit more volatile than modest innovations and reversals is something that comes when the warranty period stops. And therefore, they are quite unrelated to the activity level you have in a particular quarter.
So just to be sure, so you do not see any different pattern in your provisions, it is more a Q3 specific event. Is that how we should understand?
It's always better to use -- look at a little bit longer period of time. When you look at the provision levels, and if you look at the year-to-date, I think they are -- that's more like a run rate than what you see in the third quarter.
Okay. So it is ticking up when you look at 4 quarters' run rate?
Sorry, once again?
If it is ticking up when you do it on a 4 quarters' run rate?
Repeat the answer, please.
Sorry, yes...
He did not understand the answer.
Okay. So when you look into the reverse -- sorry, the contingency level, I would look at the first 3 quarters as run rate. And then we always have a slightly higher activity level in the fourth quarter, which gives a higher addition level. And then it is a -- the reversals and the usages in the fourth quarter will be depending on what happens on the older projects and if we have any that runs out of warranty and so on.
Our next question comes from the line of Lars Topholm of Carnegie.
A few questions on my side. First, just a household question. You mentioned a couple of times there were no large capital orders, but didn't you announce DKK 200 million to Zijin mining in August? Or isn't that a capital order?
Yes. That -- what I said, larger capital orders. But as I guided, it didn't come through. I got already the sign here. And yes, it was around the DKK 200 million order, what we announced in August. That's true.
Okay. And then -- okay. On Slide 14, where you have the EBITDA average. You mentioned an assumption of DKK 20 billion in revenue. Should we see that as guiding that you will come out in the low end of the DKK 20 billion to DKK 21 billion range? And then going into next year, the backlog to revenue conversion, can you comment whether the pace should go up or down or be given -- take the same? And maybe if you can comment on each type of businesses, so both on capital business and on service business and then by division? Just for my modeling.
Yes. So the -- what was the first question here? Didn't write it down. Sorry.
There was -- Slide 14, you mentioned DKK 20 billion revenue and assumption. Is that the guidance?
The DKK 20 billion was illustrative because it was much easier to calculate with DKK 20 billion than the midpoint of our guidance, which is DKK 20.5 billion. So don't take anything from that, except it's much easier for -- to calculate with that and illustrate these numbers, which are estimates, of course. And then the second question was around how do we see the backlog conversion into next year. And of course, we are not guiding into next year at this point in time. But I think we have given a few hints that in cement, we do see that the backlog is lower due to the lack of large orders, and that will put pressure. At this point in time, what we see on the revenue in cement, of course, it's -- we have -- still have the hot list. So who knows what's going to happen, whether they will come in, and you know they are always lumpy. And on mining, I mean, you see that there is sort of -- like a more steady level of order intake on the capital part than there is in cement. So there, I think you can more model from order intake in mining to see where we end up. On service, we do see that we have increased the backlog in both industries. So there, we expect a lot. In the absence of any new developments in the fourth quarter, we should see more revenue from the service backlog in -- next year.
So I shouldn't be concerned because if I look at mining, your backlog is unchanged year-on-year. But you're indicating sort of slower activity in general, which might lead to slower delivery. So I shouldn't worry of a revenue decline from '19 to '20 for mining, but only for cement?
Maybe just one word. Remember the 2 cancellations, these have not moved a lot in the last couple of years. So they've been sitting there, not moving in the backlog, and we had, of course, hoped that they would be reactivated. So you can take that out of both the backlog from last year and this year, and maybe that gives you a little bit hint that it's not the entire backlog that is dropping. It's -- the drop in backlog really comes from things that were not moving in the past. So if it comes...
Sure. But presumably, the DKK 500 million is both in Q3 '18 and Q3 '19. So if I strip them out, the backlog is still the same. And my question is, will an unchanged backlog in mining, is there any risk it leads to lower revenue in '20 because your customers are hesitant to execute? Or am I just being too worried with it?
No, I don't think we -- we don't see that. And I think that the delays we see is partly on the order intake front where, as Thomas mentioned, you have this -- that they award us engineering orders and then they become equipment orders later on. So this is a stop-and-go thing. So that's really the effect we see there. And then on the order delay part, we had this really in the finalization. So it's not really where we generate the revenue that is being delayed, to a large extent, it's more the finalizing the projects where that takes a little bit longer. And that's not generating a lot of revenue.
That's clear. Then one final question on my side, you mentioned an increase in trade payables. To what extent is this affected by the usual reverse factoring?
It's a very small impact in the third quarter. So actually, the number of -- the amount of what we use in the supply chain financing program is very stable over the year.
Our next question comes from the line of Artem Tokarenko of Crédit Suisse.
My first question is around demand environment in mining. I think customer hesitation has been flagged by a number of equipment suppliers. I'm just trying to understand a bit better what you expect sequentially, how you expect demand to evolve sequentially in your capital and in maintenance business versus your previous guidance, which you gave at the Q2 for better sequentially. And specifically in service business, whether there have been any large maintenance projects in that DKK 2 billion order intake and whether you expect it to be -- that level to be sustained into Q4?
The -- you're completely right. We are not the only one flagging this cautious thing. What is very important to understand is this is not the start of a new era. That is not what we hear with the customer. It is kind of a temporarily slowdown in capital order. And we have a lot of reasons where it comes from. It's actually 2 main things. Yes, the macro environment always has an impact regarding -- that it's -- if it's so volatile, then they are more hesitant. But there's a big part of sustainability where both sides, the permitting part as well as the mining customers are struggling, what is actually the way forward there. And that puts things on hold when you have then orders, let us say, we have an order for a grinding station, and then the customer comes permanently with new requests on the environment because he struggles with what actually the permitting government office in that state requests. And that is a typical sit-and-wait situation, as we call it. Delayed, but not, how to say, canceled or cut or anything like that. That is all ongoing. And that puts the pressure on us regarding absorption, of course, and then I'm done. But I have to say that if you make the engineering for such a big project, then, of course, it's perfect if that team of engineers who did the engineering is then working on the capital order. But when you have a lot of engineering orders where you know you get the capital orders, but the capital orders are not coming, then you have to see how to maneuver that. And there, we were not the greatest in the third quarter, we can say that. And out of that, we had this impact on the profitability.
I guess my question was more around your order intake, what are your sequential expectations from CA in equipment and services business in mining. And whether DKK 2 billion of service orders include any large maintenance contracts, which shouldn't repeat in the near term.
The -- what you can see is we had a good service order intake run actually since mid of last year, and we see that actually overall ongoing. It's always a little bit up and down, a little bit more, a little bit less. But in general, the trend is upward. We don't have baked in the quarter, 3 big maintenance or any big aftermarket orders in -- which would explain the 19% growth. This is underlying. This is solid. This is not as we headed in quarter 1, quarter 2 2018 where we had a lot of service orders in it, what we communicated already in these days. The other thing forward-looking, yes, we see a higher share of aftermarket versus capital. And that is what we will see onwards until this cautious period on the capital is gone. To make it a little bit, and sorry for that, more complicated, of course, we know that we will have bigger announceable, bigger, larger orders in the pipeline. When they come in, they, of course, disturb that picture. But you have to see them on top of that what we normally generate, and we are in the expectation of that.
Okay. My second question is around the bridge for 2020. Could you please help us understand a bit better that capital versus service mix headwind, which you saw in H1, given that -- given a strong order intake as services, whether we should expect DKK 100 million to reverse in 2020? And also, how do you see that profitability in Cement going forward given that services will be a higher share, but equally, you're talking about maybe some underabsorption in your capital business because of lower order backlog?
So I think the first part of the question related to the mix, when we made the original guidance, we had assumed more service revenue. And that is why we had this impact on mix in the first half. And then when you make the bridge from '19 into '20, I would look at the order intake level we have in '19 and use that as an indicator for the revenue we may have next year. And there, you can see that we have been running with higher order intake throughout the year than we've had revenue. So that is why we are seeing that revenue from the service business is likely to increase next year compared to this year.
Yes. And then to Cement, very valid question. Yes, if we -- what we see, of course, having a higher order intake growth on the service part. Then on the capital, of course, you get more revenue out of the service. But regarding the profitability, of course, we need capital orders, too. That's clear. Otherwise, we run on the top line too short regarding the costs, and that would trigger other initiatives. But that is not what we see. And that magnitude, as it is, maybe thought about. We are in expectation of capital orders, but we see that they are simply didn't end up in the quarter 3. And let's see when they come in, that will define how much revenue we will have in 2020. To make it fairly clear, if we get larger orders in Cement and they are at the end of quarter 4 or in quarter 1 next year, it will have a stress on the revenue line for 2020 in Cement, because it takes a while for the larger orders to get really into the revenue phase. So we look into that very detailed. We have a very strong program ongoing with the profit improvement, and we will not change it to target profit improvement versus growth. That is clearly what we do.
Okay. And my last question is about profitability of mining capital business. Could you maybe help us understand a bit better whether if it's now breakeven or loss-making in 2019 after the profit warning? And what has been the normalized level of margins in that business in the last 3 to 5 years?
I'm first, and then Lars can take it with the figures. This is not loss-making. To make that loud and clear, it's not loss-making. It's less profitable as we anticipated. We were too ambitious on the timeline. We thought that we can, together with our clients, push the revenue or the orders faster through, then we see that we can do it, and that creates us additional cost. That makes some of the projects less profitable, not loss-making, to make it clear. That's very important.
Yes. And there is not much to add. We were profitable in mining capital in first quarter, second quarter, third quarter, fourth quarter, and will be that, I guess, in all quarters next year, too. So we are not giving you the details of that -- of what we make in the segments. So we only have a profitability measure on total mining, but it is still profitable in mining capital and will continue to be so.
Okay. If I actually may squeeze in a last question on Cement. You obviously talked about lumpiness of large projects. But if I look at the base business, ex the large orders, which you have been announcing, I have been -- it's -- I think the order intake has been running at about DKK 1.5 billion, DKK 1.7 billion over many quarters previously, ex large orders, and you've done DKK 1.4 billion in Q3. So, I guess, there is also some weakness in more base business. Could you maybe give some color on how base business equipment is evolving -- demand for base businesses is evolving?
Yes. And it's not a weakness. It's actually a company decision not to go for us for each order. I have to say it that crisp, that we announced we were very low EBITDA margin in quarter 3 last year, which was really a low point where we got, with all respect and absolutely right, a lot of criticism that we have to improve, that we have to improve our profitability for Cement dramatically. A 2% EBITDA margin for that business is simply too low. So what did we do? We looked into several things, how to make efficient, more efficiency and so on. But one thing was clear, we will go not for orders, where we think the profitability is too low, to generate a better profitability on the bottom line. On top of it, we reduced dramatically our exposure in the operation and maintenance business, which has a positive bottom line effect, too. But both, of course, has an effect on the order intake level. That's clear. It is not dramatic, but it's there. And I know it is difficult to communicate, but of course, we should take orders where we make enough money on the bottom line to have a good future for the company. And that is what we did. And that explains that situation where we are. So it's not based on the market.
Our next question comes from the line of Klaus Kehl of Nykredit Markets.
2 questions from my side. First of all, you mentioned that you've seen some cancellations in the backlog in this quarter. And as far as I remember, there were also a couple of cancellations in Q2. But could you just elaborate a bit on the status on the overall backlog? Is there any more projects on hold that could be canceled the coming 1 or 2 quarters? Or do you now have kind of a fresh backlog? And my second question would be that in order to reach the middle of your top line guidance, you need revenues of approximately DKK 6 billion in Q4, and that would be the highest level for quite a while. So what's the risk of you when missing on this DKK 6 billion? Is there any execution risk we should be aware of, or your thoughts about that? That will be my questions.
At first, I'll start with the -- regarding cancellation. The -- when we look into orders in the backlog, which are on hold for quite a while, what is the background for that? The background is that the customer wanted to do a technical solution on the site, where he then change the opinion, and we work constantly with the customer on it. Of course, it leads to some meetings to discuss if it's feasible. And when it then comes to a point that we can't offer that, what the customer would like to have as a return calculation for his investment, then we are at the point where we would -- where we tell customers, "It is actually the time not to go on, here." So that position we have and that is what we trigger, and we do that constantly. And when it's, like in these 2 cases, was last -- with one in bankruptcy and a possible new buyer and so on, and the other one with exactly what I described, we know that, that's on hold. There is no P&L effect. It was not affecting before and after. And so it's not a cancellation out of the actual business and situation in the industry. It's more a personal thing of these customers, has nothing to do with the business environment.
Yes. So -- and then the other question was around the revenue expectations for the fourth quarter. And the only thing we can see at this point in time is that we have a strong backlog, and the -- there's a lot of momentum in the projects. So we do see that we should reach our expected revenue for the full year.
Okay. And then perhaps just a follow-up on this backlog issue. But just to be clear, is there any more orders in the backlog that are on hold?
So we have no knowledge of any other cancellations that could happen in the backlog at this point in time.
Our next question comes from the line of Robert Davies of Morgan Stanley.
I had a couple. One was just you mentioned there is a strength in the aftermarket activity. I just wonder, when you look across your installed base, what the health of the existing kit is, I mean, you mentioned the sort of big focus on aftermarket and repair and upgrade. Is there a -- are we kind of through a hump on that cycle? Do you see more kind of momentum running into next year. I guess, just what is the sort of average state of your installed base would be my first question. And then the second one was just around the timing. I remember you announced a launch of Ethiopian cement project early this year. I just wonder if you had any update. I might have missed around the timing of when that's likely to be booked or convert to sales.
Thank you very much. At first, how is the stage. When most of the equipment was installed several years ago, we went through quite a mining recession, as you all know. And in that recession, which was very special for that, it was a huge amount of capacity produced. And at the same time, maintenance and service was cut down to the absolute minimum. And from time to time, when I'm quite often on mine sites, when I then look, equipment, which is only 5, 8, 10 years old, when it's not enough maintained and enough OpEx on it, looks really awful, and that is what we see. And that is the business potential, what we have. Our business model, to be in projects and processes in the equipment as well as the services, gives us a possibility to go in any supplier's equipment to help customers to improve. So our installed base is very promising for us to upgrade and to -- for the customer to spend more OpEx on it. If it comes to the cement order, yes, we announced and we said that this is to announce that we undersigned the contract, and all sites are working on it. And we will see when it comes into a bookable order intake. But it's one of these typical cement orders or projects where we work on, where you really have a problem to check when it drops in, because it depends on local requirements, permitting. It depends on banks, it depends on customers and shareholders of the customer. There are so many variables in it that when we ask our direct contact, they have normally the same knowledge level as we have. So we can't predict when it comes.
I see. And then maybe just one sort of follow-up question. Just on the general environment within the mining. We -- you mentioned sort of permitting, some of the Board's taking, like longer to make decision about their final approval. So when you sort of speak to the customers, is there much variation across the different types of commodities or regions? Or is this just sort of a broad-based trend? Are there any particular, I guess, markers? Are there any particular commodities where things are kind of less being pushed out and kind of still moving ahead? Or is it fairly equal across the different commodity types?
It's more a country thing than a commodity thing. Very good question. It's really more a country issue than commodity issue. We have -- we saw license-to-operate challenges, mainly in the Americas. I can be quite frank with that because it's public knowledge. And this is, of course, our stronghold in the mining industry.
Our next question comes from the line of Mikael Petersen of SEB.
My question relates to the centers that you were supposed to consolidate into fewer centers. How will that affect your global reach? And maybe also how will that affect your total capacity?
The total capacity will be not affected in that way, but we can't -- that we are not able to take any longer orders or so. But we put into less centers more people then the workload over a year or over a time is simply higher in that center, and that makes it easier to maneuver. We learned that the centers, what we -- had to be very close to the customers in some areas that's actually not so much needed. So we have the opportunity to do that. And as we saw in quarter 3, it's absolutely necessary if we see fluctuations in the order -- capital order behavior of the customer.
Okay. And I have a final question. You're talking about lower project margins in your backlog, should we assume the margin of projects going forward that you receive in 2020, '21, that those will be of lower profitability as well? Or is it only the current backlog that is of lower profitability?
We will -- when it comes to project what we take, we will be not that ambitious as we were before on the time line, which normally appear then, from our point of view over the run of the project, higher cost from our side. So we will see -- or we will have a lower profitability, what we see and what we take as a profitability level for these projects. We are not seeing that the whole industry is dropping, but the timeline on large projects is very important for the cost over the project. You can imagine that if you have 100 people on the site and they stay a month, 2 months, 3 months longer than anticipated, that is a cost issue. That is where we will be less ambitious when we take orders in, how we book that, how we calculate that. I can't say it different, the contingency level will be higher.
Okay. As there's no further response from Mikael Petersen, we'll go to our next question from the line of Magnus Kruber of UBS.
I'm sorry, a couple of follow-ups here. So on the savings, I just wanted to clarify that you see a DKK 25 million run rate end of this year, DKK 75 million extra next year. But did you say those DKK 75 million would materialize at the end of 2020? Was that right?
I mean, we were -- these are not the initiatives that you do overnight. So some of them will drop in the -- towards the end of next year. So there will be a small impact, but it's not dramatic. So use DKK 25 million for the impact in 2019 -- sorry, it's '20.
Perfect. And in the Cement business, could you help us a bit with the seasonality there into Q4? I think, if I remember correctly, you seem quite optimistic on the end of the year there from your Q2 results briefing.
Yes, the -- it is in both industries, or there's a challenge for the organization because there is a year-end rally, if I may say so, predominantly in the second half of December, where, of course, customers all over the world would like to spend the money what they had actually in the budget for the year. And the background is actually when we asked them, they get a decent amount of money for the year. If they don't spend that -- their money, what they get for next year will be lower. That's a little bit the driver. So we have generally, the fourth quarter stronger than any other quarter.
So should we expect sort of normal margin seasonality there in Cement also?
Lars, about margin. So I think we should see the same level of margin progression as we've seen there in rest of the year. So the market was good in the third quarter, and we expect it to be good in the fourth quarter, too, on Cement. It is very much the same projects we execute in the fourth quarter as we had in the third quarter. So no -- you did ask about margin, right?
Yes, correct. That's clear. Perfect. And I also saw you made some comment on Cement's order intake combinations and just this have a positive impact on investments in R&D. I'm not sure if I got that exactly right. I think -- could you develop a bit more what that means?
The R&D thing, what we show is each quarter, we show one element of the R&D, one innovation, what we bring to the market. What we see is that the mining industry, Cement was always like that. It's very open for new technologies, very open for new technologies. Everything, what can improve productivity, it's really demanded. And we get more abilities to test to go in and to sell these new technologies. So we run very much on offering more and more sustainable improvement solutions for the customer on any equipment, service or process. So the innovation demand in mining is significantly higher, I'm more than 30 years in the industry, I never saw that high.
Got it. And just one final one. How did the mix develop in the Mining service between spares and technical service in the quarter? And what should we see there going forward?
We have today a higher part in the revenue out of wear parts. We actually started only a couple of years, a little bit -- roughly 3 years ago, with our wear part strategy, we promised to the market that we will have minimum 10% of the aftermarket out of the wear parts at the end of '19. We will comment on that in the Q4 announcement. But we have few percentage points in wear parts nowadays. Otherwise, the ratio between technical service and spare parts is the same as before.
Our next question comes from the line of Artem Tokarenko of Crédit Suisse.
I have one about working capital and the 10% of sales target by the year-end. How do you now expect working capital to evolve given we are at about 13% in Q3?
Yes. So I mean, this is a key focus for us and has been so for a while. And -- well we do see opportunities to improve is on our lead assets and our accounts receivable where there is a number of opportunities to really drive that half. At the end of the year, we have, unfortunately, seen a delay in the mining projects, which has unfortunately also delayed payments from customers. So that is putting more pressure on it. And the other impact that is putting pressure on us is the lack of big capital orders where we normally get quite healthy prepayments. So those 2 things are making it more difficult for us. But we do see good improvements -- still good opportunities to improve in the remainder of the year. If it's going to be 10%, that's difficult to say at this point in time because there are some big, big numbers in there that can move in either direction.
Okay. And in terms of that capital versus service mix from Slide 14. Can you help to understand how that DKK 100 million is split between Cement and Mining business?
The product mix.
Yes, I think that's -- as I remember, it's -- I think it's evenly split between the 2. So we had a slightly lower service share in both industries in the first half than what we planned. And remember, this is compared to what we planned when we made the guidance. So we were -- in hindsight, we were too optimistic on how much we could grow our -- optimize our service business in both industries this year.
Okay. And the comments, which you gave on Q2 results on weaker mix within capital, that's already fully reflected in your DKK 30 million per quarter of re assets profitability?
Yes.
Okay. And my last question is on time line of those bigger projects in Mining, which are postponed because of environmental issues, with environmental license. Can you give some color about how big those opportunities are and some rough timeline expectations for you?
That is -- yes, we could -- we actually don't guide on that. I have to say that we actually don't guide on it. But the -- it is a positive outlook. That's what I clearly can say. Normally, I make it like that. The first thing -- what you get on these bigger orders is actually an engineering order. And with the amount of engineering orders, you actually can look into how big then the capital order wave will be, what you will get. Based on this cautious behavior, what we have -- I really don't want to trigger here a figure because it has a time impact. If I get not a lot in one quarter but a lot in the next quarter, then you say in one quarter, you underperformed, and in the other quarter, you'd say you overperform. It is a timing issue in it. We see a healthy capital order intake in front of us. The pipeline looks good. And the industry -- mining is in a growth cycle. But that's the negative in it. It is not on that growth cycle as we anticipated and communicated actually in the mid-end of '17, no matter that we rectified it in the course of the last few quarters, but that is clearly what we see. But it is still a good industry to be in, and it's a growth industry.
And there are no further questions at this time. Please go ahead, speakers.
Thanks a lot for all the questions and the participation. Hope you are all safe and see you soon. Thank you.