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Edited Transcript of EPIRa.ST earnings conference call or presentation 25-Oct-19 8:00am GMT

Q3 2019 Epiroc AB Earnings Call

Nacka Oct 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Epiroc AB earnings conference call or presentation Friday, October 25, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Anders Lindén

Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO

* Karin Larsson

Epiroc AB (publ) - VP of IR & Head of IR

* Per Lindberg

Epiroc AB (publ) - CEO, President & Director

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Conference Call Participants

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* Alexander Stuart Virgo

BofA Merrill Lynch, Research Division - Director

* Andrew J. Wilson

JP Morgan Chase & Co, Research Division - Analyst

* Guillermo Peigneux-Lojo

UBS Investment Bank, Research Division - Executive Director and Industrials Analyst

* Klas Henrik Bergelind

Citigroup Inc, Research Division - Director

* Markus A. Almerud

Kepler Cheuvreux, Research Division - Senior Research Analyst

* Max Yates

Crédit Suisse AG, Research Division - Research Analyst

* Robert John Davies

Morgan Stanley, Research Division - Equity Analyst

* Vivek Midha

Deutsche Bank AG, Research Division - Research Associate

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Presentation

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Karin Larsson, Epiroc AB (publ) - VP of IR & Head of IR [1]

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Welcome to the Epiroc Q3 results presentation. We will follow the same format as we always do, which means we will start with a brief introduction of the quarter, presented by our CEO, Per Lindberg; and then our CFO, Anders Lindén. And then we will move on to the Q&A session.

(Operator Instructions) And if you have follow-ups following this presentation, you are most welcome to reach out to me or the team for further questions. And with that, Per, please present yourself.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [2]

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Thank you so much. So welcome, everyone, and it's a pleasure to be here. And let me dive directly into the meat of quarter 3 and start with a focus on the areas where I think we see a continued strong and good development.

First of all, a strong aftermarket. We do have continued good fundamentals with high activity, and that means high production activity. We also have that in combination in mining with still good mineral prices. So fundamentals are still good, driving our aftermarket, and not the least, our service business.

We also have a solid development of our underlying margins. We have a revenue mix that is positive. We do have some one-offs that is affecting the quarter due to restructuring. But I think we maintained margin that we saw in quarter 2, and we're quite happy with the level that we're at, at the moment.

We also have good cash flow. And I think that's something that we hope will continue also for the rest of the year. And it's good to see that we are -- the actions that we have taken when it comes to working capital are -- has given effect.

Also very good to see that we continue to have a high interest in our solutions when it comes to automation, information management, and not the least, for battery-electric vehicles. So several areas with continued strong and good development. But of course, we also have our challenges. The order intake, when it comes to equipment, was lower than expected.

We knew, in quarter 2, that typically quarter 3 is slower than quarter 2, and this is also something that we highlighted the last quarter that actually, the demand for equipment was lower than we did expect. We've seen a continued increase of uncertainty when it comes to economic development. We see also our customers being somewhat hesitant to deploy capital, and they tend to postpone or delay decisions. So that translates into a relatively slow order intake for equipment, as mentioned, lower than we did expect.

What we do is, of course, we adapt to whatever scenario that we have, and we've done that from really -- we do that continuously, and we've done that throughout 2019, and now we're intensifying that adjustment. And so we're taking action to improve resilience, but also safety. That's a continuous ongoing work. And as you've seen, we've done restructuring in Tools & Attachments. We also have some other actions that we will undertake in order to adapt to the current scenario.

So key financials. Order intake and revenues up slightly, but if we adjust for currency and acquisitions, down organically, and orders down 6% organically, of course, on the back of the low order intake for equipment.

Operating profit up 2% in absolute terms. Currency and acquisitions also contributed here, even though currency contribution is relatively minor as compared to last year. And again, we have restructuring costs of SEK 179 million for what we're doing in Tools & Attachments, restructuring that business, and we will continue to do adjustments of this structure in Tools & Attachments and the costs taken so far, again, it's EUR 179 million.

The reported margin, 19%. If we adjust for the restructuring costs and long-term incentive program, we're at 29 -- 21.3%. But actually, we can also adjust for some other one-offs. Anders will elaborate later, where we end up at 21.7%, and that's pretty much on par with what we had in quarter 2. So again, margins, I think, we're doing reasonably well. As mentioned, the cash flow is strong at SEK 1.9 billion.

Now innovation is clearly a theme that we continue to emphasize. We do have strong interest -- continued strong interest in the solutions around 6th Sense. And we have several orders for the solutions when it comes to automation and information management. And in conjunction with a very large service order that we received in Chile, we also have possibilities to implement automation. And that really demonstrates our capabilities when it comes to automation and certainly also when it comes to deploying our service operations.

We also -- last quarter, we talked about the number of machines connected, and we mentioned the number 2,500. And now we see an increase of well above 10% of connected machines now in quarter 3, so that number is increasing rapidly. It's very good to see. We also have very strong interest for our battery and equipment solutions, continued interest. And on the picture to your right, you see the Scooptram and the Minetruck 42 at Kittilä in Finland.

And as you know, perhaps the batteries are supplied by Northvolt. And that gives us an opportunity to minimize carbon footprint and also with the ambitions of Northvolt to increase levels of recycling of batteries. I think that's a very good development in general.

We've also launched Scooptram Automation Total. That's an information and fleet management system that really allows the management of several machines simultaneously, and that's a good development for us to offer further solutions when it comes to automating fleet on the ground.

Also launched Mobilaris Onboard that's a real-time awareness system or situational awareness system that really don't need a tracking infrastructure. I don't know exactly how they do this, the technicians, but they do it. That is fantastic. So it's really good to see this has been launched. And we also launched New Powerbit Underground, which is a new series of power bits or drill bits that delivers up to 37% more drill meters per bit. So several new innovations. And again, that's very good to see.

Operational excellence, of course, we -- this is something that we always strive to improve, and we have -- we're really increasing the intensity of the adaptation of our costs. We have already, this year, reduced the workforce with roughly 500 people organically, and this is primarily in manufacturing. Now the increasing intensity means that we have identified further improvements of our cost base, primarily targeting indirect costs in administration and marketing, and this is starting to be carried out as we speak. And we expect to see full effect of this in the beginning of the next year and as it says here in the first half of 2020.

Now the magnitude of these savings that we now also implement in the indirect cost is, we think is going to be above SEK 300 million -- in effect, SEK 300 million. And we will also have a restructuring cost between SEK 50 million and SEK 100 million as a consequence of these actions.

We also continue our restructuring of RDT, as mentioned. We have divested the geotechnical consumables, and we're also restructuring the handheld rock drills in China. And we also, as announced earlier this week, we have sold off a facility in Sweden for also handheld rock drilling tools, so this restructuring is ongoing.

We've also, of course, worked with our supply chain program. This is something that we -- is a long-term initiative and that progresses according to plan. And also in the line of efficiency, as we also have announced, we are expanding our production facility in Örebro, and the reason behind that is to consolidate production, increase efficiency and decrease production costs.

Sustainability continues to be something that is really close to our hearts, and it is, we believe, a competitive advantage if we do it right. And we think we do it right. We work with safety and well-being. We have -- we continue to roll out the program SAFESTART throughout our operations, and we also see a positive trend and reduction of work-related injuries. Of course, a good sign, given that this is of high importance and a key emphasis of ours.

We also -- we have also launched an initiative called Speak Up, which is really an internal or a system which allows any employee to highlight any wrongdoings internally if that would happen, and which means that we also emphasize the ethics in the company.

And I think also, we've already seen higher activity in terms of highlighting issues internally, not that something is terribly wrong, but it's good to engage all of our employees and the management of ethics in the company.

We have also gathered all the key leaders in the company in the quarter in order to align ourselves when it comes to expectations going forward in terms of efficiency, in terms of results. And I think we do have a very passionate team going forward. And it's also very good to see that we're fully aligned in terms of what we want to achieve into next year.

And finally, when it comes to sustainability, of course, the responsible use of resources, a key feature of sustainability, certainly for us as well.

Now we do have a high proportion of recurrent business, and that's really the graph to your right. As you can see, 68% of our business is aftermarket should be compared to the 63% quarter 3 of last year and 66% in quarter 2 of this year. So the portion of aftermarket continues, and that's not necessarily a bad thing because aftermarket is a profitable part of our business.

So going into our segments. Equipment & Service, first of all. Orders received, down 4%, and the mix is really between Service & Equipment, of course. Service, up 11%, very strong. And it's worth highlighting that, of course, service is the key part of our business, the most profitable part of our business. So 11% growth is very, very good to see.

And of course, that's on the back of high customer activity, high production, high intensity of service, and we expect, of course, our service volumes to continue at a high level going forward.

Equipment orders, as mentioned, down more than expected, and 27% down versus last year. And as I mentioned, the investment decisions tend to be postponed in the light of the current uncertainty. We've also seen a cancellation of a large order, and that the magnitude of that is roughly 5% of equipment turnover. It doesn't affect the orders intake all that much. But nevertheless, it's worth highlighting that this is part of the orders received, less cancellation.

And it's worth commenting also that we do have variability between quarters when it comes to equipment demand. First of all, it tends to be lumpy and, yet again, the variability is between quarters. So we think that the minus 27% and where we're at right now in quarter 3, may not necessarily be representative of the market as such. We -- when we look at the pipeline that we have of potential orders, that's still very strong. So again, we feel that our possibilities to continue to work with the improved equipment orders is there, but we have to see. Still uncertain in terms of where this is going to go.

Revenues up 2%, supported by currency and the margins, again, worth highlighting 26.3%, very strong, and not the least on the basis of a revenue mix trending towards service rather than equipment.

Tools & Attachments. Orders and revenues up 16%, 17%. And if you back out currency and acquisitions, down 3%, primarily impacted by the optimization of product offering, i.e. the voluntary step-down from business in rock drilling tools for profitability reasons. We've also seen an organic decline of volumes in hydraulic attachment tools, and this is on the back of a decline of the volumes and user volumes, and also adjustments of inventory in our dealer network.

Margins at 5.7%, not that impressive, but we -- of course, if we adjust for the restructuring cost, we are at 12.2%. Also, again, worth highlighting is that we do have a collection claim versus a distributor that have engaged in financial irregularities. And this is now a court case, and we have made full provision for the amount of SEK 41 million as well. So that's included in the profits, of course, also.

So that's the initial summary. Anders, I leave it now to you to go through details.

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [3]

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Thank you, Per. Yes. Some more details about the financials. Per has quite well explained the overall picture. This, I would say, the underlying profit is solid. As you see here, we have the noncomparable items of SEK 223 million, which we have described. If we adjust for that, we are at 21.3% and also this collection claim that was mentioned. If we look at that as a onetime item, the profit becomes 21.7%. So the underlying profit is solid.

If we look at the -- if we look at a little bit on the bridge, the details here coming from last year, we reported 19.0%. Obviously, with the bridge, we had a negative effect year-over-year from the structure, positive from the organic, altogether arriving at the 19.0%, with the noncomparable items then the SEK 223 million, the SEK 179 million for restructuring that we have described and the SEK 54 million change in provision for long term in this incentive program. And if we then add also the SEK 41 million for the collection claim, we are at 21.7% that you see to the upper right. It means a 16% increase of profit in value.

A few more words about the segments. From Equipment & Service, good flow through continued. We prefer to talk about year-to-date flow through rather than quarterly. It can be quite difficult to take a single quarter, and we elaborated on that during the Q2 call when you have the nominator. And the nominator sometimes going in the wrong or different directions. It's good to see for the Equipment & Service that we actually improved the flow-through year-to-date. We're now at around 33% flow-through. And obviously, that was helped by the mix and good service growth that Per described, the 11% organic growth. So obviously a mix effect here, but solid and good development organically for Equipment & Service.

Tools & Attachments. I would say, all-in-all, the underlying profit is largely unchanged compared to last year. There is -- if we do it a little bit more sequentially, there is a seasonality mix with a little bit of less of attachments, which is normal. We still have good flow-through. It's -- if we then adjust for the claim that we have described, we're largely on the same level as we were in Q2, year-to-date.

So although here, we obviously can understand that they are a little bit more difficult to follow with the noncomparable items, but the underlying activity is good and also the high level of actions that we have announced recently, which you have seen in a couple of press releases. So that's a good development also.

On the cost side, you can see from this -- the bars here that -- which is normal, the Q3 is typically a little bit lower than the Q2 activity level, vacation periods and so on. In these bars, we have excluded the long-term incentive program provisions, as usual, and we've also taken out restructuring costs. And this is the part of the restructuring costs as we put in the administration, marketing and R&D. So it's the SEK 62 million.

So having said that, we can see that we -- there are signs of our ongoing activities. Giving some effect, we don't increase anymore in the number comparison year-over-year. Obviously, we have an inflated number from acquisitions and currency. And that, together, is about SEK 110 million if you want to compare quarter-over-quarter.

If we look at the net financial items, the increase largely, quarter 3 this year compared to quarter 3 last year, has to do with our acquisitions where we have funded them in foreign currency. And with that, we also hedged those loans and the 2 good-sized acquisitions that we made earlier this year. And part of that hedging goes as interest cost, and that is the majority of the difference here.

On the tax expense, we have a higher effective tax rate, as you have noted. The underlying tax rate is still below the 25%. We have cautiously taken the cost for the restructuring as impacting the tax rate that's nondeductible. But the underlying rate is still where we want it to be.

Some words about the capital structure. Net debt, SEK 2.4 billion. And of that, the SEK 2 billion is related to the IFRS 16. And this is largely what we've had the last 2 quarters, the Q1 and Q2, where we started to implement this according to the regulations. So we had a good cash flow in Q3, which I will come back to and elaborate on.

We also, in Q4, will pay the dividend, which is approximately SEK 1.2 billion. The second part of the dividend will be paid out preliminary on November 4, with the -- excluding the rights on the 29th of October. So that will be, obviously, seen as a cash flow, not operating, but a cash flow item in Q4.

If we then look at the capital efficiency a little bit more, then the net working capital in nominal terms is up 12%. But if we try to look at the numbers behind, 11% of that 12% is related to currency and acquisitions. So only 1% is -- you could say, is organic. And in the light of the revenue development, that gives quite a different picture than just looking at the nominal 12%.

If we look at the return on capital employed at 29.5%, we still have around 1% impact from the IFRS 16 if we compare year-over-year last year when the IFRS 16 was not implemented, and that is pretty stable since Q1 and Q2. So I think you recognize that comment.

Cash flow. We had good cash flow in Q3, both year-over-year and sequentially, the SEK 1.9 billion. It's not the best quarter we've had, as you can see from the graph, but it's one of the second best to be more precise.

Inventories are going in the right direction. We had also strong, very good collection in Q3. There was largely then outbalanced by a reduction in payables, which is normal that time of year. We see that every year. And also, to some extent, impacted -- the reduction impacted by a lower activity on the capital equipment side. But overall, strong development of the cash flow and -- which is good to see that the trend is as expected.

So with that, I would like to hand over to Per again to do a little bit of a summary.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [4]

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Yes. Thank you, Anders.

Okay. So quarter 3, a quarter with several areas of strength for the company. We do have a strong aftermarket driving, not the least service. And service is highly profitable, a growth of 11%. We're very happy with this. And also this -- the aftermarket is certainly driven by strong fundamentals in terms of high levels of production, good mineral prices. And that's a very -- certainly a very good sign.

Good margins, good cash flow, high interest for automation. But given that we also have challenges when it comes to orders for machines. And that's on the back of uncertainty, cautious behavior of our customers delaying orders. And a consequence of that, in turn, is that we adapt, and we have continued to adapt.

We will continue to adapt to whatever context we have. And we also have to realize, I think that fundamentals will prevail. The fundamentals are still strong. So I certainly hope that there is an upside going forward when it comes to machines rather than anything else, but we cannot guarantee that.

So looking at the demand expectation, we think that demand will remain largely at the level seen in the third quarter. And that being said, the economic development continues to be uncertain, which is pretty much what I just said. It is difficult to say exactly where we will end up in a specific quarter, and that it's definitely the case also for quarter 4. But again, fundamentals continue to be strong.

So with that, we also turn to our Capital Markets Day. I just want to highlight and remind everyone listening that there is a Capital Markets Day the 14th of November here in Stockholm, and registration is open. For those of you that have not decided as of yet, please decide and join us, that would be very nice.

I think it's going to be a good event. And now Q&A.

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Karin Larsson, Epiroc AB (publ) - VP of IR & Head of IR [5]

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So perfect. Thank you very much, Per and Anders.

I think it's all clear, but I'm pretty sure there are some questions on the line. So please, operator, would you mind starting the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have a first question from Klas Bergelind from Citi.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [2]

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My first one is on the cost adaption, the 500 people in manufacturing the last couple of months. This is outside of Tools & Attachment. What kind of savings are we talking about here? And are you planning to push through any cost actions also on the OpEx side? Or is this manufacturing all in? And maybe squeezing in, also how the margin will be impacted by the divestments and closures in Tools & Attachments?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [3]

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Okay. Well, first of all, the 500 is a reduction from year -- from the beginning of the year. So those -- the effect of that is already in the numbers, more or less. Certainly, we've seen also a reduction in quarter 3, but the key and the main bulk of that reduction was actually done prior to quarter 3.

Now again, as we mentioned, we have additional initiatives starting pretty much right now. We're in the end of quarter 3. Going forward, we expect that to deliver above SEK 300 million, and again, the effect starting next year, beginning of next year. I think that's what we're trying to say.

And again, just remind you that I also mentioned a restructuring cost for the latter SEK 300 million between SEK 50 million and SEK 100 million. So that's really what we're trying to say here.

And the margin effect of the restructuring in Tools & Attachments. Yes, there's going to be a margin effect. We have decided to divest the ground engineering. We've also -- we're also divesting the handheld business in Ockelbo. We're also divesting part of the business in China. And we're also closing down part of the business in China when it comes to handheld tools. And all of that will have an improvement -- will mean an improvement of margins and, of course, but also a drop of top line as a consequence.

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [4]

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Maybe to add, I think it's worthwhile to remind that our operating model means that we do have a fair amount of temporary, and what we call additional workforce and temporary employees, which means that we constantly or continuously review the workforce, and that's why the 500 may look like a big number, which it is, but it's also a part of the way we operate, how we try to adjust. And we don't see that as a sort of a major restructuring program.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [5]

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No, I get that. And the second one is to understand the comment, Per, on hesitation for larger orders with underlying activities still being healthy. You, of course, don't announce all large orders, but just so we understand what is underlying demand. The equipment orders that have reported this quarter, are these what you would say is underlying adjusted for seasonality? And if seasonality is perhaps 5% quarter-on-quarter adding that back? Just want to understand what is underlying at large?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [6]

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Well, that's a good question, but also very difficult to answer, I will say. I mean how to define underlying orders? If we look at the SEK 2.7 billion that we are in terms of orders for equipment in the quarter, that's pretty much in line with the average over the last, I think, 10 years, if I'm correct. Right? Yes, they say. So maybe that's an underlying level then. And the number of large orders in Q3 were not -- we didn't have -- I think we had one, basically. And that's -- we always have 1 or last year we had several. But and that -- this tends to vary between the quarters. And so I don't know exactly what this answer means to you, but I'm trying to establish, I think that maybe we're at some sort of an underlying level in the quarter maybe. So difficult to define.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [7]

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All right. My final one is on Equipment & Service. Would you say it's more mixed this quarter helping the drop through? Last quarter, the drop through was pretty good because of both mix and productivity. Would you say it's more mixed this quarter? It looks like -- it maybe sounds like a too-detailed question, but want to understand how productivity moves in the bridge versus the second quarter then.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [8]

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Yes. I would say probably more of a mix issue than a productivity issue, but...

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [9]

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Yes. No, it's -- you're right. It's a detailed question, but the mix has certainly helped. And we -- you can see also from the revenue going quite significantly between Q2 and Q3 to the aftermarket side. And even though we don't disclose exactly the margins in the segments, you know fairly well that it's quite a big difference between the 2 parts of the segment, Equipment & Service.

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Operator [10]

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Next question from Guillermo Peigneux from UBS.

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Guillermo Peigneux-Lojo, UBS Investment Bank, Research Division - Executive Director and Industrials Analyst [11]

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It's Guillermo Peigneux from UBS. I wanted to get some granularity in the hesitation that you commented on. Is there any way you can share with us if any particular region or any particular mineral was more hesitant, so to say?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [12]

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Well, I really don't think so. I think what perhaps stands out is gold, where the optimism has increased over the quarter, and that's obvious, I guess given what has happened to gold prices. We've seen quite a significant uptick in the exploration activities in gold, but that's exploration.

When it comes to the uncertainty and hesitation, as you say, I think that's visible throughout. Certainly not any particular region that stands out. One thing that perhaps should be mentioned, we mentioned that also in quarter 2 is that China is doing really well also in quarter 3. So the Chinese do not seem to hesitate at the moment.

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Guillermo Peigneux-Lojo, UBS Investment Bank, Research Division - Executive Director and Industrials Analyst [13]

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And then with regards to a particular region, Chile, there's been certain volatility from political environment, from a social environment. Have you seen your customers there preoccupied about the stability of the country? Or it all seems to be working from a mining company -- companies there?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [14]

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Well, we haven't. I have no report. I mean we get daily reports from the -- our customer center there, but I have no reports of anything happening specifically among our customers. The only thing that has been affected is that we did have 2 seminars planned this week in Chile, one around rock drilling tools, the other one around underground automation. And one we did follow through and the other one, we postponed to a later date. And that's the only impact so far that I've actually heard.

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [15]

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I think it's going to take...

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Guillermo Peigneux-Lojo, UBS Investment Bank, Research Division - Executive Director and Industrials Analyst [16]

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And another one from my -- sorry.

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [17]

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Yes. No, I think it's fair to expect if this goes on for a long time that then obviously it will have an impact also on customer activity, but...

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [18]

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Yes, but we don't know that.

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Guillermo Peigneux-Lojo, UBS Investment Bank, Research Division - Executive Director and Industrials Analyst [19]

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Yes. And then last question on cash flows, actually. If you look at the progress of cash flow developments, if you also imply some progress in sales evolution and so on. And as we see the year could well be that by Q4, you're practically levered with almost a net cash position, unless obviously there's moves that are missing here. But obviously, you're not really participating in large or mid-scale consolidation projects at the moment. Is this an indication that a very solid and rich cash flow statement could actually end up with shareholder returns in some sort of way?

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [20]

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Well, I think that's speculation, and it's something that we can't comment on.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [21]

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Yes. But also I mean we, just a reminder, will be paying the second half of the yearly dividend now in November, which is SEK 105, and it's 1.2 billion shares. So that's some cash flow there as well.

And -- but you're right. I mean we don't participate at the moment in large-scale consolidation. So -- and we have strong cash flow. So at the end of the day, this is going to be beneficial to our customers one way or the other. No, not to customers, to shareholders. I mean shareholders.

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Guillermo Peigneux-Lojo, UBS Investment Bank, Research Division - Executive Director and Industrials Analyst [22]

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Don't give money to customers.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [23]

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No. No. Shareholders.

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Operator [24]

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Next question from [Erik Karlsson from JPU].

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Unidentified Analyst, [25]

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A little bit surprised about your commentary about the weakness in infrastructure. Could you just elaborate a little bit what you're seeing then?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [26]

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Well, our infrastructure market primarily is North America and Europe. And typically, Q3 is slower than other quarters. But this Q3 was lower than last year's Q3. And I think what we're looking at is a slowdown of activities related to the use of our machines. I mean that's pretty much what we see.

And of course, also hydraulic attachment tools, 100% -- more or less 100% infrastructure. And we also see a slowdown of end-user demand. And as a consequence, that has kind of a whiplash effect on our division through the reduction of dealer inventory. So these are the things that are happening or happened during Q3.

And I think that's pretty much how specific I can be at the moment.

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Unidentified Analyst, [27]

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That's very helpful. And the second question, if I may. How would you characterize your current inventory levels?

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [28]

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I think we should admit that they are higher than what we want them to be, and that's also one of our focus areas to address. And I think we've talked about that, and we do see that they are trending in the right direction now, and we expect it to continue that way.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [29]

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Correct. And -- but I just want to add to that, that we don't have any inventories of machines just standing around. I mean we produce to orders. So we don't have a huge inventory of machines standing around, as I said. We have inventory in transit, and that's pretty much it.

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [30]

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Yes. And maybe to elaborate on that. Obviously, with the business model we have with all the direct sales. We -- and with the, let's say, where our customers are and where our production facilities are, then obviously the transit part becomes a big number.

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Operator [31]

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Next question from Alexander Virgo from Bank of America Merrill Lynch.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [32]

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I wonder, could you just expand a little bit on 2 things? The first one, I wonder, can you explain how much of your own actions is weighing on the organic decline in rock tools? Obviously, I understand that you're actively moving away from lower margin or trying to move away from lower-margin business. So just wondering quite how much of a handicap that is on the top line?

And then on the second point, I just wondered if you can explain a little bit around this customer cancellation of the order. What exactly is that? Because your order equipment development has been markedly different than I think what we've seen elsewhere in the market. And I'm just trying to understand what you believe to be driving that?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [33]

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Yes. Okay, good. The first -- the answer to the first question is about 3%. And the answer to the second question, the order cancellation is we think, we've certainly been looking at this. We don't think it's an indication that, all of a sudden, we'll see massive cancellations across the board. No, this is related to a contractor, and this contractor has had the financial difficulties. It doesn't have anything to do with the development of the mineral that they are engaged in nor the mines that they're engaged in. We think it has to do with the management of the specific company rather than anything else. So it's not related to anything beyond that. And this contractor is a European contractor, active in another part of the world, basically.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [34]

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Right. And I guess on the first point, how much longer do you think that headwind is something that we need to think about in forecasting the growth of T&A?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [35]

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Well, I think we probably will continue to do this for the foreseeable future. I mean this is something -- this is pretty much like the adaptation of our cost base and workforce. We also have to adapt to the profitability of our business and not engage in unprofitable business. But when it comes to comparables, that will decrease over time.

I think we started doing this end of last year, perhaps...

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [36]

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Mid or Q3.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [37]

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Yes, something like that. So the comparables effect should decrease come next quarter.

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Operator [38]

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Next question from Bob Davies from Morgan Stanley.

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Robert John Davies, Morgan Stanley, Research Division - Equity Analyst [39]

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My question was just really around some of the trends you're seeing on the aftermarket side. I just wonder how your expectations for aftermarket growth are evolving for 2020 given the extent of the OE kind of order declines that you're seeing through this year and the recent sort of evolution in metal prices. Are you tempering your enthusiasm for growth for next year for the aftermarket business at all?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [40]

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Well, I think we've made significant progress, and we've grown service significantly over the last 6 quarters or so. And I don't think we should expect that pace to continue at that level, and the reason is pretty straightforward. We've gained market share on our own fleet and the bigger the market share, the more difficult it will be to continue to grow that market share. And I think that's pretty much what we will be looking at into 2020 without specifying any specific level.

We will do our utmost to continue to grow, but it will be increasingly difficult. I think that's fair enough to say that. But and also the potential impact of new equipment being delivered, well, new equipment typically doesn't need all that much service. So I think what we're looking at from a market perspective, i.e. our customers, I think what they're doing, they're using their existing equipment more intensively, and they are -- as a consequence, they need more service on existing equipment. And so instead of replacing, it translates into more service.

So I think if that trend continues, we will -- and lower equipment deliveries and still high production levels, we will have a push towards increased service intensity. So I think that's the dynamic we will be looking at potentially.

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Robert John Davies, Morgan Stanley, Research Division - Equity Analyst [41]

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And then maybe just 1 follow-up. Just I guess in terms of the discussions you're having with customers at the moment, how frequent is it that you're coming across people taking slightly longer to take delivery of these things? Is it more frequent that they come back to you and hold back on the orders? Or is it the actual orders that you've got coming through to sales where people are actually reluctant to sort of take the delivery in a quarter and wait an extra week or an extra month before they take it? So where are you seeing the biggest pressures, on the order side or the actual deliveries of the orders you have in the backlog?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [42]

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It's definitely on the order side. Once we have produced and shipped, there's no hesitation when it comes to accepting or taking the delivery as such; is really on the orders. So we said that we see the things being pushed out in time.

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Operator [43]

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Next question from Vivek Midha from Deutsche Bank.

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Vivek Midha, Deutsche Bank AG, Research Division - Research Associate [44]

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My first question is really around the equipment side of things. Given the equipment and order -- equipment sales this quarter as well as orders, could you perhaps talk about how large your backlogs are right now in equipment as a percentage of annual sales?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [45]

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Well, we don't disclose that number, I'm afraid. So I'm not going to give it to you. I think the -- what we've seen over the last quarter, quarter 3, now is a decline in the backlog, but still a significant backlog. So if things -- if orders were to decrease down to 0, we would still be busy for quite some time. So the backlog is still significant.

But it's also -- it should be noted that this backlog doesn't mean that everything is to be delivered immediately. Some of the orders start to be delivered later. And that's why we also, on the back of a decline in orders, also reduce production somewhat in order to not produce too early.

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Vivek Midha, Deutsche Bank AG, Research Division - Research Associate [46]

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Okay, I understand. Just trying to get a sense of your expected equipment sales next year. I mean are you -- do you think that it's likely that, that should grow next year, given your backlog? Are you still -- is it too early to say?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [47]

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It's too early to say, I would say.

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [48]

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Yes, I would agree.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [49]

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Yes.

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Vivek Midha, Deutsche Bank AG, Research Division - Research Associate [50]

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Okay, understand. And just following up earlier from one of the questions around the infrastructure and the mining customers and equipment. Could you perhaps give us a sense, quantitatively, broadly speaking, about the extent of order -- organic order growth for your mining customers and for infrastructure within equipment?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [51]

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Well, the mix -- the overall mix between the infrastructure and mining in Q3 was 21%, the infrastructure; and then 79%, of course, mining. It's typically 25-75. So the -- I guess, if we just apply that math, we lost, if you like, 4% top line because of the weakness or softness in infrastructure.

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Vivek Midha, Deutsche Bank AG, Research Division - Research Associate [52]

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Okay. Is that for the group or for equipment?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [53]

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That's for the group.

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Vivek Midha, Deutsche Bank AG, Research Division - Research Associate [54]

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Okay. I mean within...

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [55]

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We don't specify the number in equipment.

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Operator [56]

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Next question from Andrew Wilson from JPMorgan.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [57]

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I just have, hopefully, a couple straightforward ones. Can you just give us a little bit of help on the usual seasonality in the Q4 versus Q3? Just trying to get a sense, obviously, you've made some comments around the Q3 versus Q2, just be helpful to get a sense. I'm appreciating that large orders and things will move around, but just to get a sense of what you'd expect on, I guess a normal year?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [58]

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Well, Anders, maybe you can help out here?

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [59]

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Well, we see very little seasonality. But if we go long -- a long time back, it's typically that Q3 is slightly lower, but it's not a very strong effect.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [60]

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Which means that Q4 should be stronger, primarily stronger when it comes to revenue. So I think that's the typical pattern that we see and -- but I mean whether that's going to happen in quarter 4 of this year, well, we'll have to see, I guess, but that's a typical pattern.

I think the average decline that we've seen, if we just apply the statistics to historical quarters, is that Q3 is 5% lower than quarter 2. I think that's the number that we've mentioned historically, something like that.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [61]

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And do you have a similar number for Q4 versus Q3?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [62]

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No.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [63]

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And can I check -- shifting over to the savings which you outlined. I just wanted to check. Does that apply to both of the business areas, so Equipment & Service and Tools & Attachments?

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [64]

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Yes.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [65]

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Yes, it does.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [66]

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That's perfect. I just wanted to clarify. It was actually Alex Virgo's earlier question on Tools & Attachments. But the comment you were making around the sort of gradual exit of various product lines or effectively walking away from sales, that was an organic comment. And therefore, it's an addition to some of the specific comments you've made around divestments. So I just wanted to clarify.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [67]

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That's correct.

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Operator [68]

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Next question from Max Yates from Credit Suisse.

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Max Yates, Crédit Suisse AG, Research Division - Research Analyst [69]

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Just my first question is on the current Tools & Attachment margins. And I just wanted to understand, if we look back to sort of 2011-'12, when we were at the sort of previous mining peak, just where were levels of profitability back then versus where they are today? I just wanted to try and understand a bit more what the kind of runway for improvement is in the medium term in this division.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [70]

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Well, the historical margin is -- was way higher than where we're at right now. I think -- again, I don't think we've specified any details, but they were definitely closer to group average as they are right now than the current level.

So what does that mean? Is that to mean that we can make efficiencies back to the historical level? Well, I think that's going to be a struggle. Things have changed, the competitive landscape has changed. And -- but of course, all the actions that we're doing and undertaking, the intention of all that is to bring us back to at least close to the historical level. But it's going to be challenging.

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [71]

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But to be clear, it's obviously, and has been in the past, also a margin, which has been well below the average because -- I mean it's a different business, it's a different competitive landscape. And I think we have mentioned that a few times that even though it's even more competitive than maybe 5 years ago, it was already at that point in time, very competitive, and that goes for most of what we sell in Tools & Attachment, and in particular, for the consumables business.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [72]

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Fair enough.

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Max Yates, Crédit Suisse AG, Research Division - Research Analyst [73]

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Okay. And just my follow-up was on M&A. And I just wanted to understand, when you look at your kind of acquisition pipeline and what's discussed internally, is there a sort of reasonably large proportion of it that includes software, battery-powered equipment? So I'm just trying to understand, is -- should we expect over the sort of coming 12 to 18 months that you look at software deals as well as kind of the Tools & Attachment deals that you've been doing? Or should we think that the automation and software business will be developed much more internally and organically?

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [74]

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I think we -- the acquisitions that we made over the last couple of years, divided into 3 categories. Essentially, it's in service, we'll continue to do that; it's in technology, i.e. software, as you say, we'll continue to do that; and it has been historically in Tools & Attachments.

Now whether that's going to continue or not really depends on, first of all, how well we digest the current acquisitions and also how well we also perform the current restructuring. So but -- to specifically, yes, we'll continue to look at, and hopefully, make acquisitions into the software space.

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Operator [75]

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Next question from Markus Almerud from Kepler Cheuvreux.

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Markus A. Almerud, Kepler Cheuvreux, Research Division - Senior Research Analyst [76]

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Yes. Markus Almerud from Kepler Cheuvreux. So just a couple of quick questions. Can you talk a little bit about the differences in your equipment portfolio? So how is surface versus underground performing? Is there -- do you see any differences there? That's my first question.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [77]

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In terms of the...

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Markus A. Almerud, Kepler Cheuvreux, Research Division - Senior Research Analyst [78]

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Yes. So in terms of hesitations and in terms of...

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [79]

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No. I think it's pretty much the same. It's actually very, very similar, both surface and underground.

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Markus A. Almerud, Kepler Cheuvreux, Research Division - Senior Research Analyst [80]

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Okay. And then my second question is just -- it's a semantic question, but just to understand a little bit more about what you're saying. So you say that there are lots of projects or orders being postponed. Are we talking about -- when you talk to your customers, are they postponing them indefinitely? Or is it just more that it takes a little bit more time than it has before to sign the orders? Just to understand exactly how the flow is going here and what kind of conversations you have.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [81]

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I think it's really the -- yes, it is a latter scenario. I think it takes time internally. I think essentially what's happening is that the intention to continue to invest is still there, but the approval processes take time because, of course, our customer is like anybody else. I mean they recognize that there is uncertainty in terms of where the economy is going to go. And therefore, things take longer time to approve. I think that's really what we're looking at here. And so which means that typically, orders are not postponed indefinitely nor canceled. That is not happening.

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [82]

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I mean to be maybe, as you say, semantic, I would rather use the word delayed than postponed, even though they're -- it's a fine line, but...

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [83]

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Okay.

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Markus A. Almerud, Kepler Cheuvreux, Research Division - Senior Research Analyst [84]

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Yes, but that's my question because it's a bit different, and that's why I was asking the question about more the flow, what's really going on. So that's very helpful.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [85]

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Delayed. All right. Good.

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Operator [86]

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Thank you. We don't have any more question for the moment.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [87]

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All right.

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Operator [88]

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(Operator Instructions)

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Karin Larsson, Epiroc AB (publ) - VP of IR & Head of IR [89]

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I would say we could actually end the call here. And if you have any follow-up questions, you're most welcome to reach out to us.

I think despite everyone asking more than one question, we managed time. You had all good questions and follow-ups for each other’s questions. So Capital Markets Day on November 14th. And until then, I wish you a lot of successful investments. And please reach out to Per, Anders, myself, Karin Larsson or Mattias Olsson. And thank you very much, and have a great day.

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Per Lindberg, Epiroc AB (publ) - CEO, President & Director [90]

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Thank you.

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Anders Lindén, Epiroc AB (publ) - Senior VP of Controlling & Finance and CFO [91]

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Thank you.