So good morning, everyone, and welcome to this third quarter of 2018. Again, thank you for your interest and thank you for calling in. Starting with the usual disclaimer, slide and then let me move straight into the key highlights of the quarter. Strong order intake 3.3 gigawatts and a 25 percent increase year over year, leading to an all time high order backlog. Also, continued good performance in the service business, an organic growth of 14% and an EBIT margin of 24%.
EBIT before special items at 1,000,000 corresponding to a margin of 9.8%. Also encouraging that we see progress from the joint venture that we have with MHI for the offshore business that contributed net profit of 1,000,000 based on the 864 turbine. The free cash flow year to date is negative due to lower profit and buildup of net working capital to cope with a higher activity level. Outlook for the rest of the year unchanged for revenue and EBIT, while total investment and free cash flow is adjusted that we will come back to. As usual then, I will talk about the orders in the market.
Mike, I will talk about financials and then we both will answer questions. So, as I said, strong order intake, yeah, of, 3.261 gigawatts and an average selling price that came up to 1,000,000 per megawatt The orders increased with 646 Megawatts year over year and all regions contributed to the growth. U. S, Canada, Australia and Argentina were the main contributor accounting for approximately 65%. ASP 0.78 in the quarter.
And if we compare that to Q2, scope and turbine type contributed 0.04. So, a slight uptick sequentially, and also a stable ASP since Q4 of last year. As usual, we should remember that the ASP, is dependent on geography. Scoped turbine type and of course, the uniqueness of the offering. Then going into the region, starting with Americas, where we saw, deliveries, basically in line with last year.
And orders up 36%. Looking at the market, the PTC, is still, of course, the main driver of a very strong U. S. Market and U. S.
Demand. From VESTA's point of view, we maintain our view from Q2 when it comes to the tariff impact is basically unchanged. And of course, we are continuously working on a range of mitigation strategies utilizing our global footprint. Latin America continued to be an attractive part of Americas. We expect an auction here in Q4 in Mexico of 700 Megawatts And on our side, we have upgraded all manufacturing facilities in Brazil.
After a good prospect in the auctions that we recently seen in Brazil. As I said, deliveries flat, Mexico, Argentina compensated the decline that we saw in the U. S. And this decline year over year was basically due to the PTC components in 2017. Order intake up 36%.
Strong U. S. Order intake, main contributor, but also good activity levels in markets like Canada and Argentina. Moving over to EMEA then, as we say, overall in on the market looking at Europe, 1st, Europe is supported by the renewable energy target the increased target of 30 2 percent in 2030 and of course, also more short term, the 20% target in 2020. We have seen Poland coming back with an auction of 1 gigawatts which, of course, is encouraging because that's a market that's been down or very low activity for the last probably 2 years.
We also see a 600 Megawatts auction coming up in Finland. In Germany, additional around 4 gigawatts onshore wind auctions has now been confirmed. It will be staged in time. And the suggestion or the proposal that is now on the table is to add a gigawatt in auction in 2019 and then increase over time to 2021. We do also say in the UHMAN PPA prices increased in auctions in recent auctions.
However, those auctions has been undersubscribed very much due to lack of permits. Looking at the Middle East and Africa, South Africa has come back, you can say, for Moza being down for a couple of years and we booked an order from previous auctions in the quarter. And South Africa now have announced a build out plan of additional 8 gigawatts up to 2030. And we also see auctions being introduced in other parts of Africa, such as Kenya and Tanzania. Delivery was down 17% in EMEA region, primarily due to U.
K. Mainly and partly offset by France and Italy. We see continued solid levels of delivery in Germany, although of course significantly down compared to the same period a good order intake in Sweden and Italy, more than compensated for lower order intake in Germany, where we where the recent auction volumes has not yet materialized into orders. Asia Pacific, strong deliveries, across the region. And if I start with the market, we see several positive signs in the broader Asia Pacific.
I talked about Australia on the order intake side. We also see good activity levels in in Vietnam where the feed in tariffs has been increased. On China has announced then a system to move away from, feeling tariff through auctions, which of course create some uncertainties in the overall market. But of course continue to be a big market from a volume point of view. On the Espa side, we have signed an agreement with Ailon to deliver blades so to broaden our supply of blades from partners.
In India, I would say that the short term uncertainty remains. KPA prices, are stabilizing, but, of course, auctions has also been pushed in time. The long term ambitious target of 80 gigawatts is, of course, still in place. Looking at delivery and so impressive percentage increase from a lower level at 2 45%. With a high activity in many markets, but especially strong than in India, Australia and Thailand.
On order intake, we're down 16%. Australia contributed to the majority of the order intake in India on par with last year. And China significantly behind. So as I said, the solid order intake has also then led to an all time high order backlog or close to EUR 24,000,000,000. And that is a 17% year over year increase.
Looking at it sequentially, the wind turbine port grew of 300,000,000 to 10.5 and the service grew 0.4000000000 to 13.2 Also, as I said, good progress in all your adventure for the offshore market, being the first manufacturer to to offer a 10 megawatts turbines to the market, a good track record pipeline solid at 4.7 gigawatts And key highlights on the project side for the quarter is the conditional order of 9.50 megawatts and the firm order of 8.55 Megawatts. So with that, Marika, please Financials.
Thank you, Anders. So if we have a look at the income statement, you can see that revenue is slightly up compared to last year with 2% and that is despite a negative headwind or a headwind of 1,000,000 from currency as a consequence also of the good activity that we see in the service business that we will come back to. Gross profit is reduced in absolute numbers, but also in percentage points by 3.7 percent. And that is primarily the overall lower margins in the Power Solutions segment. You also see that we have special items in Q3 of this year amounting to 1,000,000, and that is the closure of the factory in Lyon.
And for 1,000,000 is impairment and million is provisions. And there's also a positive from, although below EBIT, a positive from the joint venture amounting to 1,000,000. So all in all, still a solid performance in Q3 of 'eighteen amounting to 9.8 percent in EBIT margin. We are also continuing to leverage the SG and A and you see the positive impact from that in the P and L. So we are down by 0.2%.
So we are down to 6.7% on a 12 month rolling. So good performance on the SG and controlled as a consequence. The service performance continued to be good. You see an improvement of 11% And excluding the FX impact, we are actually up organically 14%. And on top of that, delivering a good EBIT of 24.4% to be very precise, as a result of very reliable turbines, but also very cost efficient or efficient cost management in the service business.
The balance sheet remains strong and also provides the flexibility that we have talked about earlier. You see that the net interest bearing position of SEK 1,700,000,000 negatively impacted primarily by the working capital that we will come back to and also the lower EBITDA as a consequence of the lower margins in the Power Solutions segment. The net working capital increased by 2 88 compared to last year. We will go more into the details of working capital, but also the solvency ratio. The changes in the net working capital over the last 12 month is an increase in inventories, as you can see here.
You can see that is well offset by the prepayments. So again, showing the overall high activity level that we have in the company. And also foresee. The net working capital changes over the last 3 months follow the same patterns. So you can see that we have prepayments that we have partly lower inventories as planned for because of high activity level and also higher receivables, which I would say is more a consequence of timing than any changes overall in payment conditions.
Warranty provisions and loss production factor continues to show stability. So you see here that we consume in Q3 less what we provide for. We have consistently provisioned 1.6% of revenue over the last 12 months. You also see that lost production due to the good quality work in the company continues to trail below 2%. The cash flow statement, free cash flow before financial investment is negative 23,000,000, again, impacted by the net working capital and lower net profit.
You can also see that we have a purchase of financial investments of 1,000,000 and that is cash based in short term financial investments, primarily. Total investments underlying investments are increasing compared to Q3 of 2017. So we are increasing by 31,000,000 The methodology has not changed. So we are investing in primarily modes. And also capitalized R and D.
So it follows the same pattern as we have shown previously. But this, again, is a reflection of the high activity level. The capital structure continues to be strong. Net debt to EBITDA is trailing well below the threshold. So we are negative 1.2%.
And the solvency ratio is within boundaries. We have a target of 5%. Here you see that we are approaching that level as a consequence of the continued share buyback programs that we have performed. By that, Anders?
Thank you, Monica. So let's go into the outlook for the year, starting with revenue, which we maintain to between 10% and 1,000,000,000 and the service business expected to grow. No change. EBIT margin before special items also unchanged between 9.5% 10.5%. And there are also no change to our expectation on the service margin to increase compared to last year.
Then we have updated in investment and free cash flow. Free cash flow is expected to be minimum 100 compared to minimum 400 previously. The adjustment is a consequence of higher inventory, no investment, sorry, now expected to be approximately SEK 600,000,000 and an increased activity level, which consumes more networking capital. With a record high order backlog, we expect that 'nineteen activity level and revenue to increase compared to 'eighteen. And to cater for this production will continue to be at a high level in the fourth quarter of this year, which means that by the end of 'eighteen is expected to have built up net working capital compared to the level of end of 'seventeen.
The additional investment of, SEK 100,000,000 is primarily as also to cater for molds and the higher volume. So with that, and before I forget, also take this opportunity to invite you to the Capital Markets Day on October 29. November 29, sorry. Otherwise, it would have already passed. And with that, we can go over to Q And A.
Please, thank you.
You. We ask you to kindly limit your questions to 2 at a time. Our first question comes from the line of Christian Johansen of Danske Bank Please go ahead. Your line is open.
Thank you. So my first question is on these impacts from UF U. S. Tariffs, which you mentioned in August. So I guess this up to 1.5% still holds.
Can you just update us on your work to mitigate these effects? And specifically, this increase we see sequentially in order prices to what extent does that relate to you trying to get the customers to pay for part of this
Yeah. No. As you say, that's correct. I mean, the the estimate, from q 2 of up to 1.5% of the global production cost is still RBST estimate. And of course, we continue to work on both finding a share a fair share of the burden between the different players in the industry.
So of course, both towards suppliers and with customers. And of course, we also continue our, mitigation action when it comes to rerouting of this, of of components and also when it comes to qualify more suppliers in a favorable geography. So even if we have 3 months more visibility, we say that our estimates from last quarter is still our RBS estimate to date. I think on the ASP, it's a it's a global ASP. And, so not specifically, for the US.
And And as I said, I mean, we continue to have discussions with with our customers, actually, not just in the US, but we always, of course, have that caching with our customer. But for competitive reasons, of course, I will not go into details on that.
Fair enough. Then my second question is regarding the contribution from MHI Vester. So obviously looking at the 1st 9 months, you had actually a positive contribution looking ahead, is there any reason why we shouldn't expect this run rate to continue or even improve into 2019?
Yes. So, Christian, what we obviously, we're very happy with the positive contribution here in in Q3. And but we haven't changed the overall view on the, at this point on the joint venture. So we will come back to if there's additional positives contribution from the joint venture going forward.
Let me just ask it another way. Is there any extraordinary effect in the earnings in the first 9 months?
No, this is a reflection and that's obviously positive from TUR of the 8 Megawatt platform only.
Excellent. That's all for me. Thank you.
Thank you.
Thank you. Our next question comes from the line of Martin Wilkie of Citi. Please go ahead. Your line is open.
Yes. Thank you. It's Martin from Citi. Two questions, firstly on the service margin. So again, you've had a very strong level of profitability in service.
And I remember last quarter you're saying we shouldn't extrapolate that too far into the future. Now that you've had three quarters of service margins sort of around the mid-twenty percent level. Just kind of kind of a bit more as to whether this is, a trajectory we can expect to continue, whether there's any sort of unusual effects that means that should fade over time, just some visibility into that. That was the first question. Second one, just coming back on ASPs, I mean, you've highlighted a 0.78.
You said there is $0.04 of I guess sort of unusual effects in there, but it doesn't mean on an underlying basis, the ESP is higher, sequentially over the last two or three quarters, should we read anything? I mean, obviously, other industry players are saying that pricing is down closer to 5%. I just wanted to get some sort of sense as to your estimate of the underlying magnitude of price declines? Thank you.
Thank you, Martin. So if I start with the service margin. And as you correctly point out, we have been showing a positive trend throughout 2018 with high margins in the service business. I think we have been Pretty clear on the stable performance of the service business also for 2018. And consequently, was a bit modest at the beginning because we took this table from 2017.
On the future performance, we're obviously very satisfied with what the business contributes with at this point. But further sort of guidance or highlights on the service business, we have to come back to in next year. But all in all, stable performance in the service business is what we see right now.
Yes. And then if I comment a bit on the ASP question, of course, you're right. So compared to Q2, we had scope turbine effect of $0.04 and if we then sort of fare it deduct that. And of course, we are on 0.74, which is, I would say, a stable level of, ASR P as we have seen now since the 0.74 in in Q4. I mean, discussed many times with ASP, it can vary, between the quarter and we have these these different scope, effect and the turbine uniqueness effect.
And we have the power mode effect and all of that that we talked about. But underlying, of course, we are pleased now that the 3rd quarter in a row, we see a stable ASP.
Our next question comes from the line of Supriya Subramanian of UBS.
Question. I just have 2 quick questions. 1, on the equipment business, in the third quarter, could you share now what portion of the top line really had the pricing impact of what portion was a lower ASP order. So does this quarter kind of bake in all the negative pricing impact, which is reflected in the margin. And on the second is specifically on the Indian market.
Now, Vesta seems to have gained some traction here. If you just look at the commissioning activity in the last 12 months, with market shares increasing. Do you see this trend continuing? And generally, what's your outlook for the Indian market Neothermal as well as medium term? Thank you.
So if I comment on your question on the impact from the BTG order intake or the lower margin order intake in Q3. I would say it's a fair mix of the lower margins impacting in, and that is also to see on the lower did 4 18 is obviously with also strong order intake in 2017 that you see that coming into
the
from the lower margins in Q3.
Yes. And then if I comment a bit on the Indian market, and first of all, also, as you said, I mean, I'm happy with with our performance there. We we have definitely increased our market share in India on the back of the investments we did in the blade factory in India. And we now see a good activity level in that factory. If I look at the market short term, I think it's fair to say that there are a lot of volatility in the market with, of course, delayed auctions and also, grid connectivity issues in the market.
And of course, that is creating volatility a short term in the market. If I do look at this a bit more midterm, I I definitely believe in in the Indian markets. I think all the all the basics, so to speak, are in place. It's a great need for energy. It's a great need for clean energy.
So, of course, the growth will come. It's a little bit hard for a moment to see exactly when. But I mean, the underlying growth factors is, of course, strong in the Indian market. Then we also know then see a more stable PPA price levels. So I think you have to be a bit patients with that market and of course go through this shorter term uncertainty.
But and in that case, I think we are fairly happy with the precision we have in the market where we are all definitely there, but on the other hand, not too exposed.
Thank you.
Thank you. Our next question comes from the line of Casper Blom of ABG Sundal Collier. Please go ahead. Your line is open.
Thanks a lot. Two questions from my side as well. First regarding your free cash flow, you're taking $300,000,000 out of the guidance roughly here. And as I understand it, roughly $100,000,000 of that is due to large investments. Then the remaining SEK 200,000,000, if you could talk a little bit about how that is being spent here, as I it is a matter of building of inventory ahead of an expectedly strong 2019.
And we can see the backlog is strong, but I mean, the backlog was also strong last year? Why is this sort of different in your planning compared to last year? And then secondly, on the balance sheet, you obviously have a lot of cash here. And I note that you are doing investments now in a financial investments of 1,000,000. Could you talk a little bit more about what is it that you're buying here?
And I mean, I don't expect that we will start seeing you being a portfolio managers or what? That's my questions.
Thank you, Casper. So if I start with the cash flow and the change from a minimum 400 to a minimum 100, and as you correctly point out, we have increased the investment to approximately 600 instead of the 500 range, again, showing that we anticipate a high a high activity level going forward. So again, more modes, but also investments in the capitalized R and D. So we are investing in technology on a continuous basis. And then I understand question on the inventory increase, which will be the primary driver for the, for the lowering of the cash flow this year.
Because we see order intake continues at a very high level. And again, if you look at the order backlog, which is again record high, And I agree with you. We have on a continuous basis increased the order backlog and the strength in the order backlog. And to basically meet the demand again instead of building even further capacity We have decided that we need to utilize the potential that the balance sheet offers offer us at this point. And we are anticipating even higher activity level in 2019.
So The change in the cash flow guidance is a consequence of a very positive view on 2019. And then your comment on the 157,000,000. It's because we have a big cash position. We're trying to on some money, which is difficult in today's market, as you know, and that's why we have placed some money in short term securities. In this quarter.
Okay. Do you want to comment more specifics on what kind of securities is it in your line?
Sorry. No, I don't want to comment on that. You can come back to IR on that question. But it's not nothing has changed from before we have invested previously in marketable securities.
Okay. But then just a follow-up on the cash flow. Since you're building inventory, towards your 2019. And should we sort of expect a release of this at some point? Or is it basically just taking the business to another level where the backlog is more like 14 gigawatts now.
I mean, obviously, if you look at what I'm trying to say is that the activity level we are anticipating is even higher in 2019 compared to 2018. And, obviously, there will be depending on the calendarization of next year, you will see, the difference in the quarter. But even if you compare with what we have done previously, obviously, you see output from the inventory equally good, but it also depends on the future order intake and also how we view 2020. But all in all, that will follow the same pattern.
Okay. Thank you. Thank you. Our next question comes from the line of Dan Togo of Carnegie. Please go ahead.
Your line is now open.
Yes, thank you. A question on the ASP to get back to that. I understand the 0 fall euro on the turbine and the scope. But you have an increase of 7 is with underlying or assuming underlying stable prices, is it fair to say that the point of 0.03 that is remaining is the more EPC that you have in the order intake here in Q3?
No. So the 0 04 then is primarily due to more EPC. I think we had 14% EPC in this quarter, and we are normally between 5 10. So the 0.04 is very much what is related to to APC. And then the other smaller part is that we compared to Q2 again, we had the percentage of 2 Megawatts ticked up a little bit in Q3 compared to Q2.
Right.
Okay. So can you then elaborate a bit, what is the remaining on to get you to 0.78 from the 0.71 if 0.4 is the EPC and then you have the then you have the scope the turbine service type, is the remaining part then simply improving prices?
Yes. But I think if you remember on on Q2, we also had some some, scope things that actually took that down. So I don't remember exact But let's say that that was 0.72 at the end if you compared to the quarter before and now you compare then with the scope changes with the 0.74. So you get to, I mean, it's almost impossible to say exactly what those 0.01s are in the different quarter. So that's why I'm saying that what we see is is a stable overall ASP.
Okay, good. Thank you. And then on the CapEx which you increased to the million. Is that the level also in 2019 that you imagine? You need to invest in business or is it somewhat driven by extraordinary things here in 2018?
No. I mean, the CapEx of 600 is, again, obviously, part of, what we need to prepare for the high activity in 2019? And on the CapEx for 2019, we will again come back to in February. But overall, we see high demand in the market, so we have a positive view.
Okay. Then just one final question on Germany. You mentioned, Alan, that you have not yet seen orders from the recent auctions feeding through. That? Is that somewhat further down the road or is it something that we should start to prepare for in the immediate future?
Yeah. I mean, of course, that's usually all to say because we are dependent on the customers that are there. So, but but the more time the more opportunities we have, of course. And I mean, we feel that we have we have taken our fair share for sure over the auction volume. So I'm there I'm I feel very confident that we have a good market share in Germany in that we've been success full in the auctions.
And then exactly the timing when those orders go firm, I still very hard to predict. But But as I said, important focus for us is of course to feel that we are well positioned in the those options that has been in Germany.
Our next question comes from the line of Akash Gupta of JP Morgan. Go ahead. Your line is open.
Yes. Hi. Good morning. I have two questions, please. My first question is on gross margins.
If I look the 9 months gross margins are down 360 basis points year on year. And the question I have is that impact of lower pricing that you have seen in Q4 and into gross margins, is it is it reasonable to expect that all of it will flow through in 2018 or would there be any carryover effect in 2019? And the second question I have is on supply chain. Some of your peers have highlighted about some issues related to suppliers. So again, maybe if you can highlight, how does that look like given that you would be having higher volumes next year?
And are there any next that we need to be aware of at this stage? Thank you.
Yes. So if I comment on the gross margins, which obviously is a consequence of the lower pricing on the orders we took in last year. You will see a lot coming in this year, but there will be some carryover also into 'nineteen. But the biggest portion is obviously 2018. And you will see the also an impact from those in Q4.
I think that's fairly, you can assume that.
Okay. If I take your supply question, I would say that Generally, we haven't seen any shortage in supply. We are, of course, seeing a much higher activity level as we have talked about. And of course, there is a certain tightness for natural reasons that you always say when volume goes up in the supply chain, but nothing that we say that we don't feel confident that we can, that we can handle. So I think if you refer to specific components or specific suppliers, we have not seen any impact of that.
And I think we have a good a good track record of using our global supply chain to ramp up production. But of course, having said that, that's you have a point that with increased volume, of course, there is a certain tightness or tighter situation in the overall supply chain. Thank
you. Our next question comes from the line of Klas Almer of Nordea. Please go ahead. Your line is now open.
Thank you. Also a few questions from my side. The first question goes to the 2019 revenue growth guidance you gave in the report. And I know it's a bit too early to be more precise about the EBIT margin in 2019, but would it be fair to assume that when you choose to guide the market on revenue it also implies that you do not see a significant different margin picture next year, which will also be in line with your midterm targets. Will be my first question.
Sorry. That will be the, I think overall, of course, as we said several times, we see a very high activity level. I think we see the clear evidence in the backlog and and we also have a good expectation for Q4 on orders. So of course, we see a high activity level and therefore a solid revenue into next year. At the same time, a lot of work remains to do.
I mean, a lot of orders hopefully remains to be taken in Q4 that will have an impact on actually both the revenue of course and the the margins for next year. We also talked about the pressure from the the cost increases that the tariff has brought and the uncertainties around that and the mitigation mitigating actions we are taking. So, we prefer them to come back as usual when we have finished the year. And when that picture is a lot clearer to have a more precise guidance for next year, both on the revenue part and of course on the EBIT part.
Sure. Okay. And then my second question, when you look at your strong order intake, which I guess is also the same situations by a number of your competitors. This high market activity, how does that impact the competitive landscape?
Yes. No, but that's of course a good question. And then and I mean, if I go back to what I said when we started to see this price pressure some time ago. Then of course, what we saw in the market then was the more it that both went from failed in tariffs to auction. And at the same time, actually volumes were squeezed.
And of course, that created a bit of a pressure to, as we have seen. And So the good news today then compared to that situation, and what we said at that time as well that for this transition take place is, of course, that we have to see that the lower price for wind actually translates to increased volumes instead of the situation as we had at that time, we'd decreased in volumes. And that is, of course, the positive thing with what we see in today's mark it that we and most of our competitors actually can grow the order intake because the volume has come back into the market. And for natural reasons, if basic economic fairy holds then the increased volume should of course lead to more stable pricing. And yachting from our ASP from the last three four quarters.
That's, of course, what we see in our ASP.
Thank you. Our next question comes from the line of Ben Aglow of Morgan Stanley. Please go ahead. Your line is
Good morning and thanks for taking the question. I had a couple mainly around working capital and cash flow. On the net working capital, If I look at it from 2017 into 2018, we've gone from a quarterly average run rate of about 1,000,000,000 to about 1,000,000,000. So that's a step up as a percentage of annualized sales from about 15% to 30%. On the comments you're making earlier, Marika, is it is what you're signaling that that's a kind of pull forward on the inventory.
And as we go into 2019, that net working capital as a percentage of sales should begin to come down? Or are you basically saying that going forward, we're going to stay at this relatively high rate? Question number 2 relates to prepayments. When I look at your prepayments, you've had about 1,000,000,000 coming so far. But actually year over year, your cash is down by 1,000,000,000.
And normally at this stage of the cycle, we might expect to see prepayments feeding nicely into free cash flow. When we think about 2019, is it a case where prepayments should still be okay and then the working capital normalizes. Is that the kind of environment to think about?
Yes. And obviously, fair questions. So I would be a little bit elaborative to start with and then answer more precisely. So if you look at the net working capital and the situation for basically 20 17, but also 2018 is that all in all, if you look at the industrial platform, we are making changes So that will also have an impact on the working capital. So we will basically do more transportation than what we have seen previously simply to accommodate You also have some localization that will have an impact on the overall networking capital.
And then when it comes to prepayments again, as I said, we haven't changed the methodology, but obviously, we've had the PTC qualifications any every year, which had a big impact on a positive note on the prepayment that we do not expect for 2018. So that is one part that has to be sort of excluded from the prepayments or that's basically down payments for the qualification. But then on a more generic basis when it comes to the inventory level, We need to accommodate the overall activity level. We need to build up and normally we would build up at the at the beginning of the year and then trending downwards at the end of the year. And we are clearly on that path also for 2018.
But we also see that we have to continue build up here in the latter part of the year. Simply to accommodate for the overall high demand and high activity level at as indicated by Anders earlier for 2019. But obviously, this is a core item, but the balance we are in now is obviously investing in capacity that potentially could go idling or in inventory because for us, that's a cheaper option. So we're doing a combination to optimize both the P and L and balance sheet uses. The usage.
Understood. Thank you. And one quick follow-up, if I may. Just can you give us a sense, I don't frankly understand it well, but what is the relationship between your gross margin and your inventory? How will that trend if inventory goes up or down?
No, I mean, the gross margin is an impact of how well we execute the projects in any given quarter.
Our next question comes from the line of Phil Florent of Berenberg. Please go ahead. Your line is now open.
Yes, thank you very much. Philippe Florent from Berenberg. And just to bounce back on the previous question basically on the net working capital, Could you provide the kind of long term networking capital your envisaging for the whole business and also to bounce back on, this quarter's performance. I think if I do understand your bridge chart, on slide 16, right, basically you had a tailwind from the inventories and the headwinds actually from the receivables on the net working capital. And the guidance change that you are giving at free cash flow level is basically 1,000,000 explained by higher CapEx and 1,000,000 explained by higher networking capital.
So what did really change compared to the previous activity levels that you were seeing? Because, obviously, you're not changing the earnings guidance and yet you are still missing 1,000,000 at cash flow level, compared to the previous guidance.
So if I start with the latter part of your question, the changing guidance is Obviously, the CapEx that we consume, simply because of meeting the higher activity level and looking at the strong orders, So what we are changing is obviously the strong order intake and the strong order backlog. We see a need to do less flash out in inventory than what you have seen earlier simply because of high demand in 20 19. So that is why we are changing the guidance for free cash flow in 20 18. So all in all, I would say a positive because we have a good overview of 2019.
Okay. But if you have a much higher activity level in terms of order intake and order backlog, wouldn't it be fair to actually assume that you get wind at least on the prepayment side, so on the liability side, on the net working capital?
But I mean, if you looked at the If you look at a normal pattern, you start building up at the beginning of the year. You start emptying your inventory at the latter part of the year, but simply because it's trending on a very high level also going forward. We have chosen to build inventory instead of just investing in additional capacity simply because that will also mean higher depreciations.
Our next question comes from the line of Sean McLaughlin of HSBC. Please go ahead. Your line is open.
Thank you. Two questions from me. Do I understand from a previous comments, that you're expecting appetite for 60% PTC orders in ore to be relatively low compared to the 80 percent or 100 percent appetite in previous years?
I think, yes, as we discussed, 80% last year, I think it's too early to to have an opinion on that. I mean, we are definitely in discussions with customers on 60% PTC components as well. It will be most likely at the lower level than what we saw. 80% let's say components, but We will not have any conclusion on that until the endoftheyear as last year, I would say.
Thank you. And just a question on the Chinese market, just to understand, I mean, you've I guess not really being able to break into this market. The market's moving to auctions. I mean, what is that changing, A, in overall industry dynamic? And B to your prospect of increasing sales in China?
I think if you look at the order intake loss, year on delivery this year, we we have increased our position in China. But as I said sorry. As I said already at that time, we are dependent on that we get our enablers in place, but we are also dependent on on which segment of the Chinese market that is sort of active at any given year. And And that means, of course, that we are we have a good offering in the segment that looks at the 20 year IRR and that has a low to medium wind speed. And we don't, we are not we don't have a competitive offering or are not targeting the ultra ultra low wind segment of the Chinese market.
And when we have a year then, where primarily the orders goes to the ultra ultra low wind segment. Then of course, that will be visible for us. But I'm I'm fairly confident that the 2020 are IRR segments and also the more similar wind space to that we see in other markets will be a sizable segment going forward. So that, I would say, follows very much what we have talked about before where we feel that we are relevant. I think on the product side, we have localized all three megawatt product in China.
We have fully localized, of course, before the 2 megawatt platform. We have adopted all service strategy and those are all important enablers for us in the Chinese market. When it comes to the move to from feeding tariffs to auctions, I think it's very hard today to say exactly how that will pan out in the Chinese market. So that is short term, of course, uncertainty where you see a rush into the old failing tariff on the ultra low insight. But where you also have we have to wait and see how the auction system is going to be designed, before we have a clear view of of our opportunity in that
Our next question comes from the line of Mark Freshney of Credit Suisse. Please go ahead. Your line is now open.
Hello. Can I Please ask a question on cost out? If I look over the last 2 years, it seems that gross margin on your metric has fallen by 300 to 400 basis points. So I guess we can say that the price war took 2% to 3% off or 3% off your margins It's clearly ongoing cost out that you do every single year, but there's also if you like accelerated cost out where you have to take cost out to get margins to higher levels. It's interesting that you haven't spoken about cost out on this call.
Is there anything you can do over and above what you would normally do? And can you talk about some of those initiatives if they are taking place Thank you.
Yes. I think that, even if we haven't talked about it on this call, I think we always talk about cost out. So of course, there are 2 big, big levers to, improve, on the model generation. And they are the as before. It's about the securities of new products, which is extremely important.
And coming back to our investment level, I mean, we will continue to invest in the capitalized R and D because the product part with higher production with lower cost is the biggest labor for the margin. So I think that is going to be very important for us. And the second is the cost out. And And I'm I think I've described this before. We have the same target this year as we've had last 3 years when it comes to absolute cost out.
We are delivering well on those cost outs. And of course, we have a maximum priority on that. So but that doesn't mean that we can all of a sudden find some magic brilliant that improves that cost out program significantly in the short term. But if you look at it on a year to date basis, if you look at the targets, we have this year and compared to what we have delivered in the cost out program before. We maintain a very good pipeline and we continue to execute on that.
Our next question comes from the line of Alok Katri of Societe Generale. Please go ahead. Your line is now open.
Hi, Alok Katri from from Jen. Thanks for taking my questions. I have 2 follow ups really. Firstly, on the working capital side, to understand the inventories, sort of growing up because you're building an in anticipation of stronger 2019 and managing the capacity, plan shouldn't I in proportion also than expect the payables to go up because you would have to order more material if you're ramping up production as well, but actually payables have gone down. And by quite so margin versus, if I look at the inventory and prepayment sort of balance on an ongoing level.
So just wondering what's really going on over there? Because I think normally what we've seen is if production goes up, payables go up as well and it sits about the balance between inventory and payable, but this case, we've actually seen payables go down, not just in Q3, but also in 9 months. So maybe if we just elaborate a bit over there, And then I'll ask you my second question after this.
So to your comments on the payables, it's I would say the same as for the receivables, that is a timing question. So depending on exactly where in the month you have the payment that will have a consequence in the quarter. And that could be favorable or less favorable. So again, the payable situation have not at all changed and we have good payment terms overall. And that has been a big focus area for us.
The big driver of the inventory or the working capital again is the inventory part and the payables and the receivables follow the normal pattern. And bear in mind also that the prepayments are not only down payment is also milestone payments. So it's a combination of the 2.
Fair enough. I mean, wouldn't you need in a way to order more material as well. So I can understand if payables were, let's say, expanding at a lower pace stand inventories or so on, but just going in completely different directions to what you see on the inventory side. Just wondering within the inventories, how should we be thinking about things like components and so on? Or is this really just a reflection of something else then?
No. I mean, what obviously what we're trying to be as, as efficient as we possibly can is with the work in progress so we time the deliveries from our suppliers as tightly as possible. So we don't have to put a lot of components in inventory. So that follows sort of the what we have implemented years ago in terms of efficiency
thing side, so I'll come back to that. But I mean, clearly, everyone including ourselves in the industry are talking about, let's say, stabilization of pricing and I can sort of gather the ASP sort of sense, particularly in the States and otherwise as well, if you're not pass on, let's say, the tariff increases in the U. S, then, is it really a step on an underlying basis? Or are we just talking about different effects in the sales line and then in the EBIT line? Effectively meaning the ASP stabilization is not a real stabilization that you would otherwise have seen or expected?
I don't know if I understand the question, but if I start with ASP, I think it's very are now that we have seen 3 quarters of a stable ASP. And of course, ASP has many components maybe to your point. And of course, I fully agree on that. And that's why we also have mention those components in the different ASP numbers that we have seen. So I think that the Yashin from what we have seen, as I said in our ASP, we say that we see a stable development And as I said on the mitigating actions, of course, we are working with all mitigating actions, both with suppliers rerouting and of course also with our customers in the market.
And I will again, not comment for competitive reasons not going to more comments around that with the customers.
Okay. Fair enough. Thank you. Our next question comes from the line of Peter Tester of One Investment. Please go ahead.
Your line is now open.
Hi. I had two questions, please. One I should mention a couple of times this a more capitalized R and D. And I was wondering if you could give some sort of sense in terms of total gross R and D year over year and capitalized R and D just so we could understand that. First question.
Okay. So, we have, we, as we said earlier, we continue to invest in R and D. So you have the overall cost that has an impact on the P and L. Innovation would be part of that overall number. And I would say that number is a slight increase, but fairly stable.
And the capitalized R and D is trending in the $2.50 range on a yellow basis And that's what we have said also earlier, and that's what we're trending for here in 2018.
Okay. And then the second question is just really trying to understand a bit on timing of produced and shipped versus deliveries and how this influences the gross margin because there's been quite a step down in gross margin versus Q2. If you look at the balance that produced and shipped versus deliveries, the produced and shipped has come down sequentially and year over year. And I was wondering how that reduction in production rate impacts the gross margin. And maybe if you could give some thoughts as to how, that balance are produced and shipped versus deliveries, will flow into Q4 and going forward as you normalize inventory?
Yes. So basically the difference what you see and what we have said before is that you will see a difference simply because you have different scope and different accounting rules to be very precise. So you have a higher, if you have a higher average price on what you have shipped and produced. That could be because you don't on an EPC project, you don't get the volume out. You only get the revenue and the profitability and you don't get the revenue out until you have fully installed or handing over the key basically on the projects.
So there, that's why you have a gap. What we have said is that It should over time even out, but you will see in some quarters that you have a gap in between the two numbers. And that is primarily scope of the projects that is impacting.
Okay. But does the swing in production ship balance impact the gross margin because of the volume of activity? And when you look at the balance between the producers' deliveries, can that make some distortion of what you talked about?
No, it doesn't have an impact on the gross margin. It's only the inventory levels that is impacted.
Okay. All right. Thank you.
Thank you.
Go to the last question.
Our last question comes from the line of Klas Kew of New Credit Markets. Please go ahead. Your line is now open.
Yes. Hello. Two questions from my side. There's been quite a lot of talk about the ASP, and I believe that several of your peers, they also say that the ASP has to go down by another 3 to 5% per year. But just to be clear, is it the ASP on the order side that has to go down by another 3% to 5 percent per year?
Or is it the cost of energy that has to come down by 3% to 5% per year? Because I guess that's quite a difference. Would be my first question. And secondly, you stated a couple of times that we should expect a higher volumes and high activity level going into 2019. And just thinking about your earnings in 2019, then I guess there will be a couple of negative drivers pricing and the tariffs.
But wouldn't it be fair to say that higher volumes will also drive a lot of operational leverage, which we have seen in the past? That would be my two questions.
Okay. If I start with your first question, and I mean, I cannot comment on what others are saying because, yes, for obvious reasons. But I agree with you that, of course, what we have seen before is of course that the level I say cost of energy has come down, with maybe 3% to 5% per year, something like that. Pending a little bit, which external source you look at. And I think that is, of course, an important distinction.
I mean, ASP as well for pure structural reasons will, of course, come down. If you're if you have more power modes than not, if you have more 4 megawatts and 2 megawatts everything else equal from a structural point of view without the price element in the ASP coming down. The ASP as such will come down. If you have less APC, the APC will come down if you have more of the APC will come up. So I think that what we are looking what the customer, Yaj, also on this, of course, the levelized cost of energy.
And of course, what we have succeeded with before was, of course, to reduce the levelized cost of air, not the and still actually in a reasonable manner and at the same time actually improve our margins. So it's It's, of course, that balance that is the important part. And ASP, of course, gives with the different components gives an indication, on the price level in the market.
And if I comment on the earnings for 'nineteen, and I understand your questions. Obviously, we are all in all happy with the overall demand that we see for 2019 and with the overall demand in the market. And as a consequence, our activity level also in in higher than in 'eighteen. I understand your question, but the and again, to explain is that we we have enough sufficient capacity in some parts of the operations or in the production. But we run the blades very tightly the molds because that's what we primarily are investing in terms of capacity.
So that's why the combination that we're doing right now is having inventory to accommodate for the blades And we're also investing in certain capacity for the blade side, but that will always be run as tightly as we possibly can. So if I look at it from an average point of view, the benefits from a production or absorption rate we would have is pretty small. But then overall, volume is good for what we're doing and in terms of other negotiations. But all in all, from a production or an absorption point of view, it's fairly limited the benefits.
Okay. Thank you very much.
Okay. Thank you very much for interest. Thank you for calling in. And I'm sure that we will meet the least some of you during the next couple of days. So I'm looking forward to that.
And again, don't forget the Capital Markets Day on November 29. Thank you very much.
Thank you.