Epiroc AB

STO:EPI A

Earnings Call Transcript 2018-Q3

[Ingrid Östhols, Vice President Investor Relations]

Good morning, everybody, and warmly welcome to Epiroc's Q3 result presentation. I am Ingrid Östhols, Investor Relations of Epiroc. Today, our CEO, Per Lindberg, will start telling us about the performance in the quarter. He will then hand over to our CFO, Anders Lindén, who will deep dive into the figures. And after the presentation, we will have a Q&A session. So Per, please go ahead.

[Per Lindberg, CEO, President & Director]

Thank you, Ingrid, and it's a pleasure to be here. And I think we are looking at a relatively solid quarter 3 that we have behind us. We've seen continued strong customer demand, we've seen high production levels, and we have seen also high activity in general. We've also seen our own revenues increasing quite substantially, which means that we have managed to continue to ramp up. Our capacity is now at a good level and is more in line with demand, in general. So I think we've made some significant progress there. We've also seen our profitability increase, and I think from that, I think we are looking at a quite satisfactory quarter. We've also seen our orders increase, but not to the extent that we did expect after the record quarter 2 and also very strong quarter 1. And that was not surprising actually because we know that quarter 3 is normally slower than quarter 2, which was the case also this year. We also saw large package orders that we had in quarter 3. Our quarter 2 and quarter 1 did not really materialize in quarter 3. And of course, these large orders, they tend to vary when they actually come in and it did have an impact also on quarter 3. We should also know when we look at quarter 3, we should realize that this is actually quite a good quarter historically. It's actually the fourth best quarter ever. The 2 best quarters are the previous quarters in this year and the third best quarter is actually quarter 1 of 2012. So quarter 3 is actually quite a good quarter from a demand standpoint. Looking at the cash flow, that's an issue for us. I think, we expected cash flow to improve significantly during quarter 3, but we continue to tie capital and working capital, and we expected that to improve during the quarter. It did not really, to the extent that we expected. So we will continue to pursue our long-term efforts to improve working capital through supply chain efficiency. We do have a program in place. But we will also, as a consequence of this, increase our efforts on a short-term basis to improve our working capital and make sure that we do not tie unnecessary capital in our supply chains. So speaking of excellence programs, we also have of course numerous excellence programs apart from supply chain. We're working with manufacturing, with sourcing and service. I think, we're making good progress, and we expect that also to continue to contribute to efficiency going forward. And I'm also happy to note that we made an agreement to acquire Fordia out of Canada. It's a supplier of exploration drill bits and casings, which is a very good strategic fit to Epiroc going forward. And we expect that -- to close that later on this year or beginning of next year. Turning over to financials. I mentioned the strong revenue growth of 19%. And I think, again, that's a good sign of our ramp up. We had 25% increase of our operating profit and the adjusted operating margin increased from 20.2% to 21% in the quarter. We do have continued costs for split even though they are now decreasing. And we do have also provisions for the long-term incentive program, and of course, that's tied to the development of the share price, so that will have an impact on individual quarters, up or down, depending on the share price. But as mentioned, of course, we expect the split cost to taper off during this year. When we compare quarter 3 to quarter 3 of last year, we should remember that quarter 3 of last year, first of all, was a relatively strong quarter. But also that we were not a independent company last year. And the consequence of that is, that of course now we do have -- we built up a corporate function with associated cost, and we do also have some effects when it comes to lack of scale, when it comes to some functions internally. So they are not totally comparable and if you look at the flow-through, I think, you should keep that in mind. Orders received, developed as mentioned and not as strong as expected due to a variety of reasons, but Europe developed really well. And looking at Africa and Middle East, you can see that it's actually quite a significant decline, but that's primarily due to very strong comparables last year. And quarter 3 in Africa and Middle East last year was actually the best quarter of the year. So that's really the reason why we do have that comparable decline. We are still looking at a distribution between mining and infrastructure, where mining is 70% of all orders received and infrastructure 30%, which is in line with what we've seen over the last few quarters. So looking at the segments. You can see the change between quarter 3 of last year and this quarter. And Equipment & Service is roughly 76% of orders and 74% of revenues this quarter. Aftermarket, to the right, orders received, 62% of orders received, and revenue is pretty much the same. Last year's revenue were 67% aftermarket, this year's 62%, which means this year we sell a little bit more equipment in our mix, which has an impact on margin since equipment tends to be a little lower on margin than the aftermarket margins. I will come back more specifically to the segments, but of course, you can see where the improvement or the growth of service, primarily is something that is quite satisfactory. Equipment & Service. We see high production levels as mentioned. Surface equipment primarily had a good development during the quarter. We saw lower development or lower levels of underground sales, especially when it comes to the large package orders that I referred to during the quarter. So equipment grew with 2%, service 13%. And when it comes to service, I think, our efforts to strategically target the fleet that we have in operation has given effect. And right now, the service component of the mix in service, there's service and there's actually spare parts. So service tends to grow faster now than spare parts, which should perhaps be kept in mind. But also apart from these sales efforts, we do also see progress when it comes to our package service offering. Rig scan, for example, is an offering that we have launched and that is also making good progress in the market. So the development certainly within services is quite exciting and satisfactory. Operating margin increased to 24.6% from 23.3%. We have a flow-through of over 25%. And again, I think that's a good sign. But one should keep in mind again that the mix within service is tending to more toward service. And when we increase the volumes of service, it tends to be at somewhat less efficiency initially because we introduced new technicians and it takes time for them to take it up to speed and also for us to train them to an appropriate level over time. This is a simple -- a couple of simple graphs just describing the 2 parts of Equipment & Service. As mentioned already, when you look at the equipment to the left, you see that the volume of orders received quite substantially lower this quarter as compared to quarter 2 and this is due to -- primarily due to the lower amount of large package orders, especially in underground. When you look at Service, you see that quarter 3 is slightly lower than quarter 2, which was also the case in quarter 3 of last year, but is still on a very high level. Tools & Attachments. I think we see a good demand environment because this is driven primarily by the production levels at our customers. So especially in North America, we see a very good and solid demand for especially our tools. Organic orders declined with 4%, and of course, one may ask the question, why is that if demand is robust? Well, we are right now targeting profitability rather than growth. So we have actively stepped out of some orders that we feel are not profitable enough. We of course will have to continue the orders that we have accepted, but we will not continue to accept orders below a certain profitability level. And if you look at the operating margin, it has increased from 13% last year to 13.6% now and if you look quarter 2, it was 12.4%. So we have now reversed a trend, I hope, and we see positive flow-through within Tools & Attachments. And of course that's quite satisfactory as well. And again, of course, the Canadian manufacturer of tools is within Tools & Attachments. And finally from my side now is business development. And I think if you look at our pipeline of innovation, I'm very excited. I think we do have many interesting things in our pipeline. And to the right, you can see our control tower in Örebro. This is a place where we take customers, and we have a very strong interest from customers, where they can see our suite of digitalized products to monitor and manage the flow of operations in a mine from remote, and I think this is certainly one of the tools that will help our customer to increase productivity going forward. We've also built automation centers on 5 continents and the intention there is to help our customers to implement automation solutions in their mines. And this is also something that is quite helpful for us, of course, to drive the sales of automation now and into the future. Specific innovations as this Minetruck that you can see, it's pretty much the same frame that we've had historically, but this one loads 10% more than has done historically. We've also launched a range of reverse circulation drill pipes. Now these are very specific for the ones that know mining, but it actually does improve productivity for miners. And not the least, I should say we're now launching generation 2 of our battery-powered vehicles. It will be launched in November now, and this is another development that attracts huge attention among our customers, and we expect that to be a very good event, will high attention. And we, of course, have also quite significant ambitions when it comes to increasing the volumes of battery-powered products going forward as a consequence of that. So now into financials specifically, Anders.

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

Yes. Thank you, Per. A little bit of deep dive into the financials, as you would expect. Naturally, there will be some repetition, but that is pretty normal. If we start to look at the revenue and let's say, the top line bridge. Yes, it was an orders received that was lower, but it -- than in Q2, but it's typically a slower quarter. So and Per has explained a little bit the background. We had a positive currency effect overall in the quarter and it's now flat year-to-date and slightly negative still on the rolling 12, but for the fourth quarter that will likely change. Going forward here, we have -- although we have a situation where the period-end rates in September is a little bit different than in June, but for our U.S. dollar and Canadian dollar and euro, and we have a higher period-end rates than the average rates. And as you know, we typically say that those 3 together with the Australian dollar and the rand is the 5 most important currencies that has an impact to us. The Australian dollar and the rand are pretty much unchanged. If we look then into the fourth quarter, we -- if the rates don't change, we should likely see a positive with a couple of points -- percentage points positive currency effect for the quarter. When it comes to structure, it's more or less evenly divided into the recent acquisitions that we did in the beginning of the year and the contract manufacturing that we have explained previously. If we then look at the margin, first of all, I've said that before what the underlying profit margin that we look at is the dotted line, where we have excluded the split cost or project costs and also effects from long-term incentive programs. And then of course, which I will say a few times, but I think it's still worth mentioning that when we compare with last year, we were not a fully mobilized company and also Per mentioned that we obviously have a difference. And that specifically should be remembered when we look at the flow-through, which if you do math then obviously we have a flow-through which is a little bit over 21%. But it's well over 25% if we also do some adjustment for and do like-for-like comparisons. Examples of that is, of course, that we had very little costs for the corporate headquarter last year, and we have also, during the last year, fully mobilized the hydraulic attachments division that was not -- that was brought into Epiroc during last year. We also have a little bit lost economies of scale in some functions with us being a smaller company and independent company. Then of course, when we look at the split, the negative effect is in the structure part is 1.5 but really purely related to the split is 1.1. So the 0.4 out of the 1.5 is for dilution on the margin from the acquisitions and the contract manufacturing. And as we have communicated, the split costs are in the quarter SEK 70 million and the effect from the provisions of long-term incentives is SEK 56 million and SEK 126 million for the quarter is related to that part. And those SEK 126 million, then if we take away some of the corporate -- sorry, if we take away some of the long-term incentive costs that we had actually last year as well, we didn't have any project costs last year, that together with the effect of the acquisitions -- a positive effect from the acquisitions and the contract manufacturing gives the SEK 99 million, which you see as structure and other in absolute terms. Obviously, the long-term incentive provisions will change with the share price of Epiroc. So when it goes down, likely the provision will be reduced and when the share price goes up, the provision will likely have to be increased. So if we would've made the calculation today with the current share price, it will have been -- not have been the SEK 56 million that you saw. If we then continue to the segments. And it's okay, flow-through in Equipment & Service and a clear improvement in Tools & Attachments. The flow-through in Equipment & Service you would think would be better, but I think Per explained quite well that we have grown, not the least in service, where there are inefficiencies in the -- when you grow fast. But we also have growth in equipment and growing with maintained efficiency is a challenge in all segments, even though Tools & Attachments and also the corporate part is affected by economies of scale or reduced economies of scale. In the Equipment & Service part, we also have a little bit of a mix effect, of course, to revenue mix towards equipment, which is also having an impact on the flow-through. When it goes to Tools & Attachments for the -- we should again remember that we have mobilized one new organization, which we didn't have fully established last year and that's hydraulic attachments. And that has an impact on the organic improvement as well as -- then as the flow-through. For both segments, you see a currency effect being positive. And on the structure side for the Equipment & Service then we have acquisitions and contract manufacturing. Going to the income statement. Repeating myself, I would like to make a few remarks when we compare to last year. We obviously see the main differences, I would say, in administration and marketing or the -- referred to sometimes as SG&A. With the administration part impacted by the costs for the long-term incentive programs. But also the corporate costs again, the establishment of the new division. Together with some, let's say, inefficiencies that we have from the split out in the market organization and in IS/IT in particular. The other point I would like to make on the P&L when we compare it is interest net. While in the past, as you know, we were not a complete company, we didn't have the funding, as of June this year and fully then in Q3, we are completely funded. So this interest net is more representing the level going forward. We had historically some hedgings, which we don't have any more to that extent. We still have some hedgings of external loans, but not to the extent we had before. So it's definitely lower and in the interest net. And also finally the tax rate here, we -- even though the number per se seems to be on the same level, the -- it's a very different percentage of tax -- effective tax rate. And the 2017 number is obviously not representing of our current operation. While we are at a level today of well below the 26% actually, we are on the 25% level year-to-date. So when we adjust for this, as Per said, we have an operating profit of 21.0% when we adjust for the project costs and the long-term incentives provisions and the profit before tax of 20.6%. On the balance sheet, the main points I would like to make here is, of course, that compared to last year quite easily to detect we now have a complete balance sheet with SEK 4 billion in cash, and which we didn't have last year, being part of Atlas Copco. We also have a fully capitalized equity with the SEK 17 billion. Those are more structure changes compared to the -- becoming an independent company. When it comes to the more operational, you can see the changes being in working capital, not the least in inventories and receivables and, to some extent, in payables. The -- and also some increase in intangibles, the main part there being a consequence of the 4 acquisitions that we made in the beginning of this year. Some more words on the net working capital. As you can see there, there isn't a very different number from the percent of revenue than we had in Q2. I mean, this is the average so it will not change dramatically from period to period. And while we would have liked the working capital to go down, we still see a little bit of inventory increase from the growth that we have had, especially in the equipment divisions when they are now ramping up. And we also have a small effect of the supply chain program initiative that -- where we centralized initially the inventory and to be able to, in the next step, reduce it out in the market. And we will start implementing that in Q4. So there is no major change in the working capital percent. Again, I think, we do comparably well in payables. We are average on receivables, but our improvement area is mainly in the inventory and that you've heard me talk about that a few times already. For Q3, then, as I said, inventory was the main increase. We also have a slight reduction seasonally normal for payables with the lower activity in the parts of the world where we have a lot of activity, in the Northern Hemisphere. Talking a little bit about the net debt. Yes, net debt went up from SEK 3.0 billion to SEK 3.1 billion, not a dramatic change. We had a positive operating cash flow, not to the extent we would have liked, but I'll come back to that. We also -- and I would like to point that out very much, we had obviously, a repurchase effect of SEK 1.1 billion net. We brought net 11.3 million shares, the detailed numbers you will find in the report. And that is obviously according to the plan where we were allocated SEK 1.2 billion as part of the split for purchasing or repurchasing our shares through the existing long-term incentive programs. Finally, cash flow. Again, some of the numbers which we compare with are -- we should not focus on so much and those are really the -- if we go from, let's say, the taxes part and also to other investments, they are really not so comparable. But I mean, we have, first of all, I would like to point out that although we had a sequential improvement, we are not satisfied with the working capital and in particular, in the cash flow as such. We had good increase in profit for sure, but the main disappointment here is, of course, the increase in working capital. At the same time, I would like to mention a few things to help you to understand the cash flow. During the quarter, we divested almost SEK 300 million of portfolios, all from our customer finance operation. And that due to the, let's say, different characteristics of the contracts, those SEK 300 million or a little bit below SEK 300 million, will in the cash flow statement show in different lines. And some of it will be shown in noncash items, that's why it's quite high. And the biggest part is actually in other investments, where the main -- the majority of the SEK 292 million in other investments relates to the divestment of customer, finance. There's also a minor part in the rental fleet -- change in rental fleet. Taxes paid was a little bit higher than normal. We -- obviously, taxes paid increase when you make a lot of profit, but also we did a little bit of recalibration to make sure that our preliminary taxes match quite better the effective tax together with some retroactive payments from last year's profits. So that is also slightly higher than we would have liked it to be, but it is what it is. On the CapEx, if we add up the CapEx, the different lines in CapEx that you see on this, we come to SEK 331 million, which is -- we are about on the pace where we have been with the -- if we are just for what I said on the customers finance divestment, and I don't see any dramatic change going forward in the near future. We see the divestment of credit portfolios and payment solutions as something. We support our customers with financing, but it doesn't necessarily mean that we will keep it on our own balance sheet. So it's something we've done in the past, and we will likely continue doing in order for us to have a more efficient cash flow. And with that, I will hand over to Per, again.

[Per Lindberg, CEO, President & Director]

Thank you, Anders. And the summary is pretty much where I started, I guess. I think this is a solid quarter. We've seen -- the good news is that we see a continued strong demand from our customers. And one should remember, this is a good quarter if we compare it historically. And we see high activity, we see high production levels, which should support demand also going forward. We see revenues going up strongly again, which means that our capacity is more in line with demand at the moment and profitability also going up, which is quite satisfactory, of course. I reminded you and Anders did as well that the comparative quarter of last year was not to a fully developed company. Cash flow, we mentioned several times, and of course, when it comes to inventories, when we now are in a situation where our capacity more in line with demand, we should also be able to improve the flow of the inventory through our production. And we will definitely push the organization to make sure that we improve working capital and inventory going forward. When it comes to near-term demand, I think that requires some additional comment. Of course, we've seen a decline in mineral prices during quarter 3, and we do not necessarily think that that's going to have a material impact on the activities of our customers. So we will -- we think that the activity level will continue on a high and robust level. So the expectation is that it will continue more or less at this level, where we are right now. But of course, we will need to keep an eye on the development going forward because the -- of course, the metal prices will continue to be relatively volatile most likely. And so we will keep an eye on that but the expectation -- the short-term expectation is that we will be more or less at the same level which we saw in quarter 3 going forward. So questions and answers.

[Ingrid Östhols, Vice President Investor Relations]

Okay. Thank you very much, Per and Anders. Then we will open up for questions, and I think we will start with the floor. Do we have any questions from the floor? It doesn't seem like it. So then we will hand over to the telephone conference. And operator, do we have any questions?

[Operator]

[Operator Instructions] We already have a question. Please introduce yourself.

[Klas Henrik Bergelind, Director]

It's Klas from Citi. A couple of questions from me, if you can hear me. So first on the equipment side. The weaker orders there, you report orders down slightly in underground and more and more miners are moving underground, and we still have a replacement demand of the most recent peak yet to kick in. So there should be a solid growth story for Epiroc and others out there haven't seen the same softness on the equipment side to the extent you have. If this was only a tough comp on the larger side, what do you see right now, Per, in the pipeline? Have the weaker price actually, particularly copper, started to impact you negatively when you look further out?

[Per Lindberg, CEO, President & Director]

Well, I think one should be a little careful comparing individual quarters because, as I mentioned, as which is also evident in the numbers for underground, is that individual large orders will have a huge impact on the comparables for the individual quarter. So that's one thing. And you're absolutely correct, the trend towards underground continues, may not necessarily be visible again over a single quarter, but that's a trend that we see for sure. And I -- so I guess, the key message here is not to be -- not to look at the individual quarter too much when it comes to extrapolating a long-term trend. I think that's important.

[Klas Henrik Bergelind, Director]

And a follow-up there on replacement. It was only 30% of orders last quarter. And I guess, the same this time. And the peak in 2012 is yet to be replaced.

[Per Lindberg, CEO, President & Director]

Yes.

[Klas Henrik Bergelind, Director]

When I calculate backwards and looking at the replacement cycle of your equipment, this should start to impact you positively in 2019. And I was wondering on the timing there, if you share that view. Because we had 2 peaks very close to each other, one in 2008 and one in 2012. And the first one is replaced and now it's time to replace the most recent one. So some comments there would be helpful.

[Per Lindberg, CEO, President & Director]

No, I think you're right. And personally, I'm a little surprised that we still see expansion being actually over 70% of orders received this quarter. So it continues to be my majority of expansion, which means that we are yet to see the replacement cycle being more substantial. So I think your observation is mostly or probably, absolutely correct. I think we will see more replacement going forward than expansion. And just a helpful comment to those that perhaps don't follow this too closely, the life span of underground equipment typically 5 to 6 years, whereas surface equipment is between 10 and 15 years depending on the type of equipment. So of course, the peak in 2012 would primarily be related to underground rather than surface.

[Klas Henrik Bergelind, Director]

My final one is on the service part. The weak drop-through within service with contracts growing stronger than spare parts, I understand that the majority of the service business is spare parts. And given that we had very strong growth on the equipment side over the last couple of years and as the warranties drop out, then the spare parts business should start to accelerate. And I appreciate obviously that Tools & Attachments is very linked to production, but I guess, on the service side, you had that lagged effect on the spare parts that could come through. I just want to check with you if that reasoning is correct?

[Per Lindberg, CEO, President & Director]

That's again, absolutely correct. Of course, when we ship a new piece of equipment to our customers, the first thing we do is not to sell a spare part, but we sell service. And that means changing oils and changing smaller stuff, which requires some manpower, but not necessarily major spare parts. So you're correct. So that the strong sales of equipment that we've seen will translate into more spare parts going forward, yes.

[Operator]

We have a next question, it comes from Matthew Spurr of Exane.

[Matthew Spurr, Research Analyst]

So the first one is on just what your underlying demand was in Q2. I don't know if you can do it or not, but if you strip out large orders and then adjust for this sequential decline you typically see in Q3, what was your assessment of underlying demand ex those things versus Q2?

[Per Lindberg, CEO, President & Director]

I think we're looking more or less at a flat development between Q2 and Q3, if I'm correctly informed. Our numbers given here, Mattias, that's what he tells me, more or less. So that's what we're looking at.

[Matthew Spurr, Research Analyst]

Okay. And then second question related to that. So your outlook is demand to remain at a similar level. So what does that actually mean in terms of those 2 things that you said, sequential development and large orders? Is that making an assumption around some large orders hitting in Q4? Or is that the underlying ex large orders sort of run rate?

[Per Lindberg, CEO, President & Director]

Well, it's -- if we look at the potential pipeline of large orders, if you just visualize a map across the world and look at what the potential orders out there, larger ones, it's still quite significant. But whether those are going to materialize in quarter 4 or not, very difficult for us to say. So what we're basically saying is that the underlying demand is pretty much -- we expect to be pretty much on this level, where we're at right now. And which could be -- the orders received could change as a consequence of large orders, but we don't know that. So I guess the safest best bet is to assume a pretty flat development, I guess. That's what we're saying.

[Matthew Spurr, Research Analyst]

Okay. And then, can I have one final quick one on Tools & Attachments? The margin, you talked about some improvement, both sequentially and year-on-year, but it's only at up 10 basis points and flow-through is about 15%. Does -- what would -- you had some efficiency measures dragging that down. Did you have any efficiency measures bringing that up, so underlying really, it's kind of a flat development?

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

I mean, we have -- yes, Anders here. I mean, we have taken actions in the segment to -- as Per mentioned, I think, we have started to prioritize profitability over volume. And when it comes to, let's say, the top line and the gross profit margin and then obviously, also addressing other efficiency measures. So yes, there are plenty of activities to improve the flow-through and the bottom line in the segment. But we should not -- and I would like to stress that, when we look at the organic flow-through that -- if we compare the 2 segments, the Tools & Attachments segment is the segment that had the comparably highest impact of the fact that we were not a fully developed company and had not the structure that we have today, last year.

[Per Lindberg, CEO, President & Director]

And I -- just to complement or -- complement that answer. I think it's worth reminding what we said last quarter, is that we see in the portfolio, primarily when it comes to consumables, tools, that some of that needs to be addressed on profitability. And what we've done so far in this quarter is to basically to reduce the volumes of nonprofitable orders. Now that's certainly not the end of it. We will continue to improve the profitability overall in tools, and we've started with basically addressing the low profitable segments and the orders that we have seen.

[Operator]

We have a next question, it comes from Graham Phillips of Jefferies.

[Graham Phillips]

First question really is around the drop-through margin in the Equipment & Service. Can you -- it's obviously, you commented around the mixture, and you said that the equipment, I think you said, was a little lower margin than service. I think in the past, you've said that it was sort of 3x the difference, but perhaps they are a little bit closer. And given the sort of volatility of this number, can you give us some sort of feel of where you think it should normalize, looking into sort of 2019?

[Per Lindberg, CEO, President & Director]

Well, I think the observation that the service part, including spare parts, is about 3x as profitable is historically correct. Now that refers to a situation where equipment demand is not as strong as we see right now. So now of course, the -- that relationship has shifted more towards equipment, which means that service right now -- perhaps not twice as profitable, but maybe in between 2 and 3x as profitable, to be not very precise. But -- and I think, if assuming that demand is where we expect it to be that relationship couldn't -- should be more or less maintained going forward.

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

And we -- just to add to that, why we are -- I think we should be pleased with the growth in the service part. It's obviously far higher revenue -- organic revenue growth in the quarter on the equipment side, which have this effect on the flow-through.

[Graham Phillips]

And thinking into next year, then, I mean, you would expect it to normalize, to back up what we've seen in the earlier couple of quarters, several quarters?

[Per Lindberg, CEO, President & Director]

Well, we don't really speculate on what's going to happen in next year. So you have to make your assumptions in terms of where demand is going to be, I guess. But the relationship that we see right now is the one that we just described.

[Graham Phillips]

Okay, fair enough. And you mentioned a couple of times about the lack of scale sometimes, and I think you included service in that, and clearly equipment will be getting some decent overhead recovery. But were there any costs put through, i.e., sort of rebalancing the offering at all in service margin -- impacted the margins here at all -- in organic margin?

[Per Lindberg, CEO, President & Director]

Well, I think the -- if I understand your question correctly, I mean, the allocation of costs when it comes to the inefficiencies that as a result of the split and I'm not talking about the split costs. I'm talking about the fact that we are now an independent company and need our own functions. That allocation is primarily done towards the larger divisions and service certainly being one of those. So looking at it that way, it's the proportion of such costs is higher for service for sure. So that will have an impact on the flow-through of service.

[Graham Phillips]

And the point that's -- sorry, Anders.

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

No, and just to add, as it was said before, in the times when you grow fast, it's difficult to grow with efficiency and to meet the demands, and I think that's also a -- has a part to play in this. And like Per said, we have, which we should not be surprised to see that the lack of or a drop in economies of scale for some common functions and with the growth within Epiroc, but also to become an independent company where we have not only for the corporate functions but also around the world, have had to establish some resources of our own to become a fully separated structure.

[Graham Phillips]

Okay, understood. And the point that surface was perhaps growing better than underground, we've seen obviously the bulk commodity prices actually doing better than some of the nonferrous. When you look at your offering in surface, can you just remind us the difference or the rough ratio between surface and underground exposure to your sales? And what -- is it more competitive in surface than underground you find in terms of margins and the business there?

[Per Lindberg, CEO, President & Director]

No. I think not really. I think our position in service equipment is very strong. We are -- we do have offerings that are quite niched and when it comes to -- of course, we have 2 divisions offering products. It's surface and exploration drilling and it's drilling solutions and both of those have very strong positions. I think that's -- it is not a material difference, I would say, in terms of competition at the moment, I would say. And I just want to -- just a comment on your previous question, when it comes to the inefficiencies of a loss of economies of scale. I think, of course, that's something that we are experiencing right now. It is not obvious that we will accept this as a matter of fact going forward. So of course, we expect to be able to address that over time as well. But right now, that's the scenario, that's the situation.

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

And just to mention, I think we need to be respectful to the fact that with the speed that this split has taken place. So the speed was a priority because we had this deadline and obviously, we have some work to do as Per -- that's what Per points to, that we will obviously, continue to work to take away as much as these inefficiencies as possible. But during this process, we obviously had to make some concessions.

[Graham Phillips]

Okay. And just finally on the credit rating, is there any update on this in terms of where your credit position kind of interest rates you might have to pay look like into -- with your borrowings?

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

No. I will -- I remember, I said, we expect BBB, BBB+ as the rating, and I maintain that. So I don't see a change.

[Operator]

The next question is from Markus Almerud of Kepler Cheuvreux.

[Markus A. Almerud, Senior Research Analyst]

Markus from Kepler Cheuvreux. My first question, just if you can you talk a little bit about how your exploration portfolio is moving along? And also what you're seeing in the markets in terms of feasibility studies? I'm obviously interested in the green -- coming greenfield portfolio in the mid-term, if you're seeing those kind of moving along at all. That's my first question. My second question is on Fordia. What kind of profitability does it have? Is it in line with the Tools & Attachments? And then finally, if I can -- if you can justify, get you right then pricing for Tools & Attachments, you talked about in previous quarters about pricing -- price erosion in that segment. Has that stopped now, when you're choosing more between orders?

[Per Lindberg, CEO, President & Director]

Okay. First of all, the exploration question. We've seen quite the significant pickup of activity when it comes to exploration. And that's of course good news, which means that people are looking for new ore bodies. And so timing wise, we expect the Fordia acquisition to be pretty good. But it's not even close to where the exploration activities were in 2010, 2012. So we're -- we could be just in the beginning of more of an expansive phase when it comes to exploration. Fordia profitability is something that we don't disclose, but we are quite happy with the acquisition, put it that way. And when it comes to price erosion for tools, primarily tools in Tools & Attachments, as I mentioned or as we mentioned, the activities that we've done so far, is we're dropping volumes and orders, or we're not basically taking orders that have low profitability and that in itself will stop the price erosion in those segments. Because there's a big difference in -- if you look at our portfolio in terms of profitability, the areas where we're strong, and we want to continue, we do have a pretty decent profitability. The tail, if you like, we don't and of course we address the tail, and so that's the consequence of pricing. But if you follow the industry, you can see there are pretty different signals from the various players in the market and there's -- so which is very interesting to see. I think market shares are shifting around quite substantially at the moment between the different players. So we'll see what the end result of all this is, but certainly that's happening right now. But again, as a side comment on pricing, of course, we still experience the increase in raw material prices that we have to compensate for in Tools & Attachments. We've done price increases, but we have not been able to, as of yet, to be -- compensate ourselves for that price increase. So that's still to be done.

[Operator]

The next question is from Lars Brorson of Barclays.

[Lars Wauvert Brorson, Director]

I have 3, if I could. One on order intake in the quarter, one on exploration and one on the margins in Equipment & Service. If I start with order intake, Per, down 10% quarter-over-quarter. I think that's very much what's scaring investors today a little bit. And so that's why I think it would be helpful if you can provide some numbers around the 2 reasons that you point to, so that's seasonality and lumpiness of the large orders. I mean, for me, seasonality, I pulled out 15-year history of the old mining business, I see a pretty mixed picture in terms of seasonality with no clear pattern really between Q2 and Q3 in terms of order intake. Last year obviously you were flat quarter-over-quarter. It looks like it was more driven by the cycle than seasonality. And just on large orders, I mean, we're not talking about big projects for Epiroc, we're talking about drill rigs and loader whole trucks, a large order for you is SEK 100 million or so, that's a percent of your quarterly order intake, and you actually did announce one order as I saw it in South Africa in Q3. So can you help me define what is normal seasonality in your business? Can you help me define what is large orders? And three, can you help me understand how much each of these 2 impacted order intake in the quarter?

[Per Lindberg, CEO, President & Director]

Yes. You're -- I think you have the right approach, first of all, to look at the history. But the problem is, if you look at it with the published numbers, you probably won't be able to extract the core of the business which is comparable over time. Because we have added activities, we have discontinued activities, and if we look at the history from 1990, I believe, to 2017, we see more or less a, on average, drop in quarter 3 versus quarter 2 of, I think, 10%, more or less. Now that is not a forecast nor is it always true, but that's the history and that -- what we've done there is basically to clear out everything that just -- that's in addition or that's a subtraction but just the core of the business. So it just happens to be 10% this quarter as well. So that's just perhaps a coincidence. When it comes to definition of large orders, we typically disclose a large order above SEK 100 million. And this is -- this we do if we have the consent of the customer. If we don't, we won't disclose it. So it's not like you can assemble all the press releases and see the exact amount of orders, unfortunately that's the case. But that would be more or less a definition. And as mentioned, we would -- if we would extract or just normalize, if you like, for the large orders in quarter 1 and quarter 2 versus quarter 3, we would be not perhaps exactly flat, I guess, but we would see a lot more even development between the quarters. So the underlying development according to such a definition would be more even.

[Lars Wauvert Brorson, Director]

That's helpful, Per. That's very helpful, very clear, I appreciate it. If we have time, then talk a little bit about a slow start to Q3 in order intake in the mining business and better September. I know it's not that meaningful to look at monthly orders for your business. I just wondered whether -- you were making the point earlier specifically that metal prices have not impacted customer behavior, which I take to also include on the copper side, where obviously we had a, what was it, a 20% drop in June, July. I just wonder whether you could recognize a monthly pattern within Q3 with a very slow start and a better September and to what extent that that might be a meaningful observation?

[Per Lindberg, CEO, President & Director]

Yes, of course, we asked ourselves exactly that question. And there's no clear pattern, to be honest. But as mentioned already, as we mentioned, as you mentioned, of course, mineral prices has come down, and we need to keep an eye on the development going forward.

[Ingrid Östhols, Vice President Investor Relations]

I think, we...

[Lars Wauvert Brorson, Director]

Understood. Secondly, if I can, exploration, clearly encouraging to hear you talk about a pickup there. I know it was very small for you, but it does tend to lead the business through the cycle. I'm curious what kind of growth you're seeing at the minute in exploration? And where is that business today relative to peak 5 -- 5, 6 years ago?

[Per Lindberg, CEO, President & Director]

I do not know exact -- the exact answers to those questions, to be honest with you. But I know that exploration was -- as compared to today, if we compare it to 2011, 2012, probably 3 to 4x larger than it is right now, in that order of magnitude.

[Ingrid Östhols, Vice President Investor Relations]

Okay. Thank you very much.

[Lars Wauvert Brorson, Director]

That's helpful. Finally...

[Ingrid Östhols, Vice President Investor Relations]

Sorry -- I think we're running out of time. So I think we have to close the call now, and I'm sure you can just come back with all those questions that remains. But thank you very much for joining us today, and we really hope to meet you again here in February. Thank you very much.

[Per Lindberg, CEO, President & Director]

Thank you. Thank you, guys.