Epiroc AB

STO:EPI A

Earnings Call Transcript 2022-Q2

[Karin Larsson, executive]

Hello, everyone, and a warm welcome to the Epiroc Q2 results presentation. My name is Karin Larsson, and I'm Head of Investor Relations here at Epiroc. And with me today, I have our CEO, Helena Hedblom; and our CFO, Hakan Folin. They will briefly present the results before we do the Q&A, and it's possible to listen to the presentation and the Q&A session in the webcast, but the questions will be handled over the phone as normal. Helena, please, the stage is yours.

[Helena Hedblom, executive]

Thank you so much, Karin. So I will start with some highlights. The demand and the customer activity remained high and orders received increased 21% to SEK 13.4 billion. There was a large impact from Russia, both year-on-year and sequentially, including an effect from order cancellations. If we exclude Russia from the comparison, the organic growth was 18% year-on-year. We won 5 large orders above SEK 100 million in the quarter, and the large orders were in total more than SEK 800 million. Service performed very well with strong organic growth, also the order intake from construction customers was high. And a special highlight this quarter is electrification. It was our best quarter ever with several equipment orders, orders for battery retrofits and for electrical infrastructure. And we are further strengthening our capabilities here. We acquired another provider of electrical infrastructure solutions and this time in Australia.

Our revenues were record high with double-digit organic growth in the aftermarket. And the operating profit was impacted by some one-time items, including a provision of SEK 400 million for Russia. If we adjust for these, the operating profit and margin were record high. So all in all, a strong quarter. The organization has managed to deliver in a good way despite many challenges. So very well done, everyone. A major challenge is the war of course in Ukraine. It is horrifying and we continue to take measures to protect our colleagues and manage the complex situation both in Ukraine and in Russia. And if we look more broadly, we continue to see higher input costs and supply chain challenges. However, our agile organization can adapt quickly to changes and challenges and our large aftermarket business also provides resilience. And we are also investing and building for the future, and I will come back to this later on.

But first, some key financial, and I will be brief and Hakan will come back with more details later on. So high order intake, as mentioned, with 6% organic growth, but with a large negative impact then from Russia, 9% organic revenue growth and record high revenues. And I think this is solid considering the supply chain challenges and the impact from Russia. So even in this situation with record revenues, we are building backlog, and we have long delivery times. So many of the machines that we booked this quarter will be delivered in 2023. Our operating profit was SEK 2.8 billion, adjusted for items affecting comparability, which gives an adjusted operating margin of 23.6%, and that is the highest ever for Epiroc. So a strong quarter overall, but also remember that the second quarter is a solid quarter from a seasonal point of view. The third quarter is typically somewhat softer on orders and on revenues compared to the second quarter.

So now over to Page 4. You know that innovation is one of my priorities. So a couple of examples. We continue to expand our digital offering, and we have now implemented a solution for tunneling construction. And the solutions improve both safety and at the same time, it is improving productivity. Also, it's exciting that we will try the first-ever battery electric surface drill rig in this quarter. We did not write so much about our large orders in the report, but I would like to mention a few here. As you see, we are really partnering with our customers. For example, we work together with Glencore and Boliden, which both ordered a fleet of battery electric equipment and automation solutions.

Fresnillo in Mexico is a long-term partner for us, and now they have awarded underground equipment with several automation features. So we are proud to be selected as partners by our customers. And as you can see, we have a very comprehensive offer in the areas of electrification, automation, and digitalization. And with our acquisitions, we build for the future, and we develop even closer relationships with our customers. We completed the acquisition of JTMEC, a provider of electric infrastructure solutions in the quarter, and we also agreed to acquire RNP, a rock-drill manufacturer in Mexico. So these will be great contributors to [ APROC ] and I welcome our new colleagues.

So then over to aftermarket. We are successful with our service products and our structured way of working, which is visible in the order intake. We have also introduced new innovations. And I would like to mention some highlights here. The V Cutter is setting a new standard when it comes to effectiveness in trenching and our new drill bit assortment with diamond-protected buttons prolongs the replacement intervals, which gives many benefits -- it's safety, productivity, and lower CO2 emissions. So that's really good if you ask me. And our connected fleet is also growing. We are close to 7,000 units now delivered with connectivity. I also want to mention here that we continuously invest in our aftermarket footprint. And this year, we are, for example, building for the future and investing in service facilities in North America, in Africa, and in Asia, and these investments will support our growth in the coming years.

As you know, we always try to make good things even better. And in the quarter, we announced a couple of changes to make Epiroc better for the future. So we will relocate the production of a range of surface drill rigs from Japan to China. And this move will improve our long-term competitiveness and our agility. Our facility in Nanjing in China is larger and have a significant infrastructure for production, sourcing, and logistics. And in Japan, we are instead investing in our sales and service organization. Also, we have decided to enhance focus on our digital solutions. So we have created a dedicated division with commercial responsibility for our digital solutions, including the recent acquisitions in this space. We have also appointed a Chief Technology Officer, CTO, who will have responsibility for the development of common automation and digital platforms as well as for group IT.

So then over to sustainability. And if I start with people, we are pleased to see that the share of women employees continued to rise -- and we continue to promote inclusion and diversity, and we have many initiatives ongoing in the company. When it comes to injuries, this is concerning. We continue to have a negative development here with more work-related injuries. Fortunately, we did not have any severe injuries in the quarter, but we need to bend the trend here, and we are taking many actions to achieve an improvement. On planet, our CO2 emissions from operations decreased, and we have installed many solar panels on buildings, and we are buying and using a higher share of renewable electricity. The picture shows our factory in Hyderabad in India. For transport, the CO2 emissions increased mainly due to higher volumes transported but relative to revenues, however, the CO2 emissions decreased. So I will now leave the speaker line to Hakan, who will give some more details on the financials.

[Hakan Folin, executive]

Thank you, Helena. Before we go into the details and the analysis of the financials, some words on Ukraine and Russia and our financials and our exposure there. For us, the #1 priority has been and is the safety and well-being of our colleagues. During the quarter, we have continuously evaluated the situation, which is very complex. Now it is our assessment that it's currently not possible to conduct business in Russia. It also means that we make adjustments in our Russian operations to adapt to the current situation. And in a difficult situation like this, we want to do this in a controlled manner, and we respect our employees. Therefore, we have taken a provision of [ SEK 400 million ] relating to accounts receivables, inventories, and restructuring costs in Russia. And after this, the value of assets in Russia and Ukraine amounts to, in total, [ SEK 1 billion ].

During the quarter, we have collected outstanding receivables, which means that the majority of the assets are now in cash. If we adjust for currency and the provisions, the assets have decreased by more than SEK 400 million since the end of March 2022. And at the end of June, we have orders on hand of about [ SEK 1.4 billion ] combined in Russia and Ukraine. The number is heavily impacted by currency here as well. If we adjust for currency, orders on hand more than half since the end of March, mainly due to the cancellations of [ SEK 480 ] million in Russia. And also in the second quarter last year, close to 8% of the order intake was related to Russia and Ukraine. Some revenues have been recognized in Ukraine and Russia during Q2 2022, but significantly less than in Q1 and then in Q2 2021. And then finally, a reminder that Ukraine and Russia represented almost 7% of revenues in 2021, and we do not have any manufacturing in these markets.

Okay. If we then look at the development in Q2, our operating profit increased 9% to SEK 2.4 billion, but we also had SEK 420 million of items affecting comparability. SEK 400 million of these for the provision in Russia that we talked about, SEK 95 million relating to restructuring in Japan, and then a positive impact of SEK 75 million from the LTI program. So the reported margin was [ 28.1% ] and the adjusted margin 23.6%, which, as Helena said before, actually the highest ever for Epiroc. If we look into the details then on the profit bridge, the organic growth, volume and price contributed with [ SEK 445 million ], 2.4% points to the margin, so a good flow-through compared to last year. Currency supported the operating profit as such, but actually diluted the margin slightly with 50 basis points. Structure and acquisitions together, large negative, as mentioned on the last page. Acquisitions had a negative impact on the profit and the margin. And the dilution of margin from acquisition was about 80 basis points.

Now I'll focus on the segments, and I will start with Equipment & Service. Here, order increased 10% organically. If we exclude Russia, organic order growth was actually 25%. Orders received supported by currency by 11% versus last year. We had a contribution from acquisition with 5% to orders and about half of this came from the acquisition of JTMEC, which we closed during the quarter. As Helena mentioned, we won orders above SEK 100 million, 5 of them and in total, SEK 800 million. And as we have said before, these equipment orders are lumpy, but we see that the underlying demand was healthy during the quarter.

Organic growth in service was 14%, very strong and supported by some large orders, for example, for midlife services. And also in this quarter, we saw examples of customer placing orders for parts to safeguard deliveries, but I would say, to a lesser extent than what we saw in the first quarter. On the revenue side, organic increase was 8%, actually, with negative growth in equipment, but strong growth of 18% in service. I will cover the details on profit and margin on the next page. But before this, I want to follow up on the financials of the relocation of manufacturing from Japan to China.

We took a restructuring cost of [ SEK 95 million ] this quarter, as mentioned. And we have sold our property in [ Yokohama ]. We will have a capital gain of about SEK 350 million from this. And in our press release, we indicated that this capital gain will occur sooner, but now we expect it to be realized first in 2024 when the property actually changed ownership. Okay. The reported operating profit was the same as last year, SEK 1.9 billion. But if we adjust for the provisions in Russia and the restructuring cost in Japan, totaled SEK 422 million. Adjusted profit was [ SEK 2.3 billion ]. The adjusted operating margin was 26.6%. Organic growth and mix contributed to the margin with 2.6 percentage points. This was almost offset by currency and dilution from acquisitions. The share of service revenues was 63% compared to 58% last year, which impacted profitability positively. And as you know, we do not guide on margin, but the mix effect and in this quarter, very strong mix effect from service, we expect this to taper off once we deliver and invoice more equipment.

So over to Tools & Attachments. Orders increased by 5%, but actually decreased 8% organically, mainly due to Russia. And if we exclude Russia, organic order decrease was 2%. Order intake, SEK 2.8 billion, clearly lower also than in Q1. Typically, there is a seasonally lower order intake in Q2 versus Q1, and then we have Russia on top of this. Revenue, however, grew 11% organically and was as usual in the second quarter, seasonally strong. This was actually the highest revenues ever and the focus right now for this division is to maintain a good level of profitability and deliver on our orders on hand, which are at historically high levels.

And the profit bridge for Tools & Attachment, where we had a reported operating profit, which increased 20%. If we adjust for the provision in Russia, it increased 38% to SEK 573 million, supported by the organic growth, currency and also acquisitions. Adjusted margin was 18.2%, and also the margin was supported by the organic growth in currency, while there was no bargain impact from acquisitions. And now we have actually had 4 quarters in a row with an operating profit margin above 18% for Tools & Attachments.

Back to group level then, and we dig down in cost, net financials and tax. We saw again after lower Q1, higher cost. This is [ logic with ] more activities, more cost of logistics, continued investment in R&D, et cetera. And the absolute number is also impacted by currency and acquisition, both year-on-year but also sequentially. If we measure as a percentage of revenue, costs were at 16.7%. Net financial items, SEK 89 million versus SEK 44 million last year. Volatility here is mainly exchange rate related, while interest net was actually quite stable. Income tax expense was SEK 590 million. This corresponds to a tax rate of 22.6% versus last year, 20.8%.

And last year, we had some onetime effect which lowered the overall tax rate. If we then look at cash flow, our operating cash flow in the quarter increased to SEK 1.5 billion from SEK 1.2 billion last year, positively impacted by higher working capital, but then negatively impacted -- sorry, higher operating profit, but negatively impacted from a change in working capital. We increased working capital with about SEK 0.5 billion during the quarter. And we do tie up more working capital when we grow. And for inventory, we also secure availability of components. And as you know, both inbound and outbound lead times are unusually long and also unreliable. Cash conversion last 12 months was 82%, slightly higher than in Q1.

And on this page, you can see the increase in working capital. It's up 18%, excluding acquisitions and currency. We tie up more working capital when we grow. But if we relate it to revenues, it's still lower than last year at 29.5%. Capital employed is increasing mainly due to the growth due to acquisitions, and we had an impact this quarter from the dividend payment that we performed. Return on capital employed, however, continues to improve, and mainly this is due to the higher operating profit, and we are now at 28.1%. We have a strong financial position. We have net cash of SEK 876 million, and this is despite the first payment of the dividend of SEK 1.8 billion that we did in May. The second payment will be done in October, and we'll be the same amount, SEK 1.50 per share. So that's it for me. Back to you, Helena.

[Helena Hedblom, executive]

Thank you. Hakan. So to summarize then. So the demand remained high in the quarter with several large orders won and with strong growth in service. It was also the best quarter ever for electrification. We achieved record revenues and record high adjusted operating margin. At the same time, we continue to see higher input costs and supply chain challenges. And there is uncertainty about what the future will look like. Of course, we cannot predict exactly what will happen, but there are strong long-term drivers for our industries, and these are still there. The world will need metals and minerals and infrastructure to become more sustainable. I will comment on the near term shortly, but regardless of what will happen, our agile organization can adapt quickly to changes and our aftermarket business provides resilience. We just turned 4 years as a listed company. It has been an exciting journey, and it's clear that we drive the productivity and sustainability transformation in our industry, and we will continue doing this also in the future.

And then a few words about the future. Looking ahead, we continue to see high activity and solid demand overall. And therefore, we expect that the underlying demand, both for equipment and aftermarket will remain at a high level in the near term. And remember that we talk about the underlying demand and that large orders are lumpy. So thank you all for listening, and now it's time for Q&A.

[Karin Larsson, executive]

Yes. It's indeed time for Q&A. Thank you very much, Helena, Hakan. Great presentation and great results. Good execution. In the Q&A session, everyone, please keep your questions short and limit yourself to one or maximum 2 questions, if possible. This will make it easier for us as well as for you because more of you can get a chance of asking a question.

[Operator]

The first question today comes from Klas Bergelind with Citi.

[Klas Bergelind, analyst]

[indiscernible] so can I start by asking on Tools & Attachments. Orders are down a bit, 2%, even if we adjust for Russia? Would you say that this also reflects quarter-on-quarter weakness ex Russia? I'm thinking mainly about your construction exposure, Helena, [ I'll start there. ]

[Helena Hedblom, executive]

Yes. On the construction side, Q1 is very often when you build up the inventory or you get the orders and then you deliver it in Q2. But I would say also that we sit at very high orders on hand in Tools & Attachments. And it's the focus now and lead time is not really where it should be. And of course, when it comes to these type of products, customers can't wait. So I think actually it's quite healthy for us to work with the orders on hand down. And as you saw, we have really solid development on the revenue side in the quarter. So focus is to make sure that we get back to, let's say, more normal orders on hand level for this division.

[Klas Bergelind, analyst]

Yes. But there is no sort of construction weakness that is creeping in?

[Helena Hedblom, executive]

No.

[Klas Bergelind, analyst]

Okay. My second one is on services. Obviously, let's pre buy, as you said versus last quarter, but still very strong growth. You had several retrofit battery orders in there. We know the launch orders, you said SEK 800 million, I think, which I assume is all in equipment. Could you help us with the battery retrofit orders and I'm trying to understand how the conventional service business, if you like, grew in the quarter?

[Helena Hedblom, executive]

So the majority of the growth is coming from traditional rebuilds or larger component rebuilds, customers rebuilding existing fleet to push the productivity up. So that's the majority of it. Then it's supported also with orders for retrofits for batteries. The majority is traditional rebuilds of larger components.

[Klas Bergelind, analyst]

Okay. No, it's good to see. My very final quick one for you, again on [ FX ]. Did you have any revaluation effect at quarter end? It looks like a quite low impact compared to other sector reporting named this reporting season?

[Hakan Folin, executive]

No, there were no really specific items, I would say, but it always depends for currency on the exact balance day and also what -- since it's a bridge, what we had in the quarter last year. But no, there was no onetime specific items.

[Operator]

The next question comes from Will Turner with Goldman Sachs.

[William Turner, analyst]

So one thing I thought was quite interesting from the statement today was within equipment and services. So sales in equipment, despite the strong order intake in recent quarters was weaker than any member of the consensus collected from the counterparts, my counterparts likely on this call, meanwhile services was actually stronger in sales recognition than anyone had expected. So I just want to know what's holding back the sales recognition in equipment? And are you finding that the lead times in equipment are extending further where [ SMB ] in services, just given the nature of that business, it may be improving now?

[Helena Hedblom, executive]

So it's mainly related to the situation in Russia since we have paused all deliveries to Russia that has meant to all the machines that we had in the floor that was planned for Russia is now being rebuilt to able to be able to send to somewhere else to other regions. So that is the hit we take in equipment. It's mainly related to the pause of deliveries to Russia.

[William Turner, analyst]

Okay. Great. That makes sense. And then another question. I know it's probably too early to say. But obviously, we've seen some lower metal prices in recent weeks. And there are concerns quite well, frequently documented in the media and another those sources of -- around the macroeconomic environment. Are you seeing any changes in discussions with customers? And I know the near-term outlook is looking good, but maybe if we think on the long-term outlook, there's good opportunities as well. But if we look in the medium term, are you expecting the pricing discussions maybe to become a little bit more challenging later in the year?

[Helena Hedblom, executive]

I think it's difficult to predict. We see as we said, a healthy underlying demand. So replacement of existing fleet, also the expansion of one to 2 machines, et cetera. But -- and then, of course, we say the -- if we look on it, still that exploration activities it is holding up well since the mining industry needs to find more assets really to safeguard production also in the coming years. Then of course, it's all driven by -- for us, it's very much driven also the technology shifts now and up selling value. And I think the ESG focus here is really even though who knows where the future and the world economy will be a year from now. I still think the push towards ESG and the value that our solutions bring is really what the industry is looking for right now. So -- and I'm really happy to see that we have been working with electrification for many, years. This is where we have invested a lot, the same with automation, and it is taking off. So that's good to see.

[Operator]

The next question comes from Gustaf Schwerin with Handelsbanken.

[Gustaf Schwerin, analyst]

Yes. This is Gustaf Schwerin from Handelsbanken. Actually, a follow-up on the previous question on the equipment sales. Even if we're just for Russia, there's no step-up in sales organically year-over-year or quarter-over-quarter despite the bigger backlog. So could you help us a bit to understand what is actually happening [ Helena ]. Is it mainly that supply chain, [ freight has gotten ] even worse? I'm surprised that even if we take Russia out of the equation, it doesn't look to grow.

[Helena Hedblom, executive]

It's both, I would say, the component shortage or the situation with ingoing components that is hurting us. But then also that we are still prioritizing aftermarket when we have a situation when we don't have enough with components to keep existing fleet up running. So this is, of course, something that we prioritize on a daily basis.

[Gustaf Schwerin, analyst]

Okay. And we think about equipment sales for Q3, a normal weaker seasonality, but do you think we'll see a step-up in deliveries quarter-over-quarter?

[Helena Hedblom, executive]

On equipment, we believe that we will see a step up, yes. And mainly related to this Russia situation since we had quite many machines in the flow that we had to stop.

[Gustaf Schwerin, analyst]

Yes. All right. Very clear. Then secondly, on the order cancellation in Equipment & Service, roughly how much of those 430 was equipment?

[Helena Hedblom, executive]

Majority, I would say.

[Hakan Folin, executive]

The majority.

[Helena Hedblom, executive]

Majority.

[Operator]

The next question comes from Lars Brorson with Barclays.

[Lars Brorson, analyst]

I was going to follow up on Klas's earlier question just on owners in Tools & Attachments. Sorry to come back to that. And then I was going to ask a question around like-for-like pricing and also the business model in battery electric. But just on T&A orders, I mean, we don't have a lot of historical data. But historically, for what the data we do have, there hasn't been a huge amount of seasonality in Q2 versus Q1. I appreciate your point around construction in Q1. I think I heard Hakan earlier talk about less tailwind from safety stocking among -- minus on the rock tools side. Is that a kind of a meaningful element to maybe the slightly weaker orders we see in G&A? And if so, is that something we should expect to continue in the second half?

[Helena Hedblom, executive]

I think it's more related to the orders on hand, as I said, we sit at a very high level of orders on hand and lead time is not really acceptable when it comes to Tools & Attachments. The customers need it immediately. So I think it's more related to that. And then we have also, during the last year has been focusing a lot on improving the margin in this business, and that is also what we make sure that we, in this [ very well say ], complex and dynamic situation right now with cost increases that we protect the bottom line.

[Lars Brorson, analyst]

Okay. Can I ask to like-for-like pricing? I appreciate it makes us clearly better in equipment and services, but like-for-like equipment pricing, not easy, of course, given the changes from electrification, automation, et cetera. But can you help us a little bit with sort of the price cost equation? I guess we heard Sandvik last week talk about a more material and sustained headwind from raw mat prices. But can you help us a little bit there on the equipment side, please?

[Helena Hedblom, executive]

I think the organization has done a very good job when it comes to being active and would say, tying bringing more value to our customers and by that also protecting, let's say, the protecting the value and protecting the profit. So we are always very active when it comes to pricing. And of course, in an environment like we are in right now, we are even more active. So I'm happy to see how well the organization has been able to manage the situation.

[Lars Brorson, analyst]

Sorry, what does that mean just in terms of price cost for the quarter, if I can press you?

[Helena Hedblom, executive]

Do you want to take that?

[Hakan Folin, executive]

Well, I think if we look at our margin and if you look at the organic flow-through, you can see that, like Helena said, we've been managing price in a decent way. We have been more or less been able to make sure that we get the value out and we get the compensation for the increased cost.

[Lars Brorson, analyst]

Can I squeeze a third kind of bigger picture question then just on battery electric. I mean, obviously, it's very encouraging to see the adoption of electrification. I wonder whether you -- when will you come out and talk to us a little bit about how the business model might change? I'm specifically interested in battery staying on your balance sheet. One of the thoughts around kind of financing that and getting that off-balance sheet. Is there anything you can say at this stage, just given the rapid adoption of battery electric among your customers, please?

[Hakan Folin, executive]

It actually varies. I mean, battery, like Helena, said, it's taken off, and it was our best quarter ever. But then we basically do what our customer wants. Some of them, they want us to do battery as a service because they don't want to buy the battery and they want to make sure that they actually just buy the service, not the battery itself, while some other customers actually feel that now, we rather take this on ourselves and we buy all the battery as well. So it varies a bit, but definitely, Battery as a Service is very interesting for our customers. And so far, it is a rather small portion of our business. So right now, we have taken it on the balance sheet. But just like you are hinting to, over time, if this grows as we are seeing it grow right now, we will definitely also look into if we should keep it on our balance sheet if we could find some other solution for it. But right now, it's not really worth the effort, it's too small.

[Operator]

The next question comes from Guillermo Peigneux with UBS.

[Guillermo Lojo, analyst]

One is to ask a question maybe in a different way that has been already asked. How much of your customers' budget is discretionary versus how much is driven by CapEx budgets, if I may. Do you know the answer to your question?

[Helena Hedblom, executive]

How much of our customers' [ budgets are CapEx ] compared to OpEx. No, I wouldn't say, I think it, of course, varies, of course, also between the different customers. And I think it varies over time as well. So I can't give you a good answer on that.

[Guillermo Lojo, analyst]

But is it fair to assume that a percentage of the budget will be based on discretionary decisions based on the current environment versus others that are a bit more on long-term plans, long-term investment plans?

[Helena Hedblom, executive]

I think the long-term plans, if you take an expansion, if you take a brown field expansion or a replacement or a full fleet or a green field expansion, that's, of course, very long-term decisions, and it's part of the long-term mine planning. And I think that is what we have seen several of those larger decisions happening now. And that's when we announce orders like we have been doing now the last couple of quarters. Of course, that -- those type of large expansion CapEx budgets or one type of budget. And then, of course, I think when we look at everything that is service related, everything that is conversions, if we talk about the battery conversions, for example, that is more seen as OpEx, which, of course, is a way also to would say, address the potential from different perspectives.

[Operator]

The next question comes from Joel Spungin with Berenberg.

[Joel Spungin, analyst]

I was wondering if I could just come back again on Tools & Attachments. And sorry to labor the point, just to make sure I've understood correctly what you're saying with regards to the record high orders in hand. Are you saying that you made a conscious decision in this quarter to slow the rate of order intake? Is that the right way to interpret your earlier comments?

[Helena Hedblom, executive]

I think customers, the market needs consumables to be delivered at -- when you need it. This is a continuous flow of products. Of course, when you build up too long orders on hand or 2 big orders on hand, we can't really cope then with the delivery times that is needed and then that leads to lower intake. So that's really -- that's the logic, how this works. And if you look on this from a -- with a historical perspective, we are at a very high level on orders on hand.

[Joel Spungin, analyst]

Understood -- that's helpful.

[Helena Hedblom, executive]

So we need to catch up on deliveries. That's really what the main focus now to get back to growth mode.

[Joel Spungin, analyst]

Got it. Okay. Understood. And then maybe just changing slightly subject. Just in terms of the -- I was just wondering with regards to the SEK 1.4 billion of orders on hand that are outstanding still in Russia. Are you able to talk about possible outcomes there? Is it that those orders can be redirected to other customers? Might they be canceled? Could there be any incremental cost or expense incurred if that happens?

[Hakan Folin, executive]

And like we said, we have around SEK 500 million in cancellations now in Q2. And as we write in the report, it's SEK 1.4 billion, it's difficult to see or if and when these will be delivered. So I mean, we would expect that we will continue to have cancellations also in the coming quarter. And I mean the specific order as such, cannot be redirected. But as Helena talked about before, machines that were planned to go to Russia, we can do smaller or some modifications on because these were delivered by customer, and they were set up for that specific customer, but then we can do modifications and then we can sell them to other customers. So not -- we cannot redirect order by order, but of course, the planned machine, we can do modifications on and find another home for.

[Joel Spungin, analyst]

And would you envisage that might incur any incremental expense? Or would that likely be relatively minor?

[Hakan Folin, executive]

I would say, relatively minor.

[Operator]

The next question comes from Andreas Koski with BNP.

[Andreas Koski, analyst]

So I have a question on your comment about margins and the sales mix going forward, even though you do not guide on margins, it sounds like you're implying that we should expect margins to come down going forward. I just want to clarify that you expect your incremental margins to come down and be in line or even below your group EBIT margin in the second half of this year?

[Hakan Folin, executive]

I'm not sure if I understand your question, but what I was saying was that we did have in Q2 now, we had very high share of invoicing coming from service, which is at a higher margin than equipment while if you look on the order intake we have had over the last 3, 4 or maybe 5 quarters have been higher for equipment and when we catch up with -- actually, we get less component shortage. We also do these modifications on the Russia machine. We can and should be able to get higher invoicing for equipment and invoice equipment will be a larger share of the total, that might mean that margin will go down somewhat. I'm not sure if I answered your question, but that's at least what I tried to say before.

[Andreas Koski, analyst]

Yes. Yes. I guess you answered that in a way. If you grow your equipment sales, the incremental margin on that sales growth, shouldn't that be above the group margin, on [indiscernible].

[Hakan Folin, executive]

I see what you mean by that. And of course, if we get higher invoicing from one specific business line, yes, that business line, we should see higher -- we should see a positive flow-through on that.

[Andreas Koski, analyst]

Yes. So it's not that you have reached a level now when you have -- you're hitting the capacity ceiling and you need to put in a lot of investments to be able to ramp up your equipment sales?

[Hakan Folin, executive]

No. No, the reason why we are not selling more equipment given the order book we have is rather component shortages. And again, Russia, it's not that we are full in our factories.

[Andreas Koski, analyst]

Okay. That's great. And then can you just confirm that the cancellations in Russia had a negative impact on your order intake in the quarter?

[Hakan Folin, executive]

Yes.

[Helena Hedblom, executive]

Yes.

[Operator]

The next question comes from Jonathan Day with HSBC.

[Jonathan Day, analyst]

I was wondering if you could talk just a little bit about pricing again. And I know in the past, you mentioned surcharges, and I was just wondering whether you could perhaps give us a sense of how much sort of the pricing that's been done recently has been, if you like, underlying price increases? And how much of it has been down to some temporary surcharges. That's my first question.

[Helena Hedblom, executive]

I think we have been working with very active on the pricing side for quite some time now and at least for a number of quarters since we've seen that cost is going up and at the same both for components as well as for transport. The surcharges that we also have implemented has been more to mitigate the changes that have happened during the second quarter. But I would say -- so it's a combination of both. But I think it's -- and of course, it varies in different regions and different products, et cetera. But I think all in all, it's a solid performance. And as Hakan said, we are compensating for the cost increases and the challenges that we are experiencing in general.

[Jonathan Day, analyst]

Okay. And then maybe just a quick follow-up, if I could do on your exposure to Germany. I mean I can see you got a couple of manufacturing sites in Germany, and I was just wondering how you sort of felt about the risk around energy cost, energy exposure, gas rationing, et cetera, in Germany?

[Hakan Folin, executive]

We looked into that. And our -- all in all, electricity in Germany is a small cost, and it's not all-natural gas. So it's going to be minor for us.

[Operator]

As a reminder, [Operator Instructions] The next question comes from Nicholas Housden with RBC Capital Markets.

[Nicholas Housden, analyst]

I only have one left at this point. But if we look at the 100 basis point expansion and the adjusted EBIT margin, 2.4 percentage points of that is listed as being organic. I'm just wondering if you could break out how much of that 2.4 percentage points is due to the mix shift and maybe what's due to other factors like volume leverage and things like that?

[Hakan Folin, executive]

We don't specify actually how much is coming from which impact. But I can say it's coming from all 3 of the ones you mentioned, but we don't specify that exactly.

[Nicholas Housden, analyst]

Okay. Great. So there are other factors other than just the mix shift. So because there have been comments about the mix shift, turning a bit more negative, [ so I have asked it. ]

[Karin Larsson, executive]

Now it's me again, coming in interrupting here. Thank you, everyone, for taking the time. It seems like we have no further questions at this point. So thank you, Hakan. Thank you, Helena. Great presentation. And for everyone, we wish you a wonderful summer. We want you all to stay safe because COVID is not yet over. And as always, we, at Epiroc wish you all very successful investments.

[Helena Hedblom, executive]

Thank you so much. Thank you very much.