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Edited Transcript of SAND.ST earnings conference call or presentation 24-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Sandvik AB Earnings Call

Sandviken Apr 25, 2017 (Thomson StreetEvents) -- Edited Transcript of Sandvik AB earnings conference call or presentation Monday, April 24, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ann-Sofie Nordh

Sandvik AB - VP of IR

* Björn Klas Otto Rosengren

Sandvik AB - CEO, President and Director

* Tomas Eliasson

Sandvik AB - CFO and EVP

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Conference Call Participants

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* Alexander Stuart Virgo

BofA Merrill Lynch, Research Division - Director

* Anders Roslund

Swedbank Large Corporates & Institutions, Research Division - Head of Equity Research, Sweden and Co-Head of Industrials Research

* Andreas Juhani Koski

Deutsche Bank AG, Research Division - Research Analyst

* Andrew J. Wilson

JP Morgan Chase & Co, Research Division - Analyst

* Benjamin Gulliver Maslen

Morgan Stanley, Research Division - Executive Director and Co-Head of European Capital Goods Equity Research

* Daniel Schmidt

SEB, Research Division - Analyst

* James Moore

Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research

* Klas Henrik Bergelind

Citigroup Inc, Research Division - Director

* Markus A. Almerud

Kepler Cheuvreux, Research Division - Senior Research Analyst

* Peder Frölén

Handelsbanken Capital Markets AB, Research Division - Head of Equity and Credit Research

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Presentation

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Ann-Sofie Nordh, Sandvik AB - VP of IR [1]

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Greetings to everyone, and I would just like to welcome you to the presentation of the results for Sandvik's first quarter 2017.

As per norm, we will run through the presentation under the management of our CEO, Björn Rosengren; and our CFO, Tomas Eliasson and then subsequently we will run through the Q&A session.

And without further ado, I would just hand over to Tomas and Björn for the presentation.

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [2]

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Thank you, Ann-Sofie, and also I would like to welcome you to the Q1 -- first quarter result presentation.

I think the quarter, which we have behind us, was a very strong quarter for Sandvik. We continued to develop in many areas in a positive direction, and there are 3 areas which I think sticks out a little bit more than the other. And the first thing, which, of course, from our perspective is very positive, is that we see orders continued to strengthen. So this quarter, orders were actually up 16%. Sticking out in the order side is, of course, mining and rock technology and Lar's team standing over here who actually were up 30%. I think these are numbers that we haven't seen since the rise of China in the beginning of 2010. So that's very, very positive. But all business areas actually contributed to this good order intake.

The second is, of course, the EBIT margin and this is the second quarter in a row where we are over 15%. And if you have listened to me before, I think quality companies deliver EBIT level over 15%. So that's extra fun. Of course, there is a lot of currency and also alloy surcharges that have been positive for the quarter, but the underlying improvement of the EBIT level is 18% and that should put in relation to our target, which is to improve by 9%. So I'm very happy with that.

And as the third and not least important, that's the cash flow. The cash flow actually doubled compared to last year and is actually the highest cash flow that we have had in the group. So that's very positive. That's, of course, driven by the good profit, but also by keeping the networking capital on a good level, which is actually under 25%. So that's very positive.

So if we look at the different markets, we see good growth in all our 3 big regions. Europe starting up, which says 5% here, but if we exclude the big order that we received last year, it's actually 11%. So for the first time, we're really seeing Europe taking off in a positive direction.

North America 41%, I think it talks for itself. But in these numbers, there is one large mining order, about SEK 250 million. So if you exclude that, it's about 25% for the Mining side.

Asia 7%, little bit lower than we saw previous quarter, but if you look at China, by itself, it was up 31%. So China is strong while it was a little bit weaker in rest of Asia. I think India was negative for the first time in a very, very long time. I don't think that's a big issue. Recently, we said that India and I think the momentum and the positivism in the market there is on a level that you generate good growth in the coming quarters.

If we look at our segment, our targeted segment, I think all of the segments were flat to positive. Also here, of course, sticking out is the Mining side. Very positive, but very positive also the general engineering, which is positive, and I personally believe that, that's driven also by the oil and gas industry, which is coming back in the North America. Positive continues to be good is the aerospace, up; the other, automotive, flat. We have also on the oil and gas and construction is pretty flat so far. Maybe someone of you saw here that the automotive in North America was negative. And I think that should be seen from a very high level. There were, I think, produced SEK 17 million cost in North America last year so it's from a high level. In Europe, we saw a flat development in automotive industry. And actually in China, it continues to grow and strengthen.

So at the order, I said 16% up, the underlying -- that's the underlying organic and then you have to add, of course, the currency there. The book-to-bill ratio is 114%, which I think is a good sign for future growth in revenues in the coming quarter.

The revenues were up 5%, which is not that big, and we, as you know, our order's been pretty high now for the last 2 quarters. So in the coming quarters, we should see an improvement of the revenues, trailing. From the Mining, we see normally about a 6-month delay between orders and invoicing.

EBIT development, I mentioned that one of the positive, it's actually 45% up. But if you exclude the currency effects and the alloy surcharges, it is 18% and I think that's a good level. So it continues to improve, and this is driven mainly from efficiency improvement, but also of course volume improvements from what we've seen before.

So if we now look a little bit also into each of the business areas. Machining Solutions continues to impress. Strong orders this time, up 10%. That sounds a lot, but if you actually begin to dig a little bit more, there, we had during this quarter 3% more working days. So if you exclude the working days and also a big order that we received in the Powder and Blanks Technology, the underlying is about 4%, 5%. So that's about how you should see the level for SMS at this moment. If we look at the margin, 23.2%, very strong continuous improvement what we're seeing there. And SMS continues to have good control over the operations and the networking capital continued to go down, which, of course, generated an excellent cash flow for the business area.

Then to Mining and Rock Technology, and the one most recent to me, this is the area where I think we have the best improvement potential, and I think Lars and his team showed that very good during this quarter. We made 14.1% EBIT and that's an improvement from 9.6%, so I think that's a good number. But if you dig a little bit deeper in here, I think it was good. If you lift out the Varel business out of the Mining, it's actually 15.2%. So now we are talking, now we're coming much closer to the levels where I think this business should be delivering on. We can see that orders were up 30%, but invoicing still only 6%. So that's what I said it's trailing. Also credit to the whole team to keeping the networking capital under 25%, I think, and that's also why we generated a really good cash flow from the Mining and Rock Technology business.

If you look at the different metals that you are seeing there, it's actually gold, silver and zinc, which is thriving. We are still waiting to see some improvement from the copper, but the copper price is going up slightly, so maybe in the coming quarters we could see some more activity in that part.

If you look at the different businesses we have, you know that I think the most important part of the Mining and Rock Technology is the aftermarket. And they really showed strength during this quarter, 11% up. And I think that should be put in relation to how the market is developing and we know that the mining output from the mine is about 1% up per year and not more than that. That shows that actually that we have a strong belief that we are really taking market share now on the aftermarket, which is the important part, not least in tough times. We're also seeing good volumes in the underground business. Loaders and trucks is doing amazingly well, but also the drilling. We also start seeing really good momentum in the surface part while it's a little bit more slow on the core mechanical excavation part of the businesses.

Then moving over to Material Technology. Also here we see some growth, 5%. If we then exclude the alloy surcharges improvement there, it's, what we call, a black 0. Just a little bit growth. This is supported by the great order that we received in oil and gas industry from Leviathan. It's actually a gas order for umbilicals, which is actually helping us to keeping up the orders on hand on a healthy level. We also do expect that we should during next quarter get one of these subsea the orders to help -- to secure the full year. So that looks quite promising. Volumes is minus 1% here but if you take away the metal surcharges, it's actually down 6%. So that's actually what is driving the weaker earnings, which is the underlying, which is actually 6.3%. We do believe that the coming quarters will offset this loam apart and we think we will reach the targets that we have set. We are quite optimistic to a number of good quarters for SMT moving forward.

So Uncle Scrooge, did you have any money?

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Tomas Eliasson, Sandvik AB - CFO and EVP [3]

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Well, don't listen to him. He's from Gothenburg.

Okay. Yes, we do have some money if you want to buy something or build somewhere in the world. Okay, let's jump into the numbers and start with the overview: 16% order; growth of 5%, revenue growth organically, as you've heard. If you look at the upper right-hand side, you can see the currency effects, 5%, taking then order to 23% and revenues to 10% in total-total.

The operating profit or the EBIT was up 45% or 18% excluding FX and metal price effects. 16.1% in EBIT margins.

Net working capital reduced again, down to 24.5%. Should mention that the rolling 12-month number is a little bit above 26%, so we still have some way to go to reach the 25% target, but we're approaching.

Cash flow was slightly up, 94% up to SEK 3.7 billion, a very good quarter.

And return 18%, and also earnings per share grew healthy.

So if we then jump into the bridge, we can see -- we see the quarters here, Q1 compared to Q1, year-over-year. We can start on the right-hand side, the structure and the one-offs, it's just metal price effects and alloy surcharges here. SEK 235 million on the EBIT line, meant an accretion of 1.1 percentage unit. Currency, SEK 400 million on the EBIT line, 1.1%. Then on the left side, you see the organic price, volume, productivity, SEK 800 million in revenues and SEK 458 million in EBIT. So a drop-through of 56%, which we're pleased with. 1.7% in organic margin accretion.

If we then move to working capital, to the balance sheet, you can see that we continue to decrease. As you can see in the graph here, Q1 is always up a bit seasonally compared to Q4, sequentially. It's been like that all the time. There is a buildup in Q1 for deliveries to come, but you can also see that the increase in Q1 2017 was much, much less than what we've had over previous years. The percentage is down to 24.5%, as I mentioned, very good performance.

On the right-hand side, you see the business areas, and SMRT and SMS continued to perform very strongly. SMT has a buildup ahead of deliveries in the coming quarters.

The cash flow was up, a very strong quarter, probably the best in modern times with SEK 3.7 billion in free operating cash flow. And you can see on the right-hand side where it comes from. As Björn mentioned, it's mainly driven by increased earnings, so SEK 1.4 billion up from earnings. And working capital is normally negative in the first quarter but you can see here also that the negative was much, much less than a year ago, SEK 0.5 billion better than a year ago. And CapEx was slightly up.

And the last graph is this beautiful one, it's the net debt. And from the peak level in 2014, the net debt has come down from SEK 40 billion down to SEK 26 billion right now. And the gearing is 0.63. So we have the target of SEK 0.8 within reach and also we should mention that we -- after the first -- sorry, the fourth quarter closing and the release of the fourth quarter result, we had a new outlook from Standard & Poor's and the negative outlook was taken away and we instead got a positive outlook. So we now have BBB with a positive outlook. So we'll see what happens.

Now outcome and guidance. If we look at the first quarter, SEK 401 million year-over-year in currency FX, we guided for SEK 400 million so that was pretty spot on. The metal price effect here, we guided SEK 129 million and maybe we should mention that this is the in-quarter guidance, not the year-over-year guidance. So SEK 129 million was sort of the actual and 0 was the guidance. And the big differences is chromium and the U.S. dollar movement. So for the second quarter, we guide SEK 400 million in year-over-year currency effects and about 0 in metal price effects. The metal price effect a year ago was also close to 0. So it is 0, both in quarter and year-over-year basically.

The CapEx we keep at SEK 3.9 billion as guidance.

Net financial items, we keep SEK 1.4 billion to SEK 1.5 billion. Should mention that we had SEK 387 million in the first quarter. So SEK 387 million times 4, that's a little bit more than SEK 1.5 million. But that's because we have some FX and hedge valuation, temporary valuation, differences in the finals net. If you just look at the pure interest rate, net, it was downward 25% in the quarter year-over-year, close to SEK 100 million down. Then we had FX and hedge valuations going the other way, but that's just temporary. So that will flow back and forth, it's a little bit difficult to predict. So we keep the guidance of SEK 1.4 billion to SEK 1.5 billion.

Tax rate, 26% to 28% . We had 26.9% in the quarter.

And before I finish, maybe I forgot something, which is a bit important. On the cash flow side here, you can see that we had SEK 1.9 billion a year ago, we had SEK 3.7 billion this quarter, that's quite an improvement, nearly 100%.

Now we don't guide on cash flow as such, but I just want to say that don't expect 100% up every quarter for the rest of the year. We do have -- starting to have some positive numbers now on the top line, I mean, I'm talking about revenues now. And as Björn mentioned here, this fantastic order intake will transform into revenues stronger and stronger during the year. And even though capital efficiency, as you have seen, is improving all the time, growth eats up a bit of working capital. So I think we can safely say that it's not going to be 100% up in Q2, Q3 and Q4. So be a bit careful in your Excel sheets.

Okay, so with that I hand back to you, Björn.

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [4]

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Good, thank you. Just as an end. Our direction towards a decentralized structure continues. I think we start seeing all of our product areas with full management teams in place and we see improvements in all different corners.

As you know, we decided to divest 3 of our businesses, 2 of them because we call them noncore, that is the Process System as well as the Hyperion. We started the process during this quarter for Process System and that is moving well. It's a great interest for the business and we're expecting to get well paid for that business.

When it comes to Mining Systems, I'm sure many of you are curious where are we in the divestment there. We've had a good quarter in the works here, meaning that we decided instead of selling the whole business as one lump, we divided into two businesses. And one of the businesses, which is the component business, is this conveyer component business, which we are selling separately. We are close to signing there. We have a buyer and the development, it moves the right direction. For the project business, which is the big part of the business, we also here have a buyer and we are close to signing letter of intent there. So we expect now to have it closed during the second quarter. So I feel very comfortable about the development here and that we should be able to close the deal within the quarter of.

By that, I think I end the presentation and we move over to question and answers.

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Questions and Answers

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Ann-Sofie Nordh, Sandvik AB - VP of IR [1]

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Yes, indeed. And we'll start here in the presentation hall, please. We have a question at the front?

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Peder Frölén, Handelsbanken Capital Markets AB, Research Division - Head of Equity and Credit Research [2]

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Peder Frölén, Handelsbanken. A couple of questions regarding the leverage, if I may. Firstly, if you look at the order intake in the Mining business and you mentioned that not only aftermarket is strong, but also the underground and replacement of equipment. Could we discuss the future leverage in the Mining business. Extremely strong right now obviously with little invoicing increase and very strong savings increase. So what to expect there in the long term? Moving over to the SMS business, the SEK 50 million sales provision, could you explain that? Is that sort of -- is that something that we should look nonrecurring? Or it's actually provisions for salespeople doing better than expected?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [3]

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If we start with the SMS business and the SEK 50 million, as you will notice, it's that the development of the group is going a little bit better than we anticipated on the V&A. in those SEK 50 million, it's actually up for the short term and long-term incentive programs, so that's lifting it to a certain level. That's where it came in, so if you add to that it is actually nonrecurring. I mean, It moves up. It's in the special extra during this quarter. You should not expect that every quarter. So when you look at the leverage, you could actually put that back and you end up then at 47%, which I think is a reasonable level.

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Tomas Eliasson, Sandvik AB - CFO and EVP [4]

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You start the year with an assumption. But then I think if things develop much, much stronger, you immediately have to change your provisions.

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [5]

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Then on the leverage on the Mining, I think we try not to speculate much within this part. But of course, in the improvements, and I mentioned that we did a lot of cleaning during last year and some of that has been taken out, so we are now moving in more to levels that we should be seeing going forward. It's correct that the volumes are up, but they are not extremely up. How the leverage will develop, I think we'll wait and see to that -- to the next quarter. But I think we're starting coming up to see levels where I would like to see the business. If we can keep it on this part or improve it somewhat, that would be great.

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Peder Frölén, Handelsbanken Capital Markets AB, Research Division - Head of Equity and Credit Research [6]

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Another way of asking that question might be on pricing on the Mining, different revenue streams of Mining. So are you pleased with the -- when demand is returning on your equipment side where you manage to sort of also look at decent prices. I mean, the competition ought to be rather tough out there with a lot of capacity.

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [7]

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It's correct. We are seeing positive pricing now in the Mining part. So what we saw before, which was negative there, has now changed into positive. Of course, when your production facilities are full, it doesn't really make sense to sell equipment with a lot of discount. So that definitely helps the pricing situation for Mining.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [8]

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Thank you, Peder. Do we have any additional questions here in, Stockholm? Yes, please, Anders?

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Anders Roslund, Swedbank Large Corporates & Institutions, Research Division - Head of Equity Research, Sweden and Co-Head of Industrials Research [9]

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Anders Roslund, Swedbank. How does the demand picture look like in the SMS business given this issue with working days and the underlying 4%, 5%? What's the trend in the quarter?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [10]

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We normally give you a little bit of an indication here and I would say there's no big changes, I think we continue. I mean, we look -- normally we look at the invoicing per day and that continues to be on a similar level as we see now ending the first quarter.

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Anders Roslund, Swedbank Large Corporates & Institutions, Research Division - Head of Equity Research, Sweden and Co-Head of Industrials Research [11]

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Are there any differences from the -- in the different geographies?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [12]

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I don't have that information yet. I can only see what's actually going out from our distribution center, but we will see that pretty soon when we have the Q1 ready. So we'll come back to that during next quarter.

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Anders Roslund, Swedbank Large Corporates & Institutions, Research Division - Head of Equity Research, Sweden and Co-Head of Industrials Research [13]

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Okay. And then the final question about the Materials Technology business. What do you see there from the order side?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [14]

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I mean, I was, of course, happy that we received this big oil and gas order from Leviathan. It's actually the gas order. And if we're looking at what has happened during the last year, mainly the big order is actually coming from the gas side and that's also where we see the most positive looking forward. And gas, there is a big demand for gas in the market. That's, of course, what's driving this kind of investment. It was pretty flat in orders, that's pretty clear. But we are quite optimistic in the coming months when it comes to order side on the SMT. It looks pretty okay. I can't say more. It's like everything. An order is never an order before it's signed. You have it on your table. But it looks pretty okay.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [15]

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Thank you. And with that we'll move into the conference call, please, operator. Do we have the first question?

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Operator [16]

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(Operator Instructions) And our first question comes from Klas Bergelind from Citi.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [17]

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It's Klas from Citi. A couple of questions, please. Firstly, on SMS, Europe is flattish ex working days. I mean, it's good to see the better momentum in North America. But given the strong momentum in PMI for Europe ongoing since September of last year, flattish growth underlying is a bit disappointing. Could we drill down a bit more by end markets in Europe? Is there something at all that stands out on the positive side? And did you see any improvement in Europe in the beginning of the second quarter, I'll start there.

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [18]

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Yes, I think from the beginning, if you look at SMS, I think we have positive development in all 3 regions. So it's correct when you're saying that the working days is mainly affecting the European market, which continues to be somewhat positive. I don't think I have any direct information about the different segments. The only thing we can see is that the automotive industry continued to be flat. We are seeing an improvement, of course, in the general engineering side. Otherwise -- and of course, also aerospace. Aerospace is positive on that side. So I think we are pretty optimistic about the European market. Of course, North America and China is sticking out more than Europe at the moment. That's what we're seeing the best growth during this quarter. But it feels that it's pretty healthy in the industry and that the whole market trend's more solid than we've seen before.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [19]

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Can I just follow up on energy. It seems like energy in SMS took a leg down in Europe. Was it a tough combo on large orders? Or was that an underlying improvement?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [20]

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That's down -- I would say that the underlying, yes. Of course, it depends on how you measure this, but I think it's the underlying, yes.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [21]

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Would you say that -- sorry to labor the point, Björn, but would you say that the general engineering side is looking healthy and that accelerated ex working days? Do you feel more optimistic about general engineering?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [22]

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Yes, probably.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [23]

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Okay. My second question is a follow-up to Peder's question on SMRT and on the lead times and potential bottlenecks in the supply chain. We've seen very strong growth here and we've seen momentum since the third quarter of last year. Do you now see increased bottlenecks? And what is the entire lead time from when you get an order on the drill rig to when you can deliver it? And is that the key reason for pricing moving higher? Or is it just because of higher input?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [24]

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Sure. I mean, this is an assembly business mainly, so it's of course getting the whole supply chain up and moving. And you see in the acceleration in orders during the second how the last quarter and this quarter. Of course, it takes a little bit time to get everybody up and running. So I think that's the -- if we look at this quarter, for instance, I mean, we had, on the invoicing, pretty weak during the first 2 months and then we had an extremely strong March. So we start seeing things move in the right direction there. But it is normally, we'd say, 6 months. If you place an order today, it varies of course what kind of equipment that you're ordering, but it would probably be difficult to get any big deliveries before the end of the year, so it has been pretty full. And I mentioned, you see the -- if you look at the orders, it says 30% up, that's on the whole business. But if you're looking at the underground business and also the surface business, it's significantly higher. So we're talking really high numbers there. So of course, they are under pressure, that's true, but at the same time they are assembling equipment in the factories. They're working together with sub-suppliers and using the facilities we have at the moment. So I think they're doing a good job. It takes a little bit time to get up and then the pricing is definitely related to this. I mean, I think selling a drill rig today with a discount is more throwing money away. So I think this is a good opportunity to keep the pricing on a good level.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [25]

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My final one is on -- both on Mining in terms of quotations. Key commodities such as iron ore and copper rolled over towards the end of the first quarter. Has this slowed down the quotation levels at all? Or are we still looking at the same solid activity when you look at your pipeline?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [26]

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Copper is very important for us and we start seeing movement there. So that's -- but it hasn't really taken off yet. Iron ore is significantly less for us. I mean, it's related some of that, of course, in Northern Sweden, we have some. And then in South America in Brazil, that's where you see the big iron ore part of the business. But that hasn't really taken off.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [27]

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Thank you very much. Operator, we'll have the next question, please. And cautious of the time here, and no offense to you, Klas, but can we please limit the questions to two per person, please?

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Operator [28]

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And the next question comes from Ben Maslen from Morgan Stanley.

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Benjamin Gulliver Maslen, Morgan Stanley, Research Division - Executive Director and Co-Head of European Capital Goods Equity Research [29]

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A couple on Mining for me, please. Björn, you said that drilling and the underground segments are the ones that are really driving the recovery. Can you talk a little bit about what you seen the crushing and screening segment at the moment? Are you seeing any pickup in that business?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [30]

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Sure. Also -- there is also good improvement in the crushing side, but, of course, it's not on the huge numbers that you're seeing in the underground. But definitely, crushing is picking up quite well also.

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Benjamin Gulliver Maslen, Morgan Stanley, Research Division - Executive Director and Co-Head of European Capital Goods Equity Research [31]

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And just on the split between equipment and aftermarket within Mining, can you give us a split for orders and revenues, maybe, just to how much of the business is aftermarket now and just clarify what the growth rate was? I think you said it was double digit, in the release it says single digit.

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [32]

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I think when we were a little bit lower, it was 65%. We're probably around 60% at the moment.

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Benjamin Gulliver Maslen, Morgan Stanley, Research Division - Executive Director and Co-Head of European Capital Goods Equity Research [33]

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Okay, great. And then the growth rate?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [34]

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Mining on the aftermarket is 11%, if that's what you referred to.

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Benjamin Gulliver Maslen, Morgan Stanley, Research Division - Executive Director and Co-Head of European Capital Goods Equity Research [35]

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Okay. I'll also go back on that. And then just one, Björn. You mentioned Varel and it sound like it's not contributing much to profit or it's still in loss. Just what are you seeing in terms of demand there? U.S. rig count is looking better. And when can it get back to profitability?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [36]

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Sure. I mean, the Varel business is very much related. It's in the Middle East, but also in North America and where we've seen a good pickup is of course on the North American market, which very much related to the number of drill rigs. And I think the numbers we saw lately was just over 800, so it's growing. The last 5 months, Varel has contributed with a positive EBIT. It's still on -- around 5% level, but in the PPA, it's actually affecting negatively 10%. So if add the PPA zone there, it's actually negative still, so it's not contributing that well. But I think the underlying business is improving and thus I said 5 months with positive EBIT margin, I think, is a good improvement from last year. And these 2 months will add a little bit.

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Tomas Eliasson, Sandvik AB - CFO and EVP [37]

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Yes, so what that means is that it's been cash-accretive for 5 months if you take out the PPA part of things. So it's sort of taking that out is kind of mid-single digits in terms of EBIT margins. And Q1 showed a steady growth in order intake for Varel as well.

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Benjamin Gulliver Maslen, Morgan Stanley, Research Division - Executive Director and Co-Head of European Capital Goods Equity Research [38]

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Good, it should improve going further as we go through it?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [39]

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It follows pretty much the drill rigs in U.S., to be honest.

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Operator [40]

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And the next question comes from Alexander Virgo from Bank of America Merrill Lynch.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [41]

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Just a quick one on SMT, please. I think the Leviathan order ends up being about 11% of the growth. And you talk about the alloy surcharge, also I think about 500 to 600 basis points. So I was just wondering if we kind of look at everything on an underlying basis, is it right to assume the business is down order-wise, sort of 10% or so? And then second one, just to follow up on the impact on EBIT of working days as we look forward into next quarter. Presumably we can expect that to drop through at a similar sort of operational leverage you've seen in Q1?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [42]

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Yes. Starting up with the SMT there. We actually had a big order last year also so, which was actually bigger than Leviathan. So it has actually a negative effect on that part. So it is not -- underlying it's actually a little bit more positive. You take the other one?

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Tomas Eliasson, Sandvik AB - CFO and EVP [43]

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Yes, and the other one, sorry, can you repeat the question, please? Working days in Q2?

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [44]

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Yes, just obviously, you had a much longer impact from working days in Q1 than I think most people are expecting. So presumably that all reverses in the second quarter. I'm just checking that, that should drop through with the usual amount of operational leverage?

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Tomas Eliasson, Sandvik AB - CFO and EVP [45]

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Yes, I mean, it all goes back in Q2.

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Operator [46]

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And the next question comes from Markus Almerud from Kepler Cheuvreux.

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Markus A. Almerud, Kepler Cheuvreux, Research Division - Senior Research Analyst [47]

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Markus Almerud here. I would like to start with just to look again at SMS throughout the quarter to follow-up on Ander's question. If you could talk a little bit about a daily sales rate. Did it grow stronger into March coming out of January, February, that's my first question, please, and especially if you could talk about North America.

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [48]

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Sure. It's correct that we saw stronger in the end of the quarter and the level continues to be on the same level, yes.

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Markus A. Almerud, Kepler Cheuvreux, Research Division - Senior Research Analyst [49]

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Okay. And then if I can ask just on SMT and the umbilicals project. So you talk about you're optimistic here about the projects going to -- coming quarters. Is it still the same type of political orders? And can you talk a little bit about the discussions in just a regular oil project? Are there any discussions at all? And then have they progressed? And is there more optimism now as oil prices have come up? Or is it pretty much the same?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [50]

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No, it's great. I think that is more what we see, of course, is the gas side of the market, which is driving most of the projects at the moment. I think that continues. It's difficult for me to comment if it's a political order or not, because it's actually both kinds that are expected. So yes, it is mostly gas, correct, and this project, as you probably understand, you have a pretty good visibility when they are going to come and to replace, and I said we are very optimistic that it will be placed during the quarter. But an order is never signed before it's signed.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [51]

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Thank you, and we have any questions here in Stockholm? Yes, we do, please. Daniel?

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Daniel Schmidt, SEB, Research Division - Analyst [52]

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Yes, Daniel Schmidt from SEB. Björn, you've clearly sort of mentioned that you are in the process of divesting 3 of your businesses and one might be coming before the summer. And do you have any sort of -- could you give us any timing on Process System, Hyperion and also the fact that you've stated at least last year that you need to invest those proceeds into some sort of software platform for the Machining Solutions business?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [53]

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I don't know if I understand. First, I can just mention out of those 3 businesses that we are selling, the Mining Systems, I expect that to be close during second quarter. On Process Systems, that is taking place. We have a big interest in this. We are in the due diligence. A number of players are now in the last phase and we have a due diligence process that will continue to end of May where the final bids are coming in. So we expect to have a closing on this one before the end of the quarter. Hyperion is still in a startup phase so we are preparing. It's a little bit more complicated spin-off than we have on the other businesses. That process will start in August. So it's moving the right way and it's a good business and we're looking at both of these businesses. They are developing well. So that's going to support the process.

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Daniel Schmidt, SEB, Research Division - Analyst [54]

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And what about sort of the need to buy a software platform for SMS? I got the feeling that, that was something that you're not going to build greenfield or organically. Has that changed?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [55]

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Software platform for SMS -- oh, you mean the for the growth. Aha, now I know what you're referring to. Yes, that's the growth strategy, which was presented by SMS where they look at different growth opportunities going forward. And in that growth strategy, it is, of course, to strengthen the core business. It is also investing more in software. We have made a number of smaller investments within the software. So we have created like a common business for SMS where they are developing the software part of the business. Then we also look for opportunities to grow the measurement part of the business as well as the 3D printing or additive manufacturing and also on the comp side. So these are the growth opportunities. We have Klas onboard since April 1, now taking over the strategy from Jonas. Of course, he is reviewing the plans that our in and making sure that they are in line with his and his team' viewpoint forward. I don't expect any big deviations from that, but at least a little bit update and Klas should land before we really get the momentum going forward that also. Klas is new, but he's internal. He's been with the company for many years. He's been running Coromant for the 5 years. So it takes very short time to get him full speed, up and running.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [56]

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Thank you, Daniel. Then we move back to the conference call, please. Operator?

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Operator [57]

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Yes, we have a question from Andrew Wilson from JPMorgan.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [58]

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Just a couple of quick questions. On SMS and obviously the very good improvement you've seen in Q1, can you just talk a little about what you're seeing in terms of pricing and whether you've seen a kind of step-up, I guess, with obviously the improved backdrop?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [59]

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Yes, it's more positive. So if you look at SMS, I think it was up 1.7% positive pricing, which I think is a direction. But I should be noted that first quarter is normally the best quarter when it comes to the pricing side. But definitely, significantly improvement from the 0 we had in the last quarter.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [60]

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And then on the Mining aftermarket and just to clarify, I think, on Ben's question. I think in the release it talked about being up a single-digit number year-on-year and I think you've talked about being plus 11%. I just wanted to clarify what the right number was and I guess...

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [61]

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It's correct, it's 11%. So it's a very good number for that business and I think from my perspective, one of the most positive numbers for SMRT.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [62]

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Yes, and that was -- I guess, leads nicely into the question I wanted to ask about, which really was exactly how you're delivering growth through that degree. I mean, you talked very clearly about market share gains. I guess, just give us a bit of color in terms of exactly what you're winning share on?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [63]

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Yes. When we're talking market share within aftermarket, it's actually against yourself. So we look at the whole fleet and we have about 8,000 units that are operating out there. We know exactly where each of these units are operating and we also know how much spare parts and service each of the units are consuming. So when I say a market share improvement, it means that we are taking a little bit bigger market share of our own fleet. So it's actually not against any competitors, it's our own job to serve a bigger part of our own fleet and that's how we measure that.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [64]

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And we'll have a question here from Stockholm, please, from the audience?

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Peder Frölén, Handelsbanken Capital Markets AB, Research Division - Head of Equity and Credit Research [65]

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Peder Frölén, Handelsbanken. You mentioned savings, Tomas. You also mentioned the sort of the EBIT growth ambition that you sort of released on the same day. If we look at in report and we add sort of the savings comment, it's around SEK 130 million or something.

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Tomas Eliasson, Sandvik AB - CFO and EVP [66]

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SEK 135 million.

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Peder Frölén, Handelsbanken Capital Markets AB, Research Division - Head of Equity and Credit Research [67]

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Yes. So how we should think about this going forward? And also the real question I want to ask is are you reaching a higher sort of ambition? Or it's -- it runs faster than expected? Obviously, you talked about improvement of EBIT in a flat volume scenario and we need to sort of calculate the volume improvement out of the equation again. But still, are you reaching higher? Or is it just going faster and hence what will happen to the savings and the efficiency gains, well, for this year?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [68]

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Maybe I just can add on little bit just to get a little bit of understanding then. When volume goes up and you start getting choked in your production facility, it becomes a little bit more difficult to drive these kind of efficiency improvement programs within the operations even though, as you know, we have a productivity improvement target for every unit within the group. That means 3 percentages -- points. And how do we measure that? That's actually sales per employee. So that's how we measure the improvement. That will continue, and of course, it would be easier when the volume goes up, that's natural. While when you're in a downturn in volumes, you have to actually take out more people than you have and than you need. So it will be difficult to get more efficiency even though we have our supply chain optimization program where we have closed 19 factories out of 23 and we expect to do the final of these during the rest of the year. So there are still these activities going. Then I also like to underline is that with the new structure, with the so-called operating entities with full accountability, I do expect that each of these units will improve their performance and that comes -- one thing, of course, for your sales to have, but your S&A costs, your COGS, your pricing, you have to drive your businesses. So I mean, this is an ongoing story and this will never end and this is built into the, what we say, this continuous improvement. And me and Tomas, we actually follow that down to product as much as 34 units every month and we have the famous scorecards that Tomas and his team have developed, which actually gives us full accessibility of all the performance in every business unit and I can assure you we put a lot of pressure on that.

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Tomas Eliasson, Sandvik AB - CFO and EVP [69]

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Yes, we're a real pain for the organization. There's no getting away. As you mentioned, Peder, we have the 7% EBIT CAGR growth for the 3 years, that's right. We did 3% in last year, means that we should do 9% average CAGR now in next year and then we did 18% now, I mean, this quarter. But there's still 7 quarters to go, of course. And I mean, if you just look at the numbers, I'm looking at Ann-Sofie now, but if you look at the numbers, I mean, from 15% to 18% here, it's SEK 2.3 billion that we need in profit improvement to do the 7% CAGR and like SEK 1.2 billion, SEK 1.3 billion comes from the announced savings programs, then there's another SEK 1 billion from efficiency, productivity, et cetera, et cetera. We're tracking, but there's still 7 quarters to go and the comps are not getting easier, as Björn mentioned.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [70]

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Okay, operator, please, we'll have another question from the conference call.

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Operator [71]

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And the next question comes from Andreas Koski from Deutsche Bank.

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Andreas Juhani Koski, Deutsche Bank AG, Research Division - Research Analyst [72]

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A couple of questions on Mining and Rock Technology, firstly on the demand situation. In Q1 to Q3 last year, you had an order intake of around SEK 7.5 billion per quarter. Now in the first quarter, you exceeded SEK 10 billion in orders. Do you think this is the new normal level? Or have you seen a lot of larger orders although they were not recognized as large orders in your report because they were lower than SEK 200 million each?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [73]

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I think being in the mining business for so many years as I have been, I learned to understand that there are no new normals. Now is like it's always been. It goes up and it goes down.

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Andreas Juhani Koski, Deutsche Bank AG, Research Division - Research Analyst [74]

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But you look in the short term, if you look at your tender activity, you see no reason that it should slow down in the next couple of quarters at least?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [75]

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I think there is a big demand for improving the fleets in the different mines around the world. And as you know, we are 2 suppliers in this part, so we are in a very pleasant working environment for us. So we will get the questions as well as our competitor in this part, but that's going to be driving. I do believe that as long as we see the metal prices on this level, this is a level where the mines are making money. When they make money, they need to invest in our equipment because we call it capital equipment. From my perspective, it's not capital equipment, it's actually wear equipment. It's what I said before, they have a lifetime of 5 to 10 years. But after 5 years, it starts becoming expensive to maintain and to get efficacy out of the equipment. So of course, with the fleet that we have in the market and so many years without big investments. I think there's a huge demand for equipment going forward. If the mines are prepared to take in now or later, I think that we will see. But we are in a sweet spot when it comes to equipment for the mining industry.

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Andreas Juhani Koski, Deutsche Bank AG, Research Division - Research Analyst [76]

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Okay. And then, secondly, I have to ask about the operating leverage as well because it was 70% in the quarter. You had a book-to-bill of 1.22, which corresponds to a difference of around SEK 1.9 billion between orders and sales. If we would apply a 30% drop-through on that kind of gap when you bridge it, you would reach a margin of 17%. If we would apply 70% drop-through as you had in the quarter, you would more than double your EBIT in SMRT. So how much of the costs in SMRT are fixed? And how much are variable? How should we think about the drop-through now when revenues are going to ramp up?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [77]

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When you say these numbers, I look at Lars in the corner and he looks very nervous when you say those numbers. But it's correct that you should not expect 71% drop-through, that's pretty clear. What level we will get, we wait and see. Let's see what's going to happen in the next quarter. It depends a little bit on how efficient they manage to get it through their production facilities and so on. And keeping, of course, the S&A costs on a low level because that's the key. We have to make sure that we don't believe that these are like new normal levels and lift our costs in relation to that. I think we should expect that this is temporary and it will be lower later on, so we need to keep the costs and the efficiency in our operations at that. And I'm looking at Lars, he's nodding so he agrees with me.

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Andreas Juhani Koski, Deutsche Bank AG, Research Division - Research Analyst [78]

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Do have some kind of indication to give on how much is fixed and how much is variable?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [79]

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No, no, sorry. I can't give you that out, but...

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Andreas Juhani Koski, Deutsche Bank AG, Research Division - Research Analyst [80]

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Okay. May I also ask on your new product area in Sandvik Machining Solutions additive manufacturing and how that is developing. Have you now hired a new management team and what are they focusing on?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [81]

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Yes. First, of course, you know that when Jonas left, we lost a couple of months in the development there. But as soon as Klas came onboard, we went full speed ahead and we actually have the management team in place now. We will come out with the press release any day with the name and underparts. So now it comes to work to drive this business forward. But you'd still know that this is only a fractional part of the group's business. It has so far no influence on the performance of the group. But it is exciting and we're really looking forward and I personally take this -- very eager to see that we start seeing some development within this business. So I will be all over there.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [82]

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Thank you, Andreas. Do we have another call -- question from the conference call, operator?

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Operator [83]

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Yes. The next question is from James Moore from Redburn.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [84]

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I have two, one on SMS and one on the strategy. So on SMS, I wondered if you could help us understand the 31% China organic sales growth. I'm really trying to think about its sustainability and I wondered if you could help us with 2 things there? Is there a big difference between automotive growth and general engineering growth? And do you have a sense of how much of the 31% is inventory build, whether that restocking is about to end or has more to go? My second question is on savings. And you talk about the continuous improvements from underperformers, decentralization. I think you put a billion hard number on that in your original budget. Where do think that number is today? I have a sense said that it's moving upwards. And if we index the original to SEK 100 million, are we at SEK 110 million? Are we at SEK 150 million? How is that internal story developing?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [85]

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Okay. Let's -- why don't you take that last question first?

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Tomas Eliasson, Sandvik AB - CFO and EVP [86]

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Yes, I don't think we have a guided specifically SEK 1 billion on that. I think coming back to what I said here 10 minutes ago, I mean, we have SEK 1.3 billion or something like that in the announced saving programs, the supply chain optimization, 1, 2 and 3 and all that, then the gap up to the SEK 2.3 billion that we want to achieve. And the EBIT improvement plan for the 3 years is SEK 1 billion and that includes everything including decentralization, efficiency, productivity, et cetera, et cetera. But it's not a specific program as such. It's just that number that we are going to achieve.

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [87]

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That's what we've got to push for, yes. And if we're looking at the SMS performance in China, as you saw, that was at 31% so it was a -- it's good. I think we are seeing good development in the automotive industry that continues to be. But we also see aerospace and also general engineering.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [88]

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Did you have a sense of how much of the demand is restocking?

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [89]

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We don't see that as restocking at all.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [90]

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And just circling back to that SEK 1 billion gap, Tomas, if I could. Is there a way to -- I guess, you're tracking this very carefully or certainly your business units over time? Would you be able to, without putting a number on it, say in qualitative terms whether that's developing favorably?

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Tomas Eliasson, Sandvik AB - CFO and EVP [91]

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We're doing okay, but we don't have any guidance on it.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [92]

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James, if I could just clarify that. The 31% growth in China just mentioned is actually for the group, not for the SMS specifically. For SMS specifically, growth in China was 21%. Just so we're clear on that.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [93]

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Sales?

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Tomas Eliasson, Sandvik AB - CFO and EVP [94]

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Orders.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [95]

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And with that, we're actually running out of time. There may be a couple of questions still at the conference call. If you do have any more questions, you know where to find us. Either myself, Ann-Sofie Nordh, Head of Investor Relations or my colleague, Anna Vilogorac, in the Investor Relations department. And I want to just like to finish off with reminding you of us having our Capital Markets Day on November 21 in Germany. Please go on to the website and register your interest to attend. Thank you very much.

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Björn Klas Otto Rosengren, Sandvik AB - CEO, President and Director [96]

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Thank you so much.

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Tomas Eliasson, Sandvik AB - CFO and EVP [97]

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Thank you.