Welcome to the Alfa Laval Quarter 3 Earnings Conference Call. At this time, all participants are in a listen only mode. There will be a presentation followed by a question and answer session. I must advise you that this conference is being recorded today, Tuesday, October 25, 2016. I would now like to hand the conference over to your first speaker today, Mr.
Tom Erickson. Thank you. Please go ahead.
Thank you very much and good morning everybody. Let me start before going through the presentation with a couple of overview comments as to the quarter and our restructuring program. In terms of highlights, the development in our equipment division division was definitely the most positive part of the quarter. We had a number of record highs in the division, including sales in Asia. Overall, a strong performance, good profitability, and the equipment division is also weakness in the capital investment market was definitely present.
And as you noticed, we have not announced any large orders in the quarter. And in fact, larger orders that are not announced, but below €5,000,000 were also relatively weak. And consequently, that together with some seasonal weakness after Q2 in the equipment division is affecting our overall order intake ending lower sequentially. We then also announced the 2nd step in our strategic review. As you know, some time ago, we announced a new organizational structure and we're obviously working with that full speed in terms of implementation.
The second step was announced this morning, including 3 initiatives. I will give you some few comments on that now and Thomas Turisson, our CFO will give you some further detail on it later on during the call. The first part, the first initiative is the alignment of the organization into the new operating structure starting from January 1. That is ongoing now. It will result in cost savings on an annual basis in order of magnitude of SEK 300,000,000.
We expect to have that implemented end quarter 1 beginning quarter 2. So it's a relatively short term implementation going on in that area. It is to a large degree related to white collar and to a small degree blue collar, whereas normally the blue collar efficiency programs are not announced in this manner. The second part is separating out certain businesses and product groups that has not performed the way we expected over a longer period of time in the Alfa Laval operating structure. We don't see the perfect fit in the new structure either and consequently we want to take them outside of our normal operating structure.
We want the sales and marketing organizations to be fully focused on what we think are the profitable long term important products for us. And these ones that have not developed accordingly in our structure, we put them on the side of what we call the greenhouse. We will down the road make decisions as to what the next steps will be. We are not excluding keeping them. We are not excluding selling them or any appropriate action that might need to be taken.
Thirdly, we have announced a review of our production infrastructure. And at this point in time, we are not announcing the specifics initiatives in that. It will happen over the next quarter. We still have some work to be done in union negotiations and other stakeholders' interactions. So we are not going public today with the individual initiatives on the production side.
But we have as you can see from the number indicated that we will take one time charges in the order of magnitude of a maximum of SEK 400,000,000 over the quarters to come as we present the individual initiatives on the manufacturing footprint. That leaves us with about with SEK1.1 billion of restructuring charge for quarter 3. And I will just remind you that about 6 100 of those are related to write down of goodwill and other values, which are non cash affecting, whereas the restructuring charge is in the order of magnitude of SEK500 million, resulting in yearly savings of SEK300 million on the white collar side sales and administration, but there will be effects on cost of goods sold as well. However, we are not specifying that at this point in time. I would also like to remind you that we are working with other capacity measures as you will see from our personnel numbers.
We are down year on year already as we speak. We continue with other measures in operations in areas where we feel we need to take actions. So I would just want to remind you that what we are primarily looking at here are cost for sales and admin when it comes to the SEK300 million number. So with that, let me go to the presentation with the key figures for the quarter. As you can see on most dimensions, we are year on year affected by the downturn in energy and marine and it's affecting essentially all the parameters on a year on year basis.
Sequentially, our results are stable. The gross margin as well as the operating margin are in line with what we had in quarter 2. The invoicing is as expected. And as I indicated initially, we do see an absence of large projects and others affecting our order intake somewhat. And that takes us to the next page on orders received.
As you can see, the presence of large orders throughout this year so far has been very limited and in fact non existent in the Q3. There are some effects on our other businesses as indicated in our forward looking statements in the quarter 2 report. But by and large, it reflects the relative stability outside of the larger projects. We have in our forward looking statement indicated that our outlook is on the same level or slightly better for the next quarter, which indicates perhaps to you that we have some promise in the pipeline the way we look at it at this point in time. The order analysis is showing you the structure of the order intake and how it was affected in the quarter, the minus 7%.
Again, I think I commented pretty much on the reasons and explanations for what they were. Let's go to the operating margin. The operating margin is stable on 15.6%. It is affected by both positive and negative aspects. On the negative side, obviously, capacity utilization in our system and some projects in the PTD is affecting the operating margin in a negative way compared to previous quarter.
On the positive side, in general, our cost management has worked well. The service mix is increasing. We have some positive effects from currency. And I would say all in all, of course, the equipment division is contributing to good stability in our earnings. And this holds true also for the gross margins.
Let me with that go to the divisional review and start with the equipment division. And as you can see, especially on the year on year numbers, we are growing positively in all areas of that business. It's a very solid numbers on that side. The fact that we are a little bit weaker in some areas sequentially is related to the summer vacation period in Europe, which typically affects the division somewhat. But all in all, we are certainly happy with the way we came in on the order side.
In some areas like sanitary, I would say we are even at the point where we've been capacity limited in our own operations and probably demand could have been even slightly stronger if we could deliver according to those schedules. So there are some variations that you can understand in our group between different product groups where we have real capacity problems in both directions. Let me go to the marine and diesel. We're looking at it sequentially. We did have a good quarter in the equipment side.
But I must say, even with that positive note, we are clearly affected as you can see year on year as well as sequentially of the downturn in the marine industry. You have probably seen that the market forecast for the number of contracted ships this year has been reduced further. At this point in time, it is believed to be in the area just south of 600, which is the 3rd down revision this year. That is in line with how we see the market from a yard contact point of view. The expectations here is probably from the market that 2016 is the low point of the market and there is an expectation from a return to growth in 2017 from a very low level and those are the market forecasts that are there we will see.
We obviously have some strong points in the marine market in any case this point in time, both in terms of cruising ships and some other product tankers. The market is not that weak, but all in all, of course, that doesn't compensate for the weakness in the market. And finally, in Process Technology, there are parts in the PTD that is going reasonably well. You will see that on the year on year numbers. We are pleased with the way our wastewater business is developing.
We are also pleased with the way service has developed throughout this year. But on the energy side and food side, the larger project has been limited and obviously this comes through on the overall order intake. That is probably the main explanation, if not the only explanation in terms of the year on year comparison year to date. And as you will see then, if we just review the various customer segments overall, in terms of the year to date numbers for EQD, it's by and large is positive. Industrial equipment is still negative after weak beginning of the year, but that has certainly changed significantly in the later months.
In terms of PTD, you see the year to date numbers in both service and wastewater being positive. It has gone well for us in those areas. And we have some weaknesses in food and energy on the larger projects as I indicated before. And then the marine side by and large for year to date numbers, we are clearly a bit behind affected by the low contracting area. There is in marine a little bit of weakness in the service market as well based on longer service intervals for some of the ship owners probably pushed by low freight rates in the market.
It is more the larger renovation projects than the smaller spare parts and service initiatives that has declined a little bit in this year, but that's the situation on the marine. Let me then go to a quick review on where we are regionally and I will start with the numbers in Asia. The good news in Asia is that China grew including marine in the quarter. We've been having overall a pretty good and solid development in China throughout this year, exclusive of marine. And at this point in time, when we start to hit the bottom in the marine market, it doesn't have a huge effect on China anymore for the quarter.
So that was all in all very good. The big weakness in Asia was Korea. Korea is significantly impacted by the marine crisis, but it also spreads to areas outside of the marine industry. So Korea was a record low for us, and I think Korea will have industrially a difficult time and recovery process ahead of it. Japan was also affected by the marine side, but otherwise stable and Southeast Asia was okay.
Going to Europe, we've been having a good recovery in the Nordic region. We started weak in the year in Nordic, partly affected by offshore industry in Norway, but also in some other areas. And all in all, Nordic has recovered nicely during this year, and we had a strong third quarter in the Nordic area. Western Europe has been a bit more neutral, stable to slightly weak in the quarter and the difference is mainly related to some of the larger projects and some marine initiatives in certain markets that is affecting the order intake. Good development in some markets in Western Europe, including France and UK, perhaps not intuitive for some of you, but the Brexit effects as we speak are certainly not present in our order intake and our portfolio there.
Finally, Eastern Europe, where Russia remains the engine of the region, we turned the page, I think, in Russia early this year that it has been clear that Russia has been developing from a very weak situation and coming on to a good lead, good quotation portfolio and good order intake. And you will see on the year to date numbers that although the sequential numbers was a bit affected by individual projects, All in all, we are very comfortable with where we are in Russia. Then going to Latin America, we had a very strong start in Latin America, especially in Brazil in the beginning of the year that has faded somewhat. But other than Brazil, we had a strong quarter in most geographies in Latin America. And all in all for the year, as you will see on the next page, we are okay with Latin America as a whole.
Going to North America, the year started weak in the United States when we've been doing better as we came into Q2 and to a degree Q3. All in sequentially a little bit behind, but the year on year numbers is good. Canada remains affected by the oil and gas crisis, which has been a big market for us in that segment. But sequentially, they were a little bit better than last quarter as well. And that takes us to the year to date numbers that will give you that feeling a little bit better.
As you can see in North America, we are 7% behind at this point in time last year out of and we are 4% behind in the U. S. So that number is slightly better and has been improving as we've gone along this year. Latin America remains ahead of last year after 3 quarters. In Nordic, you see the weak beginning that has turned now to a much stronger situation.
Eastern Europe is clearly positive, somewhat negative in Western Europe and the 28% negative in Asia is more than related to the decline in the shipping industry, whereas in other areas we've been doing relatively well and seen stability and in most areas an okay growth rate, not least in China. So those are my comments to the market situation and the overall quarterly report and I would now hand over to Thomas Tuohuizen for some further details on the financials. Thank you.
Thank you, Tom. Good morning all of you. So as Tom has covered orders in-depth, let's move on to some comments on sales. Let me start off with the forward looking statements that I gave in connection with the quarter 2 report. At that point, I said, we believe it's reasonable to expect a somewhat lower invoicing in quarter 3 compared to quarter 2 because of the following main reasons: the phasing for delivery of the backlog, the demand development in certain sectors during the spring and a certain seasonality when it comes to revenue recognition due to the vacation period in some regions.
As you may have seen from the report, we realized sales of $8,580,000,000 in the past quarter. In comparison with quarter 2, sales was then consequently down 7% at constant rates And compared to last year, we were down approximately 12%, again, at constant exchange rates. I would say that in terms of revenues, we ended as expected in relation to our own view of quarter 3. If we then move on to service, the service activities represented 30% of revenues in quarter 3. This is to be compared with just over 26% last year and some 28 0.7% in quarter 2 of this year.
That is to say, we have gotten a positive mix effect from an increasing share of aftermarket sales in total revenues. Let me then deliver the first forward looking statement, an indication of revenues for quarter 4. We believe it's reasonable to expect an invoicing in quarter 4 somewhat higher than that of quarter 3, mainly because of the phasing for delivery of the backlog and then giving some due consideration to demand for short lead time items and services. With that, let's then move on to some comments on the gross profit margin. Gross profit margin for the quarter ended at 35.7%.
That is effectively an increase of 0.5% year on year and a reduction of also 0.5% sequentially. Let me then come back to what I said with the quarter 2 report. Then I said, in the near term, we expect adverse effects from volumeload to further increase. We expect slightly reinforced positive FX effects, assuming a relatively weak sick to provide some compensation. The actual outcome was influenced by the mentioned parameters, I would say largely as expected.
For some further comments on the gross profit margin, let's move on to the next slide. As I just said, quarter 3 came in somewhat better than last year and somewhat below quarter 2. We were suffering adverse effects from negative price mix effect within capital sales year on year. That is of course to do with declining oil and gas content in Process Technology and a mix price effect in marine and diesel as well as a weaker load in certain factories. Positive purchasing variances was supporting the gross profit margin.
That is to say initiatives to further develop new suppliers has supported gross profit margin. Compensation was also provided by a positive mix from relatively increased after sales and service share and of course more so transaction FX transaction effects. Sequentially, we had again a weakening load, which had a lot to do with the holiday season in Western Europe giving an adverse effect. Compensation then was provided by FX and the mention the increase of after sales in total revenues. Let me then, to finish our gross profit margin comments, give you the second forward looking statement.
In the near term, we expect adverse effects from load and an increasing share of capital sales. We expect continued positive FX transaction effects and positive purchase price variances. Let's then move on to something that I believe most, if not all of you, have asked for and or expected for some time a program to address the declining demand in certain sectors as well as the impact from the strategy review. The program we launched today consists of 3 individual initiatives. We're looking at an initiative to adjust as a consequence of the reorganization, adjust because of the decline in demand that we've seen in oil and gas and most recently in marine.
Secondly, we're looking at an initiative to adjust the manufacturing footprint. And thirdly, an initiative that we call the greenhouse, an initiative where we are segregating 3 product groups out of the 3 new sales divisions in order to achieve improvement of performance through a focused effort for these 3 product groups. We are let me also say that this greenhouse initiative concerns approximately SEK1.5 billion of sales if we look at the revenues of the 3 product groups at this point. For this program, we are expecting nonrecurring charges to the tune of $1,500,000,000 totally. As you have seen from the report in quarter 3, we've taken a charge of $1,100,000,000 And please note that there is a write off of mainly goodwill and step up values of some SEK 600,000,000.
This is obviously a non cash item. Let me also say that this write off of step up in goodwill may have been a bit of a surprise to you. Let me describe why this comes about. By segregating these 3 product groups out of the ordinary structure with the 3 main cash generating entities, the 3 sales division, we are effectively creating a further, a 4th cash generating entity. And as we just commented, these entities, they have been financially underperforming for some time.
And as a consequence, the step up values and the goodwill related to these activities could not be justified and maintained. So that's why there is a right of these values. The charges in quarter 3 are, of course, expected to generate substantial savings. We're looking at savings in the overhead area alone of some SEK 300,000,000 on an annualized basis. This charge, of course, involves redundancies, redundancies to the tune of some 700 employees, out of which some 250 relates to blue collar employees and we believe it will involve redundancies in Sweden to the tune of some 100 employees.
We expect the initiatives related to the charge in quarter 3 to be implemented to a very large extent at least by the end of quarter 2, 'seventeen. If you look at the $1,500,000,000 and the charge in quarter 3 of $1,100,000,000 that of course tells you that there will be more coming in the coming several quarters giving rise to further charges to the tune of $400,000,000 but of course also savings corresponding to these charges. With that, let's move on to some other elements of the P and L account. To begin with, the R and D ended at just over $190,000,000 in the quarter, a year on year increase of 5%. R and D is year to date representing 2.3% of revenues, an increase from 1.9% in 2015.
In summary, this is really a conscious effect of decisions or a effect of conscious decisions to increase R and D efforts to support future sales and that is despite that we have realized the decline in demand in some areas. Moving on to sales and admin, we ended at $1,460,000,000 in the quarter, representing a like for like increase of 1.9%. And this is evidence that our efforts to reduce resources to save are starting to generate some effects. Year to date, the increase has been 2.7% and 1.9% is clearly below the average salary inflation in this area for this year. So a real reduction in resources and costs on the S and A side.
Sequentially, the quarter 3 number represented a reduction in absolute terms of approximately SEK100 1,000,000 Then let's move on to the profit before tax line. We ended with only $93,000,000 of profits before tax. And of course, that is almost entirely explained by the one off charge of $1,100,000,000 and then some is recuperated by positive FX variances in the financial net. Before we leave the P and L, let me point out that the tax line gave rise to a charge of $199,000,000 despite only 93,000,000 dollars before tax. And the explanation is largely that there is no tax credit against the write off of goodwill.
We maintain, of course, our underlying guidance of 28% tax charges on profits. EPS ended at a negative DKK0.27 again to do with a 1 off charge. Return on capital employed and return on equity, they're, of course, both very much influenced by the one off charge as well, and they ended at 17% 13.9%, respectively. Then a few comments on the performance by division and my comments, of course, they mainly relate to the development of the operating EBIT margin for the 3 divisions. As Tom has mentioned already earlier, equipment came out very well, better than I would say ever before in this setup.
Equipment came out obviously then higher than both last year and the previous quarter. This is thanks to slightly higher volume, a better price mix and then reduced somewhat through a lower load and marginally higher cost, not least in the R and D area. Then Process Technology ended lower than both last year and last quarter due to very much lower volume, a decline in revenues of $500,000,000 but also lower load from certain factories and slightly higher costs. And finally, a worse outcome for a few projects to be more specific, really relating to 3 projects, 2 old, if you like, and 1 new bad performing project. Finally, marine also came out lower than last year and previous quarter, mainly because of the decline in volume, but also some adverse effects from price mix and dimension load.
With that, let's move on to cash flow. Cash flow from operations amounted to just over $900,000,000 a reduction of almost $400,000,000 compared to last year. And this reduction is really more than explained by the lower sales volume. Regular CapEx ended at $134,000,000 against $180,000,000 a year ago. I would like to say here that for the full year 2016, you should not be expecting this year's CapEx to exceed last year's total level of CapEx.
That is despite that we are running 2 large CapEx projects in Denmark and in India. And the reason is really mainly that we're facing delays in the relocation project in India because of delays with permits from authorities. And then of course, we are also cautious when it comes to CapEx generally because of the decline that we've talked about and the lower load in certain factories. Financial net paid was positive with some $20,000,000 an outcome of some $190,000,000 better than last year and it's really a combination of to some extent, lower interest paid, but more favorable FX differences mainly. Free cash flow, dollars 800,000,000 compared to just over $1,000,000,000 a year ago, again, really to do with lower volumes compensated by a net better net financial net pay.
This cash flow has brought us to a debt to EBITDA of 1.90% compared to 1.79% a year ago, another key figure that, of course, has been influenced by the one off charge as EBITDA was influenced by some $500,000,000 of the one off charges. Then, FX and EBITDA in the quarter 107,000,000 dollars an out count for quarter 3, somewhat below expectations for transaction effects. This is obviously explained by large variations in exchange rates during the course of the quarter having a less positive effect on open exposures than anticipated. The forecast for 2016 has been updated when it comes to some of the exchange rates applied for open exposures as you can see specified on the slide. Translation effects has been calculated based on closing rates.
The full year effect gives them a positive $510,000,000 an increase from the $475,000,000 after quarter 3. And of course, this is assuming that the Swedish krona remains on this relatively weak level throughout quarter 4. Then a few words about our order backlog. We had an order backlog of totally 17.8 $1,000,000,000 at the end of September, representing approximately 5.8 months of LTM sales. Quite a reduction from end of quarter to where we had 6.6 months of LTM sales in our backlog.
For shipments in 2016, the backlog amounted to some 6,900,000,000 dollars and that is a reduction of 1.1 percent compared to the end of September last year. Having said that, let's move on to the bridge for full year sales. To start off with, as you have seen earlier on, we have had year to date sales of $25,700,000,000 and to that we can add 2 known parameters. Backlog, as I just showed you, dollars 6,900,000,000 for shipment before end of the year. And then to give you a sense of magnitude, orders coming in and shipped before end of quarter 4 amounted to $2,800,000,000 last year.
And that gives a subtotal of $35,400,000,000 I would like to add that when it comes to demand, of course, you've seen a decline for the last several quarters. And as you may have seen, we expect the same level of demand in as in quarter 3 or somewhat higher for the coming quarter. And please remember that only business is involving really short lead time items and services are relevant for in for out business in quarter 4. I think that sets the scene for in for out as far as price is concerned, no material variations. And with that, I give the word back to Tom for the outlook and the closing remarks.
Thank you very much, Thomas. So let's go straight to the outlook statement for the Q4, where we expect demand during the quarter to be in line with or somewhat higher than in the Q3. And on a divisional level, on the equipment division, we believe it will be on the same level or somewhat lower for the quarter. On the Marine and Diesel division, we will be we believe it will be on the same or somewhat higher level than in Q3. And on the PTD side, we expect it to be somewhat higher than in Q3.
And I think this guidance reflects our earlier comments about some of the larger projects and our expectations on stability overall in the market. I would also like to point out that after the ratification of the ballast water legislation, then we are not expecting And with that, thank you very much and we turn over to questions. Thank you.
Thank you very much. Ladies and gentlemen, we will now begin our question and answer session. Our first question comes from the line of Lars Brorson. Please ask your question.
Thanks very much. Good morning, Tom. Good morning, Thomas. A couple of things from my side. First of all, just on your greenhouse project.
Normally, we associate greenhouse with creating conditions for things to grow. I think, Tom, you were saying actually it's not really a perfect fit, and you're not excluding any action here. Can you just be clear about whether there is any footprint reduction associated with this? And also just on these particularly interested in your European heat exchanger business, which obviously was partly restructured back in 2014. Are these loss making operations currently?
And also just by segment or by division, where do these operations reside? I presume, again, European heat exchanger primarily within your Industrial Equipment segment.
All right. Let me make some comments first. This is not when you say European heat exchanger, I mean, our overall heat exchanger business obviously is core to us. It continues to sit the majority of it obviously within the existing product groups. When we separate out certain activities, it is partly to create the right growth focus in our traditional sales channels for the Palavalas in the 3 operating divisions.
So that's one separation
out
of a number separation out of a number of units concerns approximately a turnover of SEK 1,500,000,000. There are obviously footprint consequences that will come as a result of this. But due to, as I think we indicated earlier, our footprint changes will need due consideration when it comes to internal dialogues and negotiations with unions. So we're not specific around that. But let me say that within the one time charge and within the separation of these units, we have a clear ambition to turn units that has not been profitable to the degree we wish them to be into a more financially viable entity.
So clearly, they are impacted by this restructuring as well in terms of the restructuring charge as well as in terms of the cost base that we will be provided with. And Thomas, I don't know if you want to complement.
No, I think that's fair. It will have implications of footprint, but of course, we have to the internal processes here.
That's helpful. I just wonder whether to my point about whether you can give us an indication where these $1,500,000,000 reside. Is it primarily in your industrial equipment segment or are you unable to say this at this point?
No, I mean the greenhouse is representing only a share, a minority share for the $500,000,000 charge. Let's take it here to make it as clear as possible to everyone. We've taken a charge of $1,100,000,000 in quarter 3, $600,000,000 roughly $600,000,000 of that is to do with write off and that then mainly relating to goodwill and step up values. That is to do with the greenhouse and with the 3 entities, 3 product groups. Then if we look at the remaining $500,000,000 so what involves for instance redundancies, there we're looking at a minority of that charge to do with the greenhouse.
If we then take one step further, the balance between the charge of 1.1 and the total expected cost of 1.5 representing some 400,000,000 initiative, which has nothing to do with the greenhouse.
But I think also the question was related to where the sales volumes are located. And I think you are correct in your assumption. You will see the majority of that, especially on the air side, which is the biggest part going into the EQD division and industrial equipment side. That's correct.
Absolutely. That's helpful, Tom. And just, Thomas, on the $400,000,000 charge, how should relating to your manufacturing footprint, how should we think about the payback on that portion? And I know you're obviously holding back what you expect to live in terms of COGS cost savings. But would you think that payback how would you think that payback compares, say, to your SG and A program?
Well, I think you at this juncture, you will have to expect that we're only going forward
with sensible projects that have
a good payoff. Initiatives once we communicate the charges and the implementation of these individual projects.
And finally, if I can, can you say anything about the costs you expect to be associated with the part of your review, which is related to rejuvenating organic growth. Can you try and quantify that? I didn't hear what you were saying earlier, Thomas, about R and D spend. Do you see a step up there? Where else do you see a potential step up in terms of spend in order to drive that part of your program forward?
Well, it's a good question. I think what we've done today is taking another step in the strategic planning and disclosing a fair amount of details in terms of where we're moving on a number of angles. There are other parts at work when it comes to the business planning of our new divisions and how we will focus resources and investments going forward. I don't and I don't want to go into the full detail of that. We have other opportunities to do that together later.
But I would like to say that we obviously not launching a huge initiative on cost savings at this point in time in order to balance it out with cost increases next year. So, you should not expect to see a neutralization of the tough work that we're doing right now on the cost side. I think with the indications you had today from Thomas on where we are in R and D spend and other things, we feel that we have included in the cost savings programs are already the announcement that has been made on increased R and D pace in the high speed separator areas, we have taken height for the fact that we will continue to grow and develop the service business of our operations and we want to make sure that we have feet on the street to drive the right product groups forward in our new organization. So you should not expect that we're announcing major cost increases prior to actually clearing out the cost challenges that we have. I think that's a fair statement.
And then we'll come back with some further language in terms of what we think is key to this group and that is how we're going to develop our business going forward. But we'll take this step first and that's why you have it today.
To be a bit quantitative related to your question, Lars, I think it's worthy of note that despite that we have seen a decline in orders received year to date of some 14%, we've actually allowed consciously an increase in R and D spend of some 6.5% year to date, I think that is really a strong commitment to development of the company going forward.
That's helpful. Thanks, guys. I'll go back in the queue.
Thank you very much. And your next question comes from the line of Sven Weier from UBS Frankfurt. Please ask your question.
Yes, good morning from my side. A couple of questions, please. Two questions on Marine. I was just wondering, if the order figure you had in Q3, if there was maybe a minor part related to some backlog adjustments, cancellations or currency adjustments. I guess if they were big, you would have mentioned it, but maybe some minor impact here.
Then your comment on Marine Service, I guess we learned from Bureau Veritas that there was a delay in the mandatory previews for some ships that where the ship owners tried to push that into Q4. Would you be also a bit impacted by that? And then I think you obviously have an old margin target outstanding, old revenue midterm guidance. I mean, is that something we should be expecting you come up with an update on that at the Capital Markets Day? Or how should we think about your 15% margin target in general?
And then the last question is just on operating leverage. I guess in the first half, you were running well above 50%. Now you're running below 40%. And if I take your comments for Q4 on gross margin development, I sense no major changes against the guidance that you gave for Q3. So I mean, should we basically expect the operating leverage to be in more the region of Q3 then?
Thank you.
Okay. Good morning, Sven. To start off with cancellations, they were at a very low level in quarter 3, so not really impacting the number. What I could mention though is of course an adverse effect from revaluation of backlog at Framo because of the strengthening of the Norwegian krona and effectively the backlog at log at Framo is very much denominated in U. S.
Dollars. So a certain impact from that adversely on the marine order intake number. For marine service, you are very specific in implications from ADMA of reviews of certain ships. Well, to be quite honest, I don't know whether we have a specific effect from these individual vessels. Our take on the development is simply that ship owners they have they are struggling with their financial performance and they are pushing out their maintenance intervals at this point to safeguard cash.
When it comes to its financial targets, whether there would be an update at the C and D, my only comment to that is, Sven, we hope to see you in Copenhagen in a few weeks and then you will certainly know. Then finally on gross profit margin, well, I would like to refer back to the forward looking statement that I gave a few minutes ago with adverse effects from for instance, an increasing share of capital sales of total revenues in the last quarter and then of course some continued help from FX, continued help from purchase price variances.
Maybe just one follow-up on the point of revaluation. I mean, I take it from your comments that the impact in total was below SEK 100,000,000.
Well, it's in that order, yes.
Okay. Good.
That's all. Thank you.
Thank you very much. And our next question comes from the line of Max Yates from Credit Suisse. Please ask your question.
Thank you. Just two questions I had. Firstly, on the cost savings. Given sort of broader wage inflation in your business, other internal costs, do you have a view on how much of these cost savings you should be able to retain at the profit line and how much will be eroded by some normal course of business?
Well, let me take that first question. We expect the full impact as a running rate by Q2 at some point in time during Q2, fully implemented in Q2. So, I think we've taken height for whatever salary inflations we will have around the world on the S and A number. Obviously, if you move forward year by year, we do have a continuous inflationary pressure on our cost base. So, we will obviously, as we move forward, have to balance our sales development with productivity development to handle the cost inflation.
But we've set this program, let's say, in 2017 value. If we down the road are successful to grow our business based on on a number of factors or whether we need to take a closer look at the cost going forward, if the cyclical downturn stays with us longer than we foresee, then obviously we will do that.
Okay. Thank you. And just my second question was on the Process Technology margins. Could you help us give help us understand how much of the margin decline in Process was due to these problem projects that you had and how much was just due to the lower volumes?
We're looking at an effect from these 3 specific projects of well over 1 percentage unit in margin terms.
Okay. Thank you. And just the final question was that one of your competitors had some issues in the quarter revolving around customers slowing down deliveries in dairy processing. And given your sort of focus on this market, I'm sure that some of your backlog have you seen any change in behavior among your dairy customers, particularly within dairy processing markets?
The answer is no.
No change. Okay. Thank you very much.
Thank you very much. And our next question comes from the line of Peter Frohnlein from Handelsbanken. Please ask your question.
Yes, good morning from me as well. On the greenhouse, you mentioned the size of the business and that they're not performing according to expectations. So would it be fair to see that there's sort of a 0 earnings type of entities, the SEK 1,500,000,000? That's the first question. And secondly, you also mentioned, Tom, that you don't expect much orders in the ballast water treatment in the Q4.
So what's the magnitude of order intake for ballast this year? And given the ratification, what would be your expectations for '17? And of course, on the scrubber side, maybe the same quantification of the orders so far this year.
Let me start with the Greenhouse thing. Now you should be aware that the greenhouse initiative includes a carve out of businesses. The reason we are not comfortable with the situation is that they have not managed to perform within our operating structure the way we normally run it. And so we will recreate those and restate the earnings in those companies when they come to the greenhouse. I would say for that reason, it's a little bit difficult to discuss about it in absolute terms in terms of whether it contributes or doesn't contribute to our earnings.
But our overall picture is that they are not supporting our bottom line in the current structure and with the current cost allocations within the group, and we are dealing with that now. We will see as we go into next year what effect we have on the measures we are taking, but we I think our expectations is that we will down the road here in next year see some positive signs of improved earnings for those units. Regarding then going to the ballast water, I mean, I will not guide you on our long term expectations. What we've said before is that there will be a big retrofit market taking place in the ballast water area over the coming 6 years. And as the ratification and then finally the expected approval from U.
S. Coast Guard presumably coming relatively soon for a number of the suppliers, we believe that the market will open up. The orders will be booked based on the dry dock service intervals of the individual ship. So we don't expect a huge inflow of orders over the next five covering the next couple of years. We believe that they will be booked for us as we service those ships on an ongoing basis.
The number that we've been giving you earlier is that the total global merchant fleet that we expect will go for ballast retrofit is somewhere north of 20,000 vessels. And the average value of an installation that we are looking at is probably somewhere in the neighborhood of €200,000 How much of that will go to us and what those numbers will mean, we will have to see. But those are, let's say, the market parameters as they have been previously defined. There has been a ballast water installations for a number of years. There is an installed base and I'm getting the number here.
It's SEK 180,000,000 year to date on the ballast water. There is no trend numbers in those. It's not reflecting the ratification or any change of the market structure. For the and then finally for the SOX, the number was low in the quarter. I think it's specifically it's very low indeed.
You might call it a 0. Again, not a big trend number. We've been doing SOX installation for a period of time and we will continuously, but we are not impacted yet of the expected legislation in this area. So you don't see that in the numbers nor is it included as a specific part of our guidance for the Q4. That's
very clear. So just a clarification, I think the ballast water sales in last year were somewhere around $400,000,000 $440,000,000 Could you just clarify that?
Orders were $400,000,000 last year, full year to be compared with the $180,000,000 for 9 months now. And remember, in the 400, that included orders connected to 2 so called frame agreements with large ship owners where most of these frame agreements were called off during the course of last year. We have seen a bit of a wait and see mode among ship owners because of the questions around U. S. Coast Guard approval, I would say, throughout this year.
Thanks a lot for the level of clarity here. I get back in line.
Thank you very much. Our next question comes from the line of Ben Maslend from Morgan Stanley. Please ask your question. Your line is open.
Yes. Thank you. Good morning. Good morning, Tom. Good morning, Thomas.
Firstly, on the Marine and Diesel orders for Q4, the flat to better guidance that you've given. You just maybe give some color around where within the market you see sequential improvement? And is that just the kind of framo SEK 100,000,000 that Sven mentioned dropping out? Or do you see segments improving? That's the first question.
Thank you.
Well,
if you want to
frame this question a little bit, you have to consider that the order backlog at the shipyard as we speak is somewhere close to 2 years. It's unusually small compared to where it normally is, but there is a backlog of ships that are being delivered and that is the reason why the contracting level is more volatile than our order intake or especially our invoicing in this area. So the contraction of the order books for the shipyards as they deliver the backlog is affecting the way we take orders. We obviously have visibility on a number of vessels that are in the pipeline that are already contracted and are in the pipeline for being sourced when it comes to component and equipment. And it's on that basis that we make our forecast every quarter.
We look at the ongoing projects and negotiation and make a judgment on what we think will hit our books during the quarter. There is one parameter, which is our degree of successfully winning those offers. And I think we historically are pretty good at judging our expected market shares for the outstanding projects. And the more difficult part of it is to judging the timing of when actually those orders booked and down payment being made. And that is the more volatile part of how we judge our forecast, the forward looking statement in the Marine business specifically.
And I think that gives you the answer for how we consider the Q4. It's not a reflective it's not reflecting any dramatically changing business climate or order rates as such. It's just our best estimate of where we think we will be on the order intake side come the end of that on this quarter.
So the commentary reflects what you see being built out of the backlog by the ship owners? So beyond that then looking into 'seventeen, I mean we've obviously seen the Clarkson data weaken further. I mean do you think your marine and diesel orders have caught up with that kind of downward trend? And I guess asking it another way, I mean, the backlog for the ship contractors is still falling. Should we assume further downward pressure on marine and diesel orders next year as a result of that?
Thank you.
Well, I hesitate to give you a forecast and forward looking statement on the Marine Division for 2017. So I think I hold on that. Thomas, do you want to give any clarity on it?
[SPEAKER JOSE RAFAEL FERNANDEZ:] I think I definitely agree. And remember, we have a lag when it in between orders are placed with yards and orders are placed with equipment suppliers for their equipment. And of course, that is giving an uncertainty for you as well as for us, but I think we should not provide any longer term forecast at this juncture.
And then finally, on the greenhouse businesses, I mean, you described it in the last answer as a carve out. I know you're looking to improve performance, but if that doesn't happen, then do these assets at some point become potentially non core for Alpha?
Thank you. We are not excluding that we are successfully finding a recipe for running this in a good way and somehow keep it in the structure. We're not excluding that we are simply not the right owner for these assets. It's a great businesses, but they haven't developed as expected within our group. So at this point in time, we are open for what the conclusions are.
But I think for me, this carve out, it's equally important and I think this is important for you to reflect on as well. It's equally important for us to get our fantastic global sales and service organization focused on the right product going forward as well as getting these slightly more, let's say, entrepreneurial businesses into a structure where perhaps they're not burdened by the big corporate entities. They are somewhat more local in nature. They are not very big in terms of service and spare parts. And for those reasons, they can be run-in a slightly different fashion than perhaps most of the normal alpha Laval type businesses, and that's why we do it.
Very clear. Thank you.
Thank you very much. And we have our next question coming from the line of Andreas Koski from Deutsche Bank. Please ask your question.
Thank you and good morning. Two questions on the strategic review. Firstly, should we expect anything more to come out of the strategic review? Or was this the final announcement from your side?
[SPEAKER JOSE RAFAEL FERNANDEZ:] I think you should expect some clarity on how we see our long term business development, our long term plan. And I must say, with all the importance we give today's announcement, this is not the answer for the long term shareholder value of Alfa Laval. The long term shareholder value for our company is to continue to develop technology market, sales service. And so I think you can expect, I think, further clarity on the long term business side. The actions we are taking today, I think, are correct.
They are necessary. They are partly a consequence of the organizational decisions we took as well as on what we think is a cyclical downturn that at some point in time will come back to us. But I think we have some other dialogues to be had. But what I think you can assume is that we don't have in the plan to launch a second restructuring program. That's not where we are in our thinking at this point.
And
I'm sorry if I missed it, but on the manufacturing firstly, on the remaining EUR 400,000,000 in restructuring costs, how large part of that will impact cash flows? And then secondly, did you or can you give any guidance what kind of savings to expect from the manufacturing footprint part?
We will I think the question has been up before. We will come back with the how we see the paybacks and the benefits of what we're doing. I must say from the way I look at the program and where we are right now, I'm very comfortable that we are building a competitive supply structure in some areas. This is an investment and not just a shutdown process. So I'm very positive to where we are heading in this and we will get a fully reasonable payback on it.
There will obviously be write offs of some assets and non cash item related issues in these restructurings as we walk away from leasing agreements and maybe have some obsolescence in both the work in process and in equipment. But I don't have the split of non cash versus cash. Thomas, would you
No, I think we will give you the details of that as we present every individual project. But as Tom says rightly, there will be a split between cash and non cash effects. There will be redundancies involved that will cause cash out, but that will also be write offs as Tom just said.
And I think lastly, Tom, when you joined, I think you said that you now in the beginning will not focus on acquisitions. You would rather do this strategic review properly. Now you're done to some extent at least. Are you focusing more on potential acquisitions now? Or is that still on hold?
I am incredibly focused in getting our new structure, our new way of working, the implementation of what we've said we're going to do. I'm incredibly conscious about the fact that when we are saying goodbye to 700 co workers of which 500 white collar and many working very close to the head office indeed. We need to if I was focused on that when I started it even more so right now. So I think that's important for you to know that we are fully aware that this is the program as a whole is a rather extensive exercise and the key is in execution and not in the plans that we have presented today. So, we have a lot of work to do.
With that said, and I said that all along, we have not taken a full time out in terms of acquisitions. There was a pipeline of acquisitions when I arrived. We're obviously looking at that a little bit differently, perhaps in timing in terms of what we are pushing and perhaps in terms of parity based on the changes that we are doing, but there are valid objects there and to the degree that you don't control the timing of the M and A because there is also a sell involved, we have not shut down our M and A department. Great.
Thank you very much.
Thank you very much. And our next question comes from the line of Daniel Schmidt from SEB Brahma. Please ask your question.
Can I just start by asking you, you guided, Thomas, for invoicing to be slightly higher in Q4 versus Q3? And you've said before that Trammel sales should start to be coming down on a year on year basis in Q4 or the latter part of this year. Does that mean that we'll see only a very small part of that down tick and more of it going into 'seventeen? Is that going to be very sort of close to the year end loaded, so to speak? I start with that one.
Well,
group as a whole. I did not comment on pharma specifically. There is no change if we look at the profile of the order backlog in Framo, it is the same as we've commented earlier on. We're starting to see the adverse effects on the traditional vessel pumping systems now at the end of this year. Offshore, of course, there we've seen a decline already many months ago.
And that meant, of course, that you still saw growth for from sales in Q3 then or?
No, it did not. Okay.
It started to come down already in Q3.
Yes. And as I say, offshore, we've seen decline for many months already, but we're starting to see the effects for traditional vessel pumping systems. Yes.
Sorry. Yes. Sorry. I meant the latter part. Okay.
Thank you. And then on for Tom, maybe, I don't know if you have missed it or not, but have you said anything about the length of any sort of evaluation period for the greenhouse setup?
No, we have not. We will make informed decision as we go along, but we will not put a deadline as such on the process.
All right. And then lastly, on the non disclosed further savings from the manufacturing footprint, could you at least say anything about when, even though it's not disclosed today, when that will be sort of hitting full effect, those savings that will come out of those $400,000,000 in charges?
Yes. What we are clear about is that we have not included we will start we are well prepared and we have an understanding I think for the timing in terms of the announcement that will be done and then consequently the start of the implementation processes that go with it. We have for good order sake not calculated and assumed that we will have any bottom line impact in 2017. However, by 2019, we will expect to have close this project. So you should expect to see a gradual effect from beginning 2018 towards the end of 2019.
That's sort of the timeline we are working with.
All right. Thank you.
Thank you very much. And we have 2 more questions on the line. The next one comes from
the line of Nathalie Fauchmann from carnage.com. Please ask your question. Good morning, Tom and Thomas and Gabriela. I have just a few questions left. On the greenhouse, I just wanted to be sure that the remaining part that outside of the inside, outside the greenhouse that you see at the core.
So that's just this EUR 1,500,000,000 that you today and for the future are not seeing as your core?
Well, at this point in time, I'm not really using the terminology of core. It has not fared well within our operating structure. We've tried for a long time to turn the tide. And let's say that the patience was up at this point in time. We need to find a different way to deal with it and this is what we're doing now.
We will as we either reintegrate or divest or whatever the actions are, come back and touch base on the core. They're obviously not. I mean, they were acquired most of these assets originally for good reasons. They have certainly relationship to the type of customers and activities and distribution channels that we are working on. So in that sense, the separation is not totally without complications.
I'll be open and say that, but it is not a sign that they are way off in terms of the scope. It's just that we are not getting the performance out of them that we expect. That's what we're tackling.
Yes, that's perfect. And then on the equipment, you had a very positive and solid development in orders in the equipment. Could you just help us understand the area that is performing well? You mentioned Russia that is really turned the corner for you. Any other areas?
Yes. For equipment specifically, we were on all time high. We had a number of all time highs in equipment division. Going well this year as you can we are very pleased that you can hear from all our comments. But I think from a sales point of view, perhaps the two things that I would point out very strongly is that China was really an all time high for the equipment.
And as we rework distribution channels and rework our e commerce platform and all of that, I think we are starting to see a little bit of traction on that. The second part, I would say, is for the year, a very strong development in the sanitary equipment business. I indicated to that earlier in this call that to a degree, we've been having longer lead times than normal for delivery based on the fact that we are now investing in production capacity to meet the market, which we feel is stronger than it has been for a period of time. So within the food sector, the large projects that you sometimes see has been scarce this year, but the ongoing work on the equipment side has certainly progressed, and we have a great year on the sanitary side.
Thank you, Tom. And just last questions. You mentioned that your lower Process Technology margin was partly due to the projects, larger projects. When do you expect this project to be completed?
Thomas, would you like to fill out on that?
Yes. Well, I have to admit that in really 2 of the cases deliveries have been completed, but we are discussing the way in which they've been completed in one case and we have an issue with the financial stability in another case. And then the third one there, the customer and there we are still in the final stages of completing the project.
Okay. Thank you very much.
Thank you very much. And our last question comes from the line of Denise Molina from Morningstar. Please ask your question.
Hi, good morning. Just three quick questions. First, just to follow-up on that last question with regard to your answer on food. If you could maybe give some color on the absence of large orders, if there's a sub segment or geography where you're seeing that and why you think that's lower? And also on in the comments on Process Technology, you talked about strength in orders in up and mid stream on energy.
Just wondering if you think that that's kind of a one off or if you see that coming back? And then the last is just to ask for an update on the application to the USCG on the last water equipment approval. I think they came back to you and asked for more documentation. Just wondering how that's going?
Okay. On the food side, I think the common wisdom is that we do see long term investment cycles in on the food sector. So although as a sector as such, the megatrends are all positive and over time, we expect that area to grow. You see investment cycles there and I think we've been through some positive investment cycle right now. It's lower.
There's been, I think, reasonable capacity in many areas. So with that said, I don't see any huge trend there. I just see a certain swing between higher and lower activity on the CapEx side. And I think the sanitary equipment provides the basis for saying that overall there is a good stability and a good situation on the food. So that's how I see the product side.
On the PTD, it's correct that we had a very you could say, a very percentage wise, a very good number on upstream energy. We have said in previous quarters that our feeling at this point in time is that we are oscillating around a low number. We bought them out, we said in after the Q2, and it's been a little bit lower and now a little bit higher. The percentage number, I think, in some of your slides indicate 8% to 8% growth for upstream oil and gas. I think that's a wonderful number.
But as you know, now we are so low on the oil and gas side that it really doesn't create a lot of attention on the top line for the group. But we see recounts being modestly positive. We see stability on current levels. We have said and we still believe that it will take some time until these capital investments are pouring into the sector, but we will expect that on current level or current level plus is probably a reasonable scenario going forward from a low level. Finally, on U.
S. Coast Guard, no, I think that process goes well. I think we expect that today as well as the market is in need for clarity soon. The clock is ticking for completing the whole installation basis for the existing merchant fleet and the longer the U. S.
Coast Guard holds back, the more difficult will it be for ship owners to make their decisions and for suppliers to get the supply line ready. So, we do not expect a long extension of this period of time. That would be putting the whole industry in a very difficult situation. Thank you.
Okay. Thanks.
And I think with that,
that was the last question. Thank you very much for a good Q and A session and for your taking the time for our quarterly review. So thank you very much.
Thank you very much. And that does conclude our conference for today. Thank you all for participating. You may now disconnect.