Epiroc AB

STO:EPI A

Earnings Call Transcript 2018-Q2

[Ingrid Östhols, Vice President Investor Relations]

Good afternoon, everybody, and warmly welcome to Epiroc's Q2 report presentation. Today, we have our CEO, Per Lindberg with us; and our CFO, Anders Lindén. And they will guide you through today's presentation. Go ahead, Per, please.

[Per Lindberg, CEO, President & Director]

Thank you. Thank you, Ingrid. And today is indeed an exciting day because this is the first presentation of our quarterly report for Epiroc. And not only it's an exciting day, it's a good day also because, I think, we have some good numbers to show you. And some highlights to start with. First of all, another quarter with orders received above SEK 10 billion. We had a very strong development for Equipment. We had double-digit growth for Service, and also healthy development for Tools & Attachments. And the good news here is that there continues to be a healthy demand in the beginning of the third quarter. Ramp-up on manufacturing is going well. We have record high revenues as well, and it's very good to see that our efforts to ramp up now is showing results and we get the response that we are looking for. We have a good operating performance, I think, even though we do have some challenges in the segment of Tools & Attachments, but I'll come back to that. We also have cash flow impact to working capital, I'll come back to that as well, and Anders will do that also, of course, but there's an impact from the strong growth, but also some inefficiencies that we are addressing when it comes to cash flow. And of course, also, the obvious fact that we're listed in the Stockholm Exchange since June 18. Now looking more specifically at orders received and how it's distributed across the world. I'm very happy to see the development and especially in South America and Africa/Middle East, as you can see, very good numbers. And in South America, we managed to get some very big orders in the quarter, and of course, that has an impact on the growth, above 50%. But you can also note that, for example, in North America, we do have a negative growth number in the quarter, but that is -- should be understood that we do compare this to last year's second quarter, where we did have a very strong second quarter in North America with big orders, especially in Canada. If you look at the bottom right-hand of this graph, you can see that the distribution between infrastructure and mining is where it typically is, with 70% in mining and 30% in infrastructure. Some other good news, and I think this is -- these are times when the industry is about to change the perception of how to push and drive productivity through innovation and technology. And one good example of this is the cooperation and partnership that we have engaged in, driven by LKAB, the Swedish state-owned mining company, iron ore mining company in the north, with an intention of developing a new world standard for sustainable underground mining. And this really means that developing a new standard for automation, for digitalization and for carbon-free production. And in this picture, you can see representatives from ABB from Saab Combitech -- or from Combitech, rather, from LKAB and Epiroc and also Volvo. So I think this is a significant development and also signifies what's going on in the industry throughout the world. We've also launched some new products. One of them is the beauty that you see down there, the Minetruck 2010. It's a 20-ton battery-driven mine truck. It's the newest addition to our portfolio of battery-driven vehicles. And this particular vehicle can be quickly charged or you can exchange the battery in a few minutes, and I think this is also something that creates a lot of attention among customers. We've also launched an automatic ventilation system based on our Serpent system and the automatic portion of this is really a system that detects the air quality and also changes the airflow, depending on the air quality. So I think, this is a step towards continuous automation of mines. And we also launched a product called V-LOK clamp, which means that it becomes easier and less hazardous to basically join a drill string when drilling. So these are some of the innovations that we have launched during the quarter.Looking more specifically at the financials. We did have an order growth of 18% organically or 21% in total. Revenue growth of 22% or 25% in total. Book-to-bill is now at 107%. So we continue to build our order book, even though this ratio is more healthy than it was in quarter 1, where we did have a much higher ratio of book-to-bill, meaning that we now are ramping up production. Our operating profit is SEK 1.8 billion, or corresponding to a margin of 18.4%. In absolute terms, the margin increased 23%. And included in this is the cost for the split from Atlas Copco and also the change in provisions for the long-term incentive program, all this is about SEK 181 million. The same quarter last year, that number was SEK 53 million. So if you back that out and adjust the operating margin, we're at 20.2% this quarter as compared to 19.3% last year. So we do have a positive development of the margin and also a quite good flow-through when it comes to revenues and profits.The cash flow, as mentioned, at SEK 199 million. Well, that's a number that is pretty low given the profitability. The big impact there is working capital, and again, the big impact on working capital is the buildup of customer receivables as well as inventories to -- and inventories, of course, to support the deliveries going forward, and receivables as a consequence of the ramp-up of invoicing.But we do also have some inefficiencies in the supply chain that we are addressing, and I expect that to get some improvements over the longer term. And over the shorter term, of course, improvements in working capital will be achieved once we get a better balance between our production and order inflow.Looking at the segments. Well, you can see the growth is quite healthy and basically in all segments. 31 -- now we're talking orders received. 31% for Equipment, 14% for Service and also a reasonably healthy 6% for Tools & Attachments. And the strong growth when it comes to Equipment & Service means that this now represent 76% of orders received. And if you look at the distribution between equipment and aftermarket, we are now at 41% equipment and 59% aftermarket. Last year, we were at 63% aftermarket and then, of course, 37% equipment. So we do have a very strong development when it comes to equipment. And of course, that's good news going forward because that will mean that our fleet increases and the potentials for continue to increase aftermarket sales also increases.Equipment & Service segment. We do have a continuous strong demand for equipment, as mentioned. Most of that is driven by our customers' expansion investments, and still about 2/3 of the sales is expansion. And the alternative to expansion is really replacement, where an expansion means that, basically, the mines have more equipment in operation, and replacement mean that you just interchange one piece of equipment for another. And we think that's a good sign because it means that the activities increase and also that the potential replacement cycle is not here yet. We've also increased the efforts to -- when it comes to marketing and sales, when it comes to service. Again, as you can see, the orders received for service increased 14%, and that does have an effect, all in all, order growth of 22%, revenue growth of 30%, and margin increase from 22.6% to 23.9% this year with a very good flow-through in this segment. And breaking that down and looking at Equipment & Service individually. You can see to the left, the bars for equipment, the black bars are orders received and the yellow ones are revenues. And as you can see, a very steep increase of orders received in quarter 1 and quarter 2 of this year. But I'm particularly happy with the development of revenues in Equipment. We actually increased revenues with 43% as compared to last year, when it comes to Equipment. And again, that's a good sign because, indeed, we can see the response in our supply chain in our factories when it comes to ramping up production. Service, the relationship, of course, between orders received and revenues is a little different, more immediate consumption of these services. So there's not a big difference between orders received and service as a consequence, but you can also see that there's a very healthy development when it comes to both of those in the first 2 quarters and, not the least, quarter 2 of this year. We did increased, as mentioned, orders received with 14%, and revenues with 19% for service in quarter 2. Finally, the segment, Tools & Attachments. We did have a healthy demand, as mentioned. Order growth of 6%, revenue growth of 5%, and that really gives us a book-to-bill ratio of 101%. What I'm not happy with is the operating margin. It actually came down from 14.3%, down to 12.4%, and with a negative flow-through. And this is not satisfactory. We are undertaking actions in order to mitigate that. We have already increased prices in the beginning of the year. That has not been enough. We've also done some structural changes in the beginning of the year, and has not really given the effect as of yet, but I don't think we have done enough. So we will continue to take action in order to break this trend that we see in profitability when it comes to Tools & Attachments. So -- well, I'll come back to the summary, I guess. So before that, I'll leave it to Anders to talk more specifically about financials.

[Anders Lindén, Senior Vice President of Controlling & Finance]

Thank you, Per. Yes, I will give a little bit of flavor to the numbers that Per briefly described. But first to talk a little bit about the orders received in revenues, the bridge. There is a good trend, I think, in particular, I would like to highlight that it's good to see that the organic growth revenue is exceeding the organic growth for orders received. Obviously, we still are building backlog, as Per mentioned, with book-to-bill being 107%. But it's a good trend and we see the result of the ramping up. Most of our currencies actually improved during the quarter and the end rates are higher than the average rates. It meant that, as you can see, the currency effect turned positive in the quarter, and in particular, the strong development of the U.S. dollar. So we also have a positive effect of the acquisitions, but it's minor, as you can see. When it comes to going forward, we should be aware that a big part of our markets are in a vacation period in Q3. So that normally has a dampening effect on the top line from the northern hemisphere. Looking at the margin development, again, Per mentioned, and here, I would like to -- you to look at the dotted line here, which represent the -- what we can refer to as the underlying margin of 20.2%, which then has been adjusted for the one-time costs related to the split from Atlas Copco as well as the change in provisions for the long-term incentive programs. Obviously higher than last year. Last year, we didn't have the split cost, of course, and we had a little bit less of the long-term incentive program costs or change in provisions. Also, we should be aware that we have a higher corporate cost this year than last year where we -- when we obviously didn't have the full corporate capacity which we have today. The flow-through, around 30% on the organic growth. And in the structure and other, we have a little bit of a dilution effect on the margin from the acquisitions as well as the contract manufacturing that we have. When we go into the segments, also mentioned by Per, we have a very good development in the Equipment & Service, with well above 30% flow-through. But we are not satisfied with the development of the Tools & Attachments, which is quite obvious from the bridge that you see here. Also here, we have a diluting effect from the structure as well as the contract manufacturing, which is in the Equipment & Service segment. Going into the -- looking at the P&L, I would like to make a few remarks. Obviously, the growth drives the numbers in general. We have our gross profit margin, which has an impact from the mix effect with more equipment than last year. We have also increased the efforts in R&D, which you can see from the expense. I would also like to mention that in the administration, which is obviously here in the marketing and administration expense, we have the provisions for the long-term incentive programs, and we also see an effect from the higher corporate costs, which are mainly in the administration. And now, we are more or less on a reasonable run rate for the corporate level, not completely fully loaded. On the interest net, and here, I would like again -- when we go down below operating profit, and I think we've mentioned that several times during the Capital Markets Day, for example, we have a situation where last year's numbers are not fully comparable because they -- we were not, I'd say, a stand-alone company at the time. So it means that the interest net is not really representative. Right now, we have an interest net, which is probably a little bit more negative than it will be going forward. But we can expect that it will be probably a negative also in the near future. It has an impact of the hedging that we do for loans in foreign currency, but it also, obviously, fluctuates with the exchange rates to some extent, which we cannot really predict. When it comes to the tax, we have landed on a level, which we believe is reasonable. We said before that we would be below 26%. This quarter, it was 25.2%. And yet, today, 25.5% were the effective tax rate. A few notes on the balance sheet. The funding is in place, which is we have according to plan. When we were listed on the 18th of June, we also paid back the loans that we had from Atlas Copco and replaced it with a bridge loan and also with a loan from the European Investment Bank. So that's all according to plan. Obviously, with the growth, we also have quite an increase in working capital. There is also a currency effect in the balance sheet. Otherwise, it's fairly as expected. When we look at the net working capital, it's obviously driven very much by the growth, and when we look at the KPI, the 31.7%, it's an average. I mean, if we look at the short term, it's a little bit higher, the ratio as such. But -- and in particular, I would just say, the inventory has increased and the receivables, and part of it for the inventory, also indicated by Per, with a limited effect though is the fact that we have the supply chain program, which means, in the simple words, short term that we have increased centrally inventory levels to secure availability before we can actually do a little bit of reduction out in the field. Looking at the debt, net debt. We have said we would be around SEK 3 billion in the net debt by the time of the listing, and we were at SEK 3 billion, with net debt-to-EBITDA of 0.4, it was 0.35 last quarter. And this is obviously very much according to the plan that we made and with the financing that we'll put in place. So the SEK 7 billion in loans are roughly SEK 5 billion from a bridge loan, which we will replace during the near future with more long term, and we have about SEK 1 billion from European Investment Bank, and also another SEK 1 billion in local loans around the world. In the -- the plan was also to buy back shares for hedging of the long-term incentive programs. So we have estimated that to be SEK 1.2 billion, roughly. We have a mandate to buy back 30 million shares, and we expect to use around half of it. As it seems right now for the programs, 2014 to 2017, all of that you -- there are plenty of details in the previous communications, for example, in the prospectus. And then, cash flow, which is obviously, given the profitability level, as Per has expressed, the SEK 199 million as operating cash flow, very much burdening by the growth, the growth has been stronger than we anticipated, which has also now, in the short term, consumed more working capital, both inventory and the receivables. So it's weaker than we would have liked, but it -- we see an improvement to come, of course. When it comes to the operating cash flow, we exclude the cash flow impact from the hedges of the foreign currency loans, which, with the strong euro -- or you could -- most of the currencies that we work with have strengthened during the quarter versus the SEK, which has -- with a neutral P&L effect, but it has had, with the hedging or the rollovers, had a negative effect on our cash flow. On the CapEx side, a little bit higher than in Q1, around SEK 400 million if you add up the different types of CapEx that we have in our cash flow statement. But it follows quite well the business -- the activity of the business, or the level of activity of the business. So with that, I've covered the financials in rough terms and takeaways, I'm sure there will be questions. So Per, if you can sum up before we continue?

[Per Lindberg, CEO, President & Director]

Of course. Summary is basically saying exactly what we just said, so I think we're looking at a strong quarter. We have very strong orders received, even stronger development when it comes to ramp up and invoicing. We're quite satisfied with the operating performance, even though we have some issues when it comes to Tools & Attachments, as mentioned, but we're dealing with that. And as mentioned, we do have, of course, a negative impact from the incentive program and also from the split cost, but that's highlighted, so you know the level of that. And of course, also the cash flow impact. But overall, we're quite satisfied with this quarter. And also, of course, the fact that demand beginning of the quarter 3 now continues to look healthy. And finally, I would like to point out that we have our quarter 3 report now on October 25. I think we have communicated another date previously, but now, it is on October 25. So that's the brief summary. And I now turn it over for questions. I think we'll start with the floor here.

[Unknown Analyst]

[indiscernible] Handelsbanken. If I may start on the -- you mentioned, Per, on the equipment side, it's mostly -- or 2/3s is sort of expansion of existing mines. Given the pattern that we're seeing that's been ongoing for a while now, when do you expect the replacement demand to come on stream? And also, tied to that, of course, another demand would be then new mines, and there were a couple of projects put in the icebox back in 2012. On those type of discussions you have, obviously, regarding automation projects and others, I guess, what's your best guess when we're going to see those type of orders coming into Atlas Copco or the Epiroc business?

[Per Lindberg, CEO, President & Director]

Well, I think, first of all, when it comes to replacement, the last peak, if you like, when it comes to equipment was back in 2012. The typical lifetime of equipment is perhaps 6 to 7 years underground, and 10, maybe to 15 years, surface. And we still haven't seen a big replacement cycle for neither underground or surface. So -- and we're approaching 6 years now. So it's not unreasonable to assume that replacement could pick up. I'm not saying should, but I'm saying could. So that's kind of where we are on the replacement cycle. When it comes to opening up new mines, relatively few such discussions. It's still really in existing mines. You can see that also from -- some interesting is to see the exploration is actually quite active, not the least, of course, in existing mines, trying to find new ore bodies on existing mines, but also trying to find brand-new, sort of greenfield ore bodies. But as of yet, not very many discussions on greenfield mines.

[Unknown Analyst]

My second question would be on the issues within G&A. And firstly, I’d like to understand, in what business did you see this? Or is it both? Is it in production in [indiscernible]? Is it the attachments business? Maybe open up a bit here so we can understand. And also tied to that, of course, the actions that you're planning.

[Per Lindberg, CEO, President & Director]

No, it's really -- Tools & Attachments is really 2 different parts. It's our rock drilling tools, and it's tools and -- it's attachments, hydraulic attachments, it's really for infrastructure. The hydraulic attachments is doing well. Rock drilling tools, obviously, that's where we have our issues. It's not really related to the bigger production facilities, such as [indiscernible]. But we do have a structure where we have, I think, 16 production units for rock drilling tools and some of the portfolio, of course, we do have a portfolio also when it comes to rock drilling tools. Part of that portfolio is under pressure. And of course, that can be related to some of the production sites that we have across the world. And so what we've done so far, as I alluded to, is we have worked with pricing in order to, call it, counteract raw material price increases that we have not been fully successful. We will continue to work with pricing because we feel fair enough that we shouldn't absorb that, we cannot absorb that. But there's still a question mark how successful we're going to be going forward. And I also mentioned that we've done some restructuring already. We have closed a plant -- the small plant in the U.S., so that's historically now. But still, we've done some restructuring also in China. But I think, given sort of the footprint that we have, I think we probably need to continue to do some restructuring within that area.

[Anders Roslund, Analyst]

Anders Roslund, Pareto. Have you talked anything about the very recent fall in metal prices? Is that something which concerns you? And have you had any discussions with your clients about that?

[Per Lindberg, CEO, President & Director]

Well, I haven't had that myself, but maybe I'm sure that somewhere in the organization, that discussion is happening. This is true. I think what we see, obviously, is metal prices becoming a little bit more volatile now over the last month or couple of months as discussions around trade is happening, and trade barriers. Now where this is going to go, well, I think, is difficult for anybody to assess. And I cannot see that it has had any material impact on our business.

[Anders Roslund, Analyst]

I just read that you commented about the short-term developments, saying that, so far, you haven't seen any difference, or could you?

[Per Lindberg, CEO, President & Director]

So far, so good.

[Ingrid Östhols, Vice President Investor Relations]

Okay. I don't think there are any more questions from the floor, then we can turn on the telephone conference. Do we have any questions from...

[Operator]

And the first question is from the line of Graham Phillips with Jefferies.

[Graham Phillips]

The first one is financial, and then we'll talk some other ones around investments. But just first of all, on the balance sheet, you talked about the bridge loan and the need to look for some other financing options longer term. Can you give us a bit of indication of what your average interest rate today is? And if you do get a credit rating from the rating agencies, where you think the average interest rate could go to?

[Anders Lindén, Senior Vice President of Controlling & Finance]

Graham, Anders here. For the interest rates, I mean, we have competitive rates. So they are about where they should be in the -- and it's a combination. The bridge loan is a bridge loan, which means that it's actually changing as we move on. But it's in SEK, and it's competitive with the SEK rates that you can get on the market.

[Graham Phillips]

I mean, when you get an independent credit rating, and I imagine you'll go to the capital market, and you should get a better rate or not?

[Anders Lindén, Senior Vice President of Controlling & Finance]

Well, yes, I don't think it will change a lot because we have a pretty strong balance sheet, as you know. And we have worked with our core banks closely to get the best, let's say, rates and -- we can have. So we anticipate to get around BBB+, or BBB, BBB+ on the rating once we have it.

[Graham Phillips]

Okay. And just around investments, I'm looking at your cash flow statement as well with the increase in CapEx, so both tangible and intangible. Can you give an idea of what sort of annualized figure should we be looking at here? And what the investments are going into, because I appreciate, obviously, the R&D is part of the intangible element, and where particularly are you putting in expansions in the tangible asset side?

[Anders Lindén, Senior Vice President of Controlling & Finance]

Yes. When it comes to the CapEx on annual, as I mentioned, we were a little bit higher in quarter 2 than quarter 1, so roughly SEK 400 million versus SEK 300 million in total between the components that you see in the cash flow. So I think it gives -- we're not planning any major CapEx projects. So it fluctuates fairly well with the business levels. So I think you're not far off if you use the numbers that you have first half and, let's say, extrapolate in a way and consider the business volume.

[Graham Phillips]

Okay. And just on Tools & Attachments, I mean, I imagine in here, there are consumables, not just for drilling and for the hydraulic business, so infrastructure. Presumably, the consumables that are being used in the mine, and we're seeing service growing very strongly that there should also be an increase in other consumables that are being used in the mobile underground machinery and other machinery. Is that also in here as well and is that not doing well either?

[Per Lindberg, CEO, President & Director]

Well, consumables for us is really the drilling tools. And of course, as equipment is being utilized, we also have spare parts, and spare parts is part of service. So the service business that we refer to is really pure service, i.e., man hours and also spare parts. I don't know if that answers your question but that's the way we divide it.

[Graham Phillips]

Okay. So for instance, if a bucket needs replacing on the front of a mobile machinery, then that would be treated as a spare part in service and won't show up in the consumable in your other bits of consumables which would be Tools & Attachments?

[Per Lindberg, CEO, President & Director]

That's correct.

[Graham Phillips]

Okay. So we are seeing some operating leverage effectively a little bit in service as well, because clearly drop-through margin in the bridge for your Tools & Attachments -- sorry, for your Equipment & Service is very high. I've got a number of close to 42%, and is that all equipment? Or is it some service? But it sounds like you probably are getting some sort of operating leverage out of the service business as well, is that correct?

[Per Lindberg, CEO, President & Director]

Yes. We definitely do. I think, the drop-through, or flow-through, as we refer to, is quite high in service part. We -- one should perhaps note that we also, within service, as mentioned, we have the pure service component and also the spare parts component. And these 2 are a little different in nature. And right now, the service component is actually increasing and this is due to the age of the fleet and the spare parts as a percentage is actually decreasing. That's going to change over time, back to more normal, but that's the distribution we have. And typically, the profitability for service is lower than for spare parts.

[Operator]

We're now over to JPMorgan and Andrew Wilson.

[Andrew J. Wilson, Analyst]

Can I just clarify a couple of points on the consumables side. I think, am I right in thinking that the activity levels are where you thought they were, but that profitability is being a bit just disappointed. Is that the correct way of thinking about it?

[Per Lindberg, CEO, President & Director]

Yes. That's exactly the way to think about it.

[Andrew J. Wilson, Analyst]

Perfect. And then, maybe just on the pricing side. You obviously mentioned you raised prices earlier in the year. And I think you made a comment that you hadn't been as successful as you thought to be in terms of recovering the raw materials. Is that because the price increases weren't large enough? Or because the market is rejecting the price increases? I just wanted to try and understand.

[Per Lindberg, CEO, President & Director]

I think, 2 components. I think, we were a little slow when it comes to reacting to input price increases, and so -- and of course, it always takes time to negotiate and to implement. That's the first component. I think, we didn't perhaps anticipate the magnitude of increases either, so -- which means that we haven't recovered the raw material price increases as of yet. So that's -- those are the reasons, basically. That's why we feel that we need to continue to work with pricing.

[Andrew J. Wilson, Analyst]

And just on that, do you think you're doing anything different from what your competitors are doing in terms of pricing? Or it's being just something that kind of the whole, I guess, market is struggling with a little bit?

[Per Lindberg, CEO, President & Director]

I have no idea exactly how our competitors are working with pricing, so neither their strategy nor the levels. So -- but I wouldn't be surprised if they see the same pattern as we do.

[Andrew J. Wilson, Analyst]

Perfect. And can I ask a more general question, just on the M&A side, which obviously, we talked about quite a lot at the Capital Markets Day and just getting a picture of what you're looking to do. Have you seen any change in that environment since you've been sort of separately listed in terms of incoming inquiries to you, or in terms of you getting out in the market? Just trying to get a sense of sort of what the activity levels are like there.

[Per Lindberg, CEO, President & Director]

Well, I think, I haven't seen a material change. Of course, I haven't been with the company since February 1, so my history is quite short, yes, but not that big of a change. The thing that changed, I guess, is that, in quarter 1, we made 4 acquisitions. In quarter 2, we didn't make an acquisition. But that's what I think could be expected. Sometimes, you strike, and sometimes you don't strike. But the activity from us is still high, and we expect to continue to make acquisitions relevant such going forward. I cannot say that I've seen a major change in interest for us as a potential buyer, I guess, you mean, after the listing, no. Maybe it's coming.

[Andrew J. Wilson, Analyst]

And maybe if I can just a quick one for Anders specifically. Just on the FX in Q3, could you give us sort of any help in terms of thinking about that at the EBIT line? Obviously, it's quite a lot of moving parts, but any sort of indication would be useful? Unless I've missed out and you've said something previously.

[Anders Lindén, Senior Vice President of Controlling & Finance]

It's always, let's say, difficult and a challenge to have, let's say, a future opinion of FX. But as I mentioned, the end rates for basically, with the one exception that I can think of, of our major currencies, the end rates are, let's say, higher than the average rates, so it means that if this stays, obviously, we will have -- we should have a positive impact in Q3.

[Operator]

We are now over to the line of Klas Bergelind of Citigroup.

[Klas Henrik Bergelind, Director]

Klas from Citi. A couple of questions from me. First on the supply chain program that will run for 3 to 4 years. Can you give us more concrete actions? I assume, it's on factory closures, getting inventories close to the customers, but also what kind of costs are we talking about? I appreciate that you will likely take this above the line, but just so we understand roughly, is it 200 bps of margin, 300 bps? And what kind of impact should we see from savings, both on COGS, but also net working capital, so what is your target there?

[Per Lindberg, CEO, President & Director]

First of all, the -- it's true, we're talking about a long-term program, which means that this is, call it, more or less, an entire revamp of the entire supply chain setup. Now, supply chain should be understood as the distribution of spare parts as well as consumables from our factories out to our customers. And this does not involve any factory considerations or factory closures, anything like that. It has -- but of course, it has to do with distribution centers and such. And so that's going to have, over time, a definite impact on the entire structure of both the transportation mode as well as the -- how things are distributed. So that's really what we're looking at. And just as an indication, we -- well, it's not really an indication, but I mean, it's -- we have done a fair amount of air freight over the last few quarters as a consequence of low availability in spite of high inventory, and this is something that is really showing that we do have some issues in our supply chain. So we're about to shift that to a structure where we have transportation via -- or marine transportation and another complete setup when it comes to how to fulfill demand out in the field. Cost for this will be, in the shorter period, we expect the savings to be pretty much in the magnitude of the costs, so it should be more or less neutral for the P&L in the shorter period. Longer period, we should -- the only thing I can say is that we expect to see substantial savings when it comes to both cost as well as inventories in consumables and spare parts.

[Klas Henrik Bergelind, Director]

That's good. My second one is on mining and the replacement cycle. You say that the replacement cycle is not here yet. That's a little bit difficult for me to understand because it was only in the middle of last year that [ MRET ] started talking about the increased expansion of mines or brownfield following 1.5 years of consistent commentary in the reports that all demand was driven by replacement. If we're looking at replacement cycles that are short, it seems a little bit strange that you haven't seen any replacement demand, obviously, over the peak levels that we had also before the financial crisis, '07, '08. So could you explain a bit more, Per, what you mean that we haven't seen any replacement demand?

[Per Lindberg, CEO, President & Director]

Well, essentially, what I'm trying to say and what I -- the way I think about this is that the -- we have, obviously, a substantial fleet out in the field, and at one point in time, all of that needs to be replaced because nothing is going to last forever. And when -- and if you look, again, back to the last peak was back in 2012, and there has been a sort of a, perhaps, I'm now saying perhaps, a more consistent level of replacement, that level is still here. But it's right now only representing about 1/3 of all the demand. Right now, the dominating part is expansion. So what's different from what we saw 1.5 years, 2 years ago, is that, now, we have really expansion investments and the lower portion or a smaller portion is replacement. So maybe we're looking -- it's possible that we're looking at a replacement, which is more stable over time rather than a wave or a cycle that would -- everything at the same time. So maybe that's kind of -- maybe it's skewing the perception a little bit. So -- and I cannot say exactly what's going to happen, but that's the way I think about it, at least.

[Klas Henrik Bergelind, Director]

Okay. My final one is coming back to the margin in Tools & Attachments. You're talking about the need to adjust capacity, and you are increasing prices, you were a bit late, but now you're increasing. So when can we see price-cost turn? Already in the second half? Or do we need to wait until 2019?

[Per Lindberg, CEO, President & Director]

Well, that remains to be seen, doesn't it? So we are probably more anxious than you to see a turn, believe me. And we are -- and I certainly expect us to turn the corner when it comes to pricing in relation to raw materials very soon. And that's my expectation. Now, is that going to happen? We have to see. And what I'm saying is that I don't think what we've seen in terms of pricing, nor does the structural things that we've done to be enough. I think we need to do more than that. But we have to come back to you guys once we have the decisions and the actions in place. I think there's a couple of questions from the floor.

[Ingrid Östhols, Vice President Investor Relations]

Okay. we don't have any questions from the telephone conference?

[Operator]

We do have quite a few more questions. We're over to Erik Karlsson at Industry Equity Partners.

[Erik Karlsson]

Sorry to belabor the point with the T&A margin, but it looks to me like it has decreased quite significantly for a couple of years also before raw materials, precious, perhaps started in a serious way. Could you just help us understand the history of the T&A margin a little without giving us exact numbers, but perhaps at least the primary reasons for the decline, is it more a raw materials squeeze, i.e., more short-term in nature? Or is it something more structural going on here, i.e., competitive pressures?

[Per Lindberg, CEO, President & Director]

I think, first of all, the history with Tools & Attachments is only -- is very short because we didn't have attachments in our portfolio up until basically last year, where we inherited that from CT and Atlas Copco. And to be honest with you, I think, perhaps, the comparative numbers that we saw in quarter 2 of last year for attachment tools, hydraulic attachment tools, were perhaps didn't include all the costs, so one should perhaps have that in mind. But nevertheless, your observation is correct. I think we've seen a longer-term deterioration on margins within rock drilling tools. And that has been more or less happening over the last few years. So you're correct. And now, the exact reasons behind that is, to me, I think -- you refer to either pricing pressure or raw material pressure or competitive pressure, I think, the -- I mean, short term, we see raw materials, yes, but longer term, it's clearly a competitive pressure.

[Erik Karlsson]

And so how we should think about it going forward is perhaps that you can offset the raw materials pressure, but not the competitive pressures that we have seen over the last 2, 3 years?

[Per Lindberg, CEO, President & Director]

Well, just think about it like this. I think, like any other business, rock drilling tools has a portfolio of products. Some of that is very healthy. Some of that is -- do have some competitive pressure. And we need to think about how do we shift the balance in our portfolio. And I think that's really what we're doing right now and thinking about how -- what this portfolio going to look like going forward? And where we, of course, assume and think that while the competitive pressures are not of the kind that we -- that's a business that we don't want to do going forward, we'll make those types of decisions. But we're not exactly there yet.

[Operator]

We're now over to the line of Markus Almerud of Kepler Cheuvreux.

[Markus A. Almerud, Senior Research Analyst]

A couple of questions. Many questions have been asked, but can I just talk about demand trends? And read somewhere that if you look at orders, especially for equipment, that they look kind of flattish, and you say that most of the sequential improvement is currencies. Is this correct? And if you look at your order books and discussions where you -- that you're having with your customers, is that correct also going forward in the near term that we'll see kind of demand flattening out at very high levels? That's my first question. And then, I'm just wondering when you expect to be having caught up with your production facilities and the investments so that you will deliver in line with your order book?

[Per Lindberg, CEO, President & Director]

Well, again, I mean, we're -- what we see now is that we see that demand being healthy, and that means that we, right now, we're seeing demand being pretty much what it was in quarter 2. Now, one should remember and understand that depending on when the exact orders land or we receive the specific order is going to have an impact on the specific quarter. Now we also -- we released, I think, yesterday, we released, it was a press release from an order that we received in quarter 2, Cormidom in Dominican Republic, over SEK 200 million. Of course, if that would've landed in July, the relationship between the quarters would have been somewhat different. So one should keep that in mind that the orders will have an impact on the quarters as well. So assuming that everything is flat may not necessarily be correct.

[Markus A. Almerud, Senior Research Analyst]

Okay. And in terms of metals, is it mainly copper which you're driving now? Or is it fairly balanced?

[Per Lindberg, CEO, President & Director]

I think what we've seen -- what we saw during quarter 2 is that copper is very active. Yes. Copper and gold is -- seems to be a little bit more flat, but not -- again, not necessarily an indication of what's going to happen forward, but that's what we saw in quarter 2. And again, the big commodities that we're exposed to is copper and gold.

[Markus A. Almerud, Senior Research Analyst]

And then, in terms of the building capacity, when do you expect to be caught up?

[Per Lindberg, CEO, President & Director]

Well, if orders received continue to increase with 18%, we have to increase production with 18% during the quarter as well. So that's a good question. We are as you understand, I mean, we are at more or less -- we're a little above SEK 9 billion in revenues or invoicing, and that's the pace we were in quarter 2. And it's, I guess, it's a fair assumption also that we're increasing throughout quarter 2 as well. So the pace continues to increase, I mean, that's a fair assumption. And when -- are we in balance? Well, it really depends on where we are when it comes to orders received. So it's kind of difficult to answer, I guess.

[Operator]

We're now over to the line of Matthew Spurr of Exane.

[Matthew Spurr, Research Analyst]

So the first quick one, which was what's the main bottleneck in your production that stops you being able to catch up to orders?

[Per Lindberg, CEO, President & Director]

I think, we've -- at the beginning of the year, it clearly was components, especially -- specifically hydraulic components. I think, most of those bottlenecks have now shifted into our own assembly capacity. So I would say it's our internal capacity that's the bottleneck right now.

[Anders Lindén, Senior Vice President of Controlling & Finance]

I would like to add that the, let's say, the sub-suppliers, that hasn't gone away. It's still a constant challenge. They obviously will -- when they ramp up with the same pace as we, they obviously are facing the same issues.

[Per Lindberg, CEO, President & Director]

Yes.

[Anders Lindén, Senior Vice President of Controlling & Finance]

So it doesn't mean that, that, let's say, challenge has disappeared.

[Per Lindberg, CEO, President & Director]

Yes. But it's less obvious.

[Anders Lindén, Senior Vice President of Controlling & Finance]

Yes.

[Matthew Spurr, Research Analyst]

Okay. And then, can I ask one on the cash flow, and how you think about the second half and whether there's any catch up that, obviously, by the time you take out the financial net payment with the hedging, you haven't generated that much cash in H1, how do you think about H2, what sort of conversion can you get?

[Anders Lindén, Senior Vice President of Controlling & Finance]

I mean, our expectations is, obviously, to deliver a much stronger cash flow in -- for the rest of the year. We had a very strong finish in the quarter, which meant that we're also tying up a lot of receivables, which you can see when you look at the numbers. So -- and traditionally, from a cash flow point of view, we're -- and working capital point of view, there is a relief in Q3. So we expect a strong cash flow in Q3 and the rest of the year.

[Operator]

We now go to Barclays Capital and Lars Brorson.

[Lars Wauvert Brorson, Director]

Actually, just a couple of very quick follow-up questions, maybe more to Anders. Just on the last comment you were making, Anders, with regards to relief of inventories in Q3, is that beyond normal seasonality? I think I heard you say earlier that you've obviously increased inventory centrally before reduction in the field. So should we see some of that beyond normal seasonality impact working capital in Q3 and Q4? And maybe just more generally, when should we expect, should we say, more normalized working capital level relative to where we are into the cycle and the ramp beyond these specific initiatives that you've undertaken?

[Anders Lindén, Senior Vice President of Controlling & Finance]

There are a couple of, let's say, components in this. First of all, I think, from the supply chain initiative, we shouldn't expect dramatic improvements during -- in the short term, meaning Q3, Q4. There will -- we expect some improvements. But I also think we -- the growth that we had in this year was obviously above our expectations. And if you look at the relative ratios of working capital, yes, we're a little bit higher than we were -- what we would have liked to be, but it's not exceptional. But obviously, with the growth rate that we've had, you tie up more capital. If you grow 25%, just as an example, then obviously, you also have -- unless you're improving your efficiency, you also grow your working capital 25%, just to make it obvious. So -- but we are now in a situation where we should be able to turn a lot of this working capital into cash for the remainder of the year.

[Per Lindberg, CEO, President & Director]

I would like to comment also. I think this is true, of course. I mean, the big consumer of working capital is the growth itself. But that doesn't mean that we don't have any efficiencies. So we keep an eye on this, and we will work very intensively to improve working capital levels as well as the cash flow, that's for sure.

[Anders Lindén, Senior Vice President of Controlling & Finance]

I would agree, of course. Yes.

[Lars Wauvert Brorson, Director]

Helpful. Second, and finally, can I just follow up on the FX question earlier and probe you a little bit on FX impact in Q3 on your EBIT beyond the fact it will be positive. I think, that's quite obvious. Are you able to put a number to that? Or if not, can you help us a little bit with the transaction impact beyond the translation impact on FX?

[Anders Lindén, Senior Vice President of Controlling & Finance]

I would not like to put a number on it, to start with. But obviously, we have tried to guide in the prospectus, where we say that we -- that 1% on average would give SEK 90 million on the bottom line. But I mean, that's very, very general, and that depends, obviously, on a number of things. But to guide you and to tell you exactly how it's going to influence Q3, assuming that we have the exchange rates that we have as we speak, that I would not like to do.

[Per Lindberg, CEO, President & Director]

I think, again a comment, I think this is a question that I expect to be recurrent over basically all the quarterly presentations that we have, and of course, we are now a new company and we're still understanding our own currency exposure and what to expect from ourselves going forward. So I think we'll work on understanding the currency exposure also going forward in a better way than we have perhaps right now. So hopefully, we'll be able to guide you a little bit more specifically going forward.

[Operator]

We now go to the line of Sebastian [indiscernible] at [indiscernible].

[Unknown Analyst]

First, coming back to the invoicing ramp-up, just maybe a clarification. If demand stays in line with what you've seen in Q2 for equipment, should we see a catch-up as soon as Q3, because I mean, the ramp-up was pretty steep in Q2? So could we catch-up with the current level of demand as soon as Q3? And I have a follow-up question.

[Anders Lindén, Senior Vice President of Controlling & Finance]

On the ramp up.

[Per Lindberg, CEO, President & Director]

Yes.

[Anders Lindén, Senior Vice President of Controlling & Finance]

I think, Per mentioned it and expressed it very well. Obviously, we -- it's a moving target, which means that by the end of the quarter 2, we have a higher capacity than the beginning. So I don't think we are far away from having a balance, but it depends obviously, on many things, on the orders coming in and what kind of orders. But to say that we are catching up, we still have a book-to-bill of 107%, so we still get more orders than we were able to invoice in Q2. So...

[Per Lindberg, CEO, President & Director]

I know it's kind of -- I understand how you perceive the nature of the answer, but it is difficult to say. But of course, if orders were to stabilize exactly at the level that we were in quarter 2 for some reason, and we have made progress during quarter 1 -- or quarter 2 when it comes to ramping up production, so of course, we will see a catch-up in a relatively short term, but that's no guarantee because we don't know where the orders received are going to go. I mean, that's obvious.

[Unknown Analyst]

And on tool demand, if we look at the order intake, I mean, it has developed negatively compared to quarter 1, and notably in North America. I mean, are you losing market share in North America with cheaper products? Is it part of the issue for this business?

[Per Lindberg, CEO, President & Director]

Well, I can't say that we're losing market share. And the -- you're right, we saw a negative development of sales versus last year in North America. But then, again, remember that last year, we had a very strong quarter in quarter 2. So it doesn't mean that the sales in itself was...

[Unknown Analyst]

But it's so sharply down versus Q1.

[Per Lindberg, CEO, President & Director]

Yes. That's true. But I cannot say that we're losing market share. But again, that's a good question. I guess, we have to see.

[Anders Lindén, Senior Vice President of Controlling & Finance]

Yes. I think, we need to remember that when you look at sequential for that segment, the Q1 was very strong. It's a little bit of seasonality in it and it was a very strong quarter.

[Unknown Analyst]

Okay. And a final question, again, on the Tool business. How much of your revenues are derived from long-term contract, 2, 3 years contract versus what is discretionary?

[Per Lindberg, CEO, President & Director]

Good question. I don't know.

[Anders Lindén, Senior Vice President of Controlling & Finance]

It's not a major part. If you look at the Tools & Attachments, first of all, a big part of it is attachments rather than consumables. And in the consumables, it's a smaller part of the consumables side.

[Ingrid Östhols, Vice President Investor Relations]

Okay. I think time is running out. So I think that was the last question. So we will close down this session, and thank you very much for participating, and hope to meet you again in October. Thank you very much.

[Per Lindberg, CEO, President & Director]

Thank you.

[Anders Lindén, Senior Vice President of Controlling & Finance]

Thank you so much.