A warm welcome, everybody, to this Epiroc Q2 2019 results presentation. The format for today will be very well known to most of you. We will start with a presentation of the results made by our CEO, Per Lindberg, and our CFO, Anders Lindén. Then we will go in for a Q&A session. Before I hand over to Per, I would like to briefly introduce myself.
My name is Karin Larsson, and I'm heading the IR department here at Epiroc since a couple of weeks back. Most of you know me since before, I was working for a while with Atlas Copco as well. If you have any questions, please reach out after the call as well. Speaking of questions, I must ask you in the Q&A session to restrict yourself to one question per person, so that as many of you can ask questions. With that, I leave it over to you, Per. Please go ahead.
Thank you, Karin. Welcome to the company.
Thank you.
The company, Epiroc, turned one year the 18th of June, what could be better than celebrate it with a record quarter? Not very much. That's really what we're about to present is a record quarter. I'm very pleased that this is the case. What kinds of records are we talking about? Well, first of all, we had record high order intake.
We see very robust demand in the market. The production continues to be high in mining and also in infrastructure. Activity continues to be high. The demand is primarily driven by a very strong aftermarket. When it comes to equipment, it's actually down versus last year. This was very much expected. We had a fantastic second quarter of 2018. We're still at a very good level, but equipment is actually down from last year.
All in all, a very good quarter in terms of order intake. Revenues also at the record level, obviously supported by the acquisitions that we've made and also by currency. Of course also we see a good organic development in terms of the ramp-up that we have done in our plants, we see good efficiency now in our factories throughout the world.
Of course, operating profit is at all-time high. I primarily want to comment here already on the very strong flow-through that we have in the quarter, it's actually quite astonishing levels, it's driven by the growth and also by our efficiency actions. It's also very good to see that the efficiency actions that we have undertaken in tools and attachments is actually bearing fruit.
I'm also very proud to be able to say that we do have a market-leading offer in automation and battery electric vehicles. We see that there's a very high demand and expectation on us as a supplier to the industry to be able to supply these, I think we do have, as mentioned, a market-leading offer in place.
We also have now a very strong fleet in operation when it comes to connected and automated machines. Already mentioned the celebration on the first year, we did an employee survey just to see what people think about the company, we got very good response. The energy created in the company in conjunction with the split is still there. People perceive Epiroc as being a great company to work for, that is very good to see.
Of course, the intention is to maintain that spirit and even improve it going forward. I think for the first year, this is a very good place to be with a record quarter and also very engaged employees. Now looking at the financials. As mentioned, we had a record order intake. We had a fantastic Q2 of 2018, actually better this year.
It's helped by currency and also the acquisitions. Organically, we're actually slightly down by 4%, that's equipment primarily going down. Well, we expected this, because the last year was fantastic. We are still at a very good level. We are still on par with the end of last year and the first quarter of this year when it comes to orders intake, I'm actually quite pleased with that level.
Revenues are up 8%, 3% organically higher than quarter one. We continue to do well there. Operating profit up 25%, of course, that's a very good improvement. I already mentioned the very strong flow-through. It's actually almost 50%. If you combine that with quarter one, I think you will arrive at a realistic number in terms of flow-through going forward.
Clearly, quarter two had a fantastic leverage on top line down to bottom line. Also, currency contributed positively. We had change in provisions for the long-term incentive program of SEK 39 million. If you back that out of the result, we end up at 21.7% in margin. We also had some minor split costs from Atlas Copco still there on the first half of 2019 and also in Q2, SEK 23 million in the quarter.
If you back that out also, if you have the interest to do that, we actually end up at 21.9% in an adjusted margin. Quite pleased with the margin development and the flow-through. EPS at SEK 140 and cash flow at SEK one and a half billion. That's clearly better than what we saw in quarter one and also clearly better than what we saw last year.
Anders is going to talk more about that. Clearly we are now at the level when it comes to cash conversion, to where we should be. Now, innovation. I talked about that initially. This is a very important area. I think most customers are looking for automation, they're looking for digital solutions in order to improve productivity. We launched 6th Sense this quarter.
It's really a way to tie together automation of machines, automation of processes, and systems integration, to optimize processes. We can do that for a variety of applications, both underground as well as surface. Underground, we're talking about tunneling, we talk about drilling and also transportation, which essentially is loading and hauling. We have a very comprehensive offering, packaged as the 6th Sense.
Of course, the intention here is to deliver productivity and lower operating costs to our customers. I'm quite pleased with that. With this, I think, again, that we do have a market-leading offering when it comes to automation. We also have cooperations around connectivity, 5G, and we also have battery electric vehicles, as I'm sure you're aware of. This quarter, we received orders from Canada and from Finland for battery electric vehicles, which is very pleasing.
I think I should mention also that we do not expect this to be an explosive development in terms of battery vehicles, but rather a gradual development. We see that the interest continues to be very high, and we are also quite comfortable with the solutions that we have to the market that they will deliver what the customers are asking for. Now, these types of solutions, the demand for that is growing very quickly.
We have already about 2,500 connected machines in the market, and we have more than 550 machines or drill rigs equipped for complete automation. To your right, you see the first autonomous SmartROC D65 in operation at Goldcorp Hollinger in Timmins in Canada. This is another development that we saw in quarter two, and we have a very comprehensive offering in terms of autonomous drill rigs for surface applications.
Operational excellence. As already mentioned, I think that we have demonstrated in the quarter that we can grow efficiently given the flow-through that we had. We're certainly not perfect yet. We continue to work with operational excellence, and one of the programs that we've had in place already since last year is the supply chain program for spare parts and consumables, targeting to improve inventory levels, availability, and also transportation costs.
This is starting to give effect now, starting to see some effects bottom line. Still a relatively small bottom line, but we expect it to be more visible as we move along in 2019 and also into 2020. This program is progressing according to plan. We also have positive effects from the efficiency programs in Tools & Attachments.
One of the things that we've done in the quarter is to divest the geotechnical consumables product, which is really non-core products. You will see more of these types of actions going forward in order to prune the portfolio of less profitable and non-core businesses in the product portfolio, as well as pruning the production footprint. We've also made a decision to invest in a heat treatment plant in Örebro for rock drills.
Heat treatment is one of the key processes for achieving quality in rock drills, and this is something that we do not want to outsource. We want to keep that in-house, a proprietary technology. In order to meet the increasing demands for quality and performance, that's why we make this investment. To keep it in-house and also to meet the future demands of increasing performance expectations.
Sustainability obviously is something that is very close to our hearts, and we see that as a competitive advantage. We feel that we are working quite comprehensively with sustainability. I guess we haven't talked so much about it historically, but clearly it's something that we honor.
First point in that is really safety and wellbeing. And unfortunately, one of the first things to note is that we did have a fatal accident in India during the quarter, and this was one of our contracted employees who was very unfortunately subject to an accident, a fatal accident. After investigation and retrospectively, we can conclude that there was very little we could do to prevent this accident technically.
However, we need to continue to work with the understanding and the mindset around safety, and we launched a program called Safe Start, which is really addressing the mindset for safety. We have also seen work-related injuries decreasing. We take this very seriously, and of course, this very unfortunate accident is a stark reminder that we continuously need to work with this subject.
Passionate people is something that we want to have, and I think we do have that. As mentioned, we did have the first survey. People perceive the company as a great place to work. Also they gave us feedback saying that there are areas where we can improve. Of course, it's actually quite good news because of course we want to improve.
I think the conclusion from the survey is that the engagement is there. We have a good internal reputation, and I hope that we can also spread the word to the external world that this is a great company to work for. Very pleased to see that our environmental footprint is improving in terms of resource usage. Our CO2 emissions from transportation improved, or the CO2 emissions decreased.
The energy, as a function of cost of sales, decreased as well. We're making progress in that subject as well. Now back to the numbers. We do have a high proportion of recurring business in terms of aftermarket. 66% of our business is aftermarket, and the balance there, 34%, is, of course, equipment. As you can see by the breakdown, we did have a decline of equipment of 15%, both organically and nominally. Service up 10% and 7% organically, and tools and attachments up 14% and down 2%, but I'll comment on this as we move along.
A key point here is that with the growth that we have, and primarily service, will strengthen our aftermarket, which will also strengthen our position going forward when it comes to resilience over a business cycle. First segment is equipment and service. Organically down 4%, as already mentioned. It's primarily equipment which is down. Service grew with 7% and I'm quite pleased with this growth.
It really shows that we do have a potential to grow service to take market share in our own fleet, which is essentially what we do. Orders for service increased across all regions. I'm very happy with the development in service. Equipment, as mentioned, is down. It's negative for both underground as well as surface equipment year-on-year. We saw growth in Asia, Australia year-on-year, which is essentially the area where we saw growth.
Worth mentioning here is that Australia is looking really good, both from equipment perspective, but also for the company as a whole. Also worth mentioning here is, of course, in Asia is China. There's a lot of talk and worries around China, what happens in China at the moment.
I can say that our development in China over the last year has been very good, both over the last year, also sequentially, quarter two over quarter one, as well as within quarter two. Development in China is very sound for us, and we're doing really well there. Even though it's a relatively small portion of our total sales, we are making significant progress. Revenue is up 5%, already mentioned, and margins for the equipment and service increased to 25.6% with a solid flow-through of clearly above 30%.
The order scenario is more or less reflecting exactly what we saw in quarter one, which is relatively few large orders, large being above SEK 100 million. We actually had one this quarter two, whereas we in quarter two of last year had several of those, and I think that's part of the difference between the two quarters.
Also we see a continued expansion of brownfield operations being the prime driver of orders for equipment. Second segment, tools and attachments. Orders received up 14%, of course, driven by structure and others it says in the bridge, which is essentially acquisitions. Down 2% organically, worth mentioning here is that we voluntarily back off some of the business in rock drilling tools, for profitability reasons, more or less about 3% of potential volume we have backed off.
As rock drilling tools is roughly 80% of Tools and Attachments, that corresponds more or less to the drop organically that you see in the bridge. Hydraulic attachment tools increased organically, and we saw orders increasing in all regions in local currency. Revenue is up 19%, 4% organically, of course, the 19% being driven by acquisition to a large extent. Now we have both acquisitions, Fordia and New Concept Mining, in our books.
Margin at 14.6% versus 12.4% last year, with a fantastic flow-through in the quarter. It's a number that is so good that I will not mention it. We have, as mentioned already, signed a deal to divest the geotechnical consumables product line.
As I said, this is one of the steps that we do to prune the product portfolio, to improve the production footprint, and to continue to increase profitability as well as efficiency within Tools and Attachments. Again, it's a good place to be in after one year, and I give it now to Anders to go through the financials.
Thank you, Per. Yes, I will comment a little bit more about the financials. Jumping immediately into the numbers. It was indeed a good quarter, a strong quarter, with a 21.7% operating profit if we exclude the provisions for long-term incentives to get comparable numbers. As an independent company, it is the best quarter in percentage as well as in money. Per mentioned a good flow-through.
I think that is also worth mentioning. At the same time, this could and can and will vary between the quarters. A little bit volatile due to the leverage on the top line. As Per said, the year-to-date is probably a good number to compare with around 23%. We still target and think it's reasonable to be between 25% and 30%. We still see some effects from lack of, let's say, economies of scale on the cost side.
Nevertheless, from, for example, IT costs and a little bit of corporate, that will disappear more and more year-over-year, we will probably not see that as comparing quarter-over-quarter. In Q2, as you obviously know, we are still not fully comparing apples and apples when we look at last year.
That goes for the P&L as well as maybe in so more so for the balance sheet as well as cash flow, as I will comment on later on. How do we then get to the 21.7 or 21.3 as we have reported? Quite clearly, as you see on this right-hand side of this slide, we have the organic improvement, we have the currency effects, a little bit of tailwind from the currency, the rest we call structure.
That is, we have a little bit less of the long-term incentive provisions. Per mentioned the SEK 39 million for the quarter. There are several elements of it, but the main reason is, of course, that the share price increased somewhat between end of March to end of June. We have also less costs for the split, that one-time effect that we had last year, that will gradually come down as we move on, but there are still some money spent on that also in Q2.
Finally, when it comes to structure, what we get, a positive contribution from the acquisitions, that is clear. It dilutes our bottom line somewhat, and that is fully in line with what we have expected and planned for. That is not a surprise. We end up at the 21.3% or adjusted, as we said, at 21.7%.
We then take a look at the costs. We have overall the administration, marketing, and R&D costs have increased from Q2 last year, SEK 1,569 million- SEK 1,745 million. Most of that, I would say more than half of it, is related to the acquisitions and currency, and also to some extent, it is volume driven in logistics and somewhat also in IT.
You should also note here, of course, that in this graph we have excluded the provisions for long-term incentives, so it is comparable. I mentioned that we do have some lack of economies of scale, so that is obviously part of it. While R&D and marketing is flat, the administration is where we see the organic increase mostly.
When we come to the financial items, we had a positive impact of the currency in the quarter. That is why the financial net is a little bit lower than in Q1. Looking just separately on the interest net, it was SEK 57 million. We should expect slightly above SEK 50 million per quarter. Why was it higher than last year? Remember that, as I said, not all numbers are completely comparable.
We were listed on the 18th of June last year, and just before that, we were actually fully financed, so we do not have comparables. It is Q3 that we can say that the companies are fully comparable. On the effective tax rate, the 24.5% is in line with our expectations, being below 25%, which we have said before. Capital structure. We have visualized the effect of IFRS 16 on this slide as good as we think it can be done.
We have increased our balance sheet with more than SEK 2 billion just from the pure impact of IFRS 16. That obviously has an impact of most of our balance sheet-related KPIs. For example, the net debt, EBITDA, has increased with 0.21, so it would have been 0.22 instead of 0.43 without the IFRS 16 impact. Also the return on capital employed has an impact of almost a percentage point.
In November, we will pay the second part of the dividend, which was paid with the first part in May. That will obviously have an impact going forward. We then look at the capital efficiency, net working capital. It increased year-over-year and also from the beginning of the year. Almost half the increase in nominal terms relates to currency and acquisition again.
It's a common theme as you hear, but it's also a reality that we have. Organically, receivables is the most of the increase, quite natural, especially sequentially with the sequential growth. The numbers are quite logical in the quarter. When it comes to working capital, as you see in the cash flow, we have a small increase in the quarter, but if we break that down, the inventory actually came down a little bit and the increase is primarily from receivables and the sequential revenue growth.
Even though we don't like the level of the working capital, it's actually going in the right direction and development is trending right. Looking at the cash flow. Yes, we had a good cash flow and it was a major improvement compared to Q1 with SEK 1.5 billion in operating cash flow. Obviously, it starts with a good result.
That's the baseline for having a good cash flow. Again, here I would like to mention that if we just line for line compare with last year, it's not 100% comparable. One thing that is comparable, though, is the development of the working capital, where we last year were in a ramp-up situation and obviously tied up a lot in the working capital, while this year we have a smaller increase in the working capital from, as I said, primarily from the sequential growth in revenue.
The inventory went down, and that's good to see, in particular since we, as always, have a little bit of build-up for the summer to make sure that we have sufficient availability on consumables and spare parts to meet the customer expectations. Another thing to mention maybe, many times here I've talked about IFRS 16.
Also in the cash flow, there is an element. You can read the details about IFRS 16 in our report. Nevertheless, we have a positive operating cash flow impact of about SEK 85 million in the quarter that we wouldn't have had if IFRS 16, as the lease payments, some of it moves down to become interest in the accounting treatment of IFRS 16.
I'm sure you're familiar with that. We have given some more details in the report. Looking at the right-hand side of this graph, or slide, we did have a strong cash flow. We were not so pleased, as you know, with the cash flow of Q1. Obviously rebounded well in Q2. It will likely vary between the quarters, but over time, we expect to deliver a good operating cash flow. With that, I have covered the details on the financials. Back to you, Per.
Yes. Thank you, Anders. The summary is pretty straightforward. As mentioned, we celebrate the first year with a record quarter in terms of orders received, in terms of revenues, in terms of profits. We also have engaged employees. As mentioned already, we do have a market-leading offering in automation and battery electric vehicles. Again, it's a good place to be. Now, what about the future? What about the outlook?
Well, we expect demand to remain pretty much at this level. We do not see any major trigger for demand to go up or down. We see production continuing quite well in mining as well as in infrastructure. That's going to drive both the equipment demand as well as aftermarket. Again, we expect it to continue at this level. However, typically quarter three is lower in terms of activity than quarter two.
It doesn't say anything about the underlying demand, but for us, Q3 is typically slightly lower. Now, to what extent? Well, that remains to be seen, but just as a heads up, that is typically the case. That's what we expect for Q3 and going forward. Also a reminder about save the date for our capital markets day, the 14th of November here in Stockholm.
You are all very welcome. We will essentially focus on all the very exciting offerings that we have that I just mentioned today in terms of automation and battery electric vehicles to give you a better insight in terms of what that is and what it could deliver to our customers. Again, keep that in mind in your diaries, and we'll see you there. Karin.
Perfect. Thank you very much for a good presentation, and we really hope to see you in November in Stockholm. We will make the trip worthwhile. Coming into the Q&A session and looking at the audience in here, it's rather limited. I would say we would start with the Q&A online. Operator, would you mind starting the Q&A session, please?
Thank you. We will now start question-and-answer session. Ladies and gentlemen, if you wish to ask a question, please press zero one on your telephone keypad. To cancel your question, please press zero two. Thank you for holding. Our first question from Graham Phillips, Jefferies. Sir, please go ahead.
Yes, good afternoon, Per, Anders, and Karin. My question is around equipment and service. Can you say just generally, does the service margin vary much from quarter to quarter? When we think, of course, that the main variance here is equipment and equipment sales and volumes, what's going to happen in the second half with quite tough comparables on organic sales development in the second half of last year and with organic orders down 15%-16% in equipment? Would you be expecting to see lower production in the second half of this year compared to last year? Second half of last year.
Well, first question on the service margins. It does not vary particularly much. What we've seen, what worthwhile noting is that we are growing the service part of service, which is man-hours rather than spare parts. We essentially make the investments in man-hours, having people on the ground, and making sure that we do have that interaction with the customers, which we then expect also to drive spare parts usage.
Those investments we did during the first phase of this growth, that was in 2018. Now we're slightly moving over to more spare parts and also slightly more profitable, call it volumes within service as a whole. That change is happening, but it doesn't really vary over time. The second part of the question, do we expect lower production in the second half of 2019?
Well, if that's related to our production, that is not what we expect. We still have very healthy order books at a very good level. Yes, we do have revenues. We've had revenues in 2019, which exceeds orders received slightly, but still a very healthy order book. That's going to be supportive for production for quite a while going forward. Definitely in the rest of 2019.
Thank you. Just as a follow-up, is there any particular area where production amongst your equipment plants, where we'll be seeing higher production or relative to the other types of products you're producing? I'm just talking equipment here.
Okay. Well, I think, yeah, the last quarter we did mention some of the less than expected efficiencies that we had in some of our factories. I think things have become somewhat better. There's still one or maybe two factories where we would expect the production to continue to ramp up somewhat within equipment. That we expect to happen as primarily related to the surface drill rigs.
I think it's fair to say that we're still on a good level. Not to say a high level.
Yeah.
There are still challenges.
Yeah.
Okay. Thank you very much.
Yeah.
Our next question from Klas Bergelind, Citi. Please go ahead.
Hi, Per and Anders. It's Klas from Citi. Can you hear me?
Hi.
Yes.
Yes.
Hey, Klas.
Had some problems with the line before here in the morning. Thank you. First on the drop-through, I get why the margin is better in tools and attachments following the order selectivity earlier. I had a question on equipment and service. How much is mix versus productivity here? Obviously, services is growing faster than equipment, which is helping the mix.
I was wondering if there is any productivity actions that are now coming through. In addition, obviously, to the production issues abating, of course, versus last quarter. You talked there about improved transportation costs. Obviously, the supply chain effort can help cash flow, but also maybe cost of goods sold. I'll start here by asking about productivity in equipment and services.
Maybe I can try to elaborate a little bit. There is an element of mix, a positive element, in let's say, a product as well as between service and parts and equipment. Absolutely. It's not significant, but there certainly is some. We have seen some sequentially, and year-over-year, we have seen some improvements from the transportation part, from service variance, and that's what Per also mentioned, that some of the efficiency improvements are in service.
Also better utilization in the factories compared to last year. There is a little bit element of many things in here. I also want to mention that when you take one quarter, and let's say the way what you call drop-through or what we refer to as flow-through, it could vary, of course, depending on what leverage you have on the top line. If you do the math between the first quarter and the second quarter, you will also see that there is quite a change in year-over-year in the organic top line.
Absolutely. Which is inflating the drop-through mathematically.
That's why I'm trying to say that a year-to-date number is probably more fair to use.
Okay. I had a quick follow-up to you, Per, which is on automation and electrification. I'm sure you're aware of this, there is a discussion in the market whether you are lagging competition in automation or not. My view is that the mix is a bit different with you being bigger in drilling versus others being bigger in loading and hauling, and that this can create maybe a different perception of where you are stronger in the respective fields.
Could you comment on what you do in automation, electrification, a bit more in detail, and your relative position? Whether we should expect an increase in R&D going forward. We hear about all the launches, we get a lot of questions on whether we will have an R&D creep in Epiroc.
Well, I think we're fully aware of the discussion on the market, of course it's not a coincidence that we start talking about it now. We still have the perception that we do have a market leading offering, I know that our competitor has the same perception of themselves. We do have a slightly different focus, as you mentioned, where I think our competition is more focused towards underground loading and hauling.
Our focus is, has been more towards the drilling and drilling automation. I think we do have different positions of strength. Our current offering is definitely targeting all of these areas, we feel that the offering that we have, that I tried to describe, very briefly obviously, is definitely market leading in terms of what it can offer to our customers. At the end of the day, it really depends on what the customers think about our offering rather than what we think. We'll see. We're certainly fully aware of the different scenarios.
Yeah. My question is sort of boiling down to in terms of whether Epiroc needs to increase R&D to sales.
Well, what we've said is that we're currently somewhere in between 2.5% and 3% of turnover in R&D, in absolute terms, of course, that's just do the math. I think that's a level where we at least need to be going forward in terms of absolute terms. My perception is that depending on, of course, where the market and top line goes, I still think that we need to spend a fair amount of money in terms of R&D on digital solutions as well as battery vehicles. Not necessarily a creep.
One should also be aware of that the big portion of this goes into development of these types of machines. We do not have very much R&D in service, nor do we have that proportion of R&D into tools and attachments. The big chunk of our R&D really goes into our machines and our machine divisions. If you apply that absolute number into machines, you'll see that the absolute R&D in that area is significantly higher. I think that should be understood, which means that they're quite R&D intense.
Yes. Thank you.
Yeah.
Our next question is from Guillermo Peigneux, UBS. Please go ahead.
Thank you. It's Guillermo Peigneux from UBS. I have two questions, actually, if I may. One is on your install base, the one that is connected, if you're able to monitor utilization levels, could you comment on the direction of the machine hours, so to say, if you have something that you can share with us?
Second to that, I guess, after recent moves within the industry with consolidation happening in the midstream and downstream part of the industry, the question I think is, if at some point you'll see consolidation going all the way up to upstream, or there's a legit, in a way angle to or for upstream players to remain independent as equipment producers to the mining value chain. Thank you.
Okay. Well, as we mentioned, 2,500 machines plus is the number of connected machines that we have. That first of all, is a number that we expect to continue to increase quite rapidly, actually. I think the experience is that once the machines are connected and once they're available to monitor, not only from us, but certainly from the mine owners, the utilization tends to improve because you have immediate access to the status of the machine and the utilization. The experience is that the utilization increases once you're connected. It's obviously a very effective tool, one of the tools to improve utilization.
I think here it's also important to say it's not only utilization that you can monitor with the connectivity. It has sort of a, let's say, a preventive and predictive way of improving productivity by detecting issues in advance.
Yes. Correct. For the second half of your question in terms of consolidation, well, that's an interesting topic. It's one that perhaps doesn't allow itself to a very simple answer. We have certainly noticed the consolidation. I guess you refer to Metso and Outotec, that's an interesting move. I think, you look at one of the arguments around that combination is the generational synergies. Fair enough.
That's their estimate. I think for us, being further upstream, a deal for us need to be very much justified through significant synergies, and that's not as easy for us. Given the position that we have and the market shares in the areas that we're in, the issue of consolidation is not a straightforward thing. It's not obvious that the combination downstream would have any impact on us upstream.
Thank you.
Yeah.
Next question comes from Alexander Fialko, Bank of America Merrill Lynch. Sir, please go ahead.
Thanks very much. Good afternoon, everyone. Just a couple of quick clarifications. I wondered if you could repeat what you said about the rock tools impact on the bridge in T&A. I didn't quite catch what you said about the impact.
Then maybe talk a little bit about what that means for the drop-through on the margins, because obviously it was very high, and I know you've called that out saying, expect that to normalize a little bit. Perhaps you could also extend that to the impact on the EBIT of the structure.
Obviously, we're moving into a more comparable apples and apples environment in the second half, as you mentioned. I just wondered if you could call out or help us with anything that we need to bear in mind explicitly, with respect to separation costs, et cetera, that you can maybe put a little bit more of an absolute number on so that we can factor that into the forecasts. Thank you.
What I tried to say in terms of the bridge, the organic decline in volumes for Tools & Attachments was 2%. At the same time, the voluntary backing off, whatever you want to call it, in terms of volumes, i.e., volumes that we could have taken, that we historically have taken, that we now are backing off due to profitability reasons, roughly 3% of rock drilling tools.
As rock drilling tools is about 80% of Tools & Attachments, you apply the 80% to 3% and you arrive possibly at a conclusion that that's more or less exactly the organic decline that we saw. That's what I was trying to say. I hope that makes sense.
That makes sense. Thank you.
Okay.
Do you think that's now finished, or do you think that's still something you're likely to continue to see around the edges?
I think we'll continue to be firm, because this is essentially about pricing.
Sure.
If we can't achieve the prices and profitability that we want, we're not going to do the business. As a consequence, us being more firm on pricing, we're also seeing a very healthy development of pricing within the rock drilling tools division. Those two go hand in hand. If we end up in a scenario where our previous customers accept the pricing, fine, we'll do the business. It's not ideological, it's just profitability driven.
The other side of that is, of course, that as we go along, the bridge is year-over-year, that this, say, bridge effect will disappear over time.
Correct.
Already in Q2 versus Q1, the effect was less.
Yeah.
Yeah. Understood.
You had some other two questions, I actually don't exactly know how to answer those.
It was just to see if I look at the impact on the profitability in the quarter from structure, there was more than just M&A in there, and I'm guessing that's because the difference in separation costs. I'm just wondering whether or not you can help us out.
Yeah. Tools and Attachments only, or?
No, for the group.
Okay. Yeah. Just to clarify, in Tools & Attachments, the structure part is entirely related to acquisitions.
Yeah.
Although it actually gives a good contribution to the bottom line, it obviously is less, so it dilutes. It dilutes even more so on the total. In the structure, other than the acquisitions, we also have the change in what you refer to as separation costs, which this quarter was SEK 23, and was, if I remember correctly, SEK 104 last year, same quarter.
That's quite a difference. Also we had less provisions for LTIs. You can see that at one of the tables in the end of the report, it's quite clearly shown quarter by quarter, those two components. In structure, we have what we call contract manufacturing, which has actually more or less disappeared.
We have a very small part left, as of end of last year, it was almost gone, that improves the bottom line, you could say, a margin with about 0.1%, just by taking that out to that revenue with more or less a break-even bottom line.
If going forward, I think that was also your question, how you should think about separation or split costs going forward. There will be some. It will gradually disappear. There will be maybe Q3 on the same level as Q2 or a little bit less. There will be some of it, but it will not be material.
That's very helpful. Thanks very much, gentlemen.
Our next question from Matthew Spurr, BNP Paribas. Sir, please go ahead.
Hi, thanks. It's Matthew Spurr, Exane BNP. Can I have a quick one on the seasonality you mentioned then? My model going back eight years doesn't really line up with that. I think most of the time, actually, Q2 is above Q3, obviously don't have the same detail on currency and things that you have internally.
I think you said hard to quantify then, can I ask what you think drives that then, so we can just get an idea of the drivers behind why Q3 is seasonally weaker than Q2? Do you see that in equipment or do you see that in service, or is it something in the construction markets in tools and attachments? Thanks.
Well, in terms of revenues, it's primarily our own production, since we have a big chunk of our production in Swedish factories, we typically have vacation period.
No, I get that on revenue side with delivery. I thought you were talking about orders when you're talking about seasonality.
Okay. I actually was talking about both. All right, for orders.
Okay.
Well, I think this is based out of our own experience. We clearly had that last year. Actually, we had a drop between quarter two and quarter three of, I think, 10% or something like that, and it took ourselves, as well as the market, by some surprise. We didn't highlight that, but I think part of it is really that the activity tends to go down on the northern hemisphere during the third quarter, and I think that's reflected. Don't expect that to be at the magnitude we saw last year necessarily, but this is more a heads-up in terms of this. We believe this. Is going to happen also this year, but it's difficult to predict exactly to what extent.
Okay, understood. Could I have a follow-up, please, on the equipment and service margins? You basically delivered 26%, let's call it, EBIT margin. I know that's supported a little bit by currency. You talk about a normal drop-through of 25%-30%. There's still further efficiencies you can do there. I know we're at sort of a good point in the cycle, but how far do you let that margin go up before you start thinking, "Actually, let's reinvest a little bit here," because you don't need such a high margin necessarily?
Well, I think that's a difficult question for us to share with you. I also would like to remind you of the fact that we were not thrilled about our drop-through in Q1. I want to emphasize that we should look at these two quarters more together than separate, being mindful of the, let's say, the mathematical consequence of having an organic decline in equipment and growth in service. That obviously also have an impact on this. I'm not sure that's a very good answer to your question, but that's an answer.
It's a good question, but it's a very difficult answer. How far do we want to see it go before we reinvest? Well, first of all, we want to be as light in terms of investment as possible. What we did during last year was to outsource some final assembly. What we did in the beginning of the year in quarter one was to basically bring that back into our own facilities.
Not all of it, but some of it. That's a model that we will continue to deploy in order to minimize our fixed capital. Now, if volumes would increase substantially when it comes to our machines, well, then we have to look at what we do. Right now we're not there.
No. I think it's fair to say we intend to be assets light i n the future as well as in the past, but definitely make sure that we control and manage the core competence in our, say, core production. That's why we actually invested in the new heat treatment facility in Örebro. That's also something that we do, of course.
All right. Thanks for the color.
Our next question from Markus Almerud, Kepler Cheuvreux. Sir, please go ahead.
Hi, good afternoon. Markus Almerud from Kepler Cheuvreux. Can I come back on automation, please? Could you maybe quantify what are the revenues that you're having currently from the automation product, and just the product per se? Then in the licenses that you have sold, how many of those are you also selling equipment to the same customer? Has it driven equipment sales, or is it more equipment which is already in place, and then you connect it, so to speak?
Well, it's a combination. I think what we have is, first of all, the automation proportion of our sales is still relatively small. I wouldn't say it's immaterial, but it's small. At the same time, it's profitable, so it is contributing to our bottom line margin. That's the first observation. Secondly, a fair amount of the automation that we have sold so far has been retrofit, i.e., to have automation kits on already delivered and existing machines.
Now, the prerequisite of that is that the machines are equipped with computerized control systems. If they're not, that's not going to be possible. It doesn't make sense. If they do have that already in place, automation is possible. That's the bulk of what we've done so far. Increasingly, we also have automation-ready machines already from production line, so to say.
You saw one example, the SmartROC D65 is already from the factory equipped with automation possibilities. As we go to the bigger drill rigs, some of those are equipped already from the start, but majority is still retrofit. That's the scenario that we're in.
Okay.
The trend is definitely to have automation-ready machines already in production.
When you sell the automation program itself, I assume it's a license fee for it.
Yes.
Is that correct, right?
Yes.
Okay. Thank you very much.
Sure.
I think we need to finalize. We can take one last question, and then we need to wrap this up. Thank you. Okay, our last question from Andrew Wilson, JP Morgan. Sir, please go ahead.
Yes. Hi. It's actually William Ashman from JP Morgan. Just had a question on the flow through in Tools and Attachments, and why if largely this is a result of s ort of productivity and internal measures, some portfolio rationalization, why should we not see the drop through continue this similar level for at least the next couple of quarters? Thank you.
Well, I think also here we expect to have a good flow through, not the exceptional flow through. I again refer to the fact that it depends a little bit on the top line and the leverage on the top line. We certainly expect to have a good flow through. We had very good development on the hydraulic attachments and also the efficiency measures on the rock drilling tools side. To expect the level that you saw in Q2, that we shouldn't do.
We should see it over a longer period of time. As Perry mentioned, we will expect some continued efficiency improvements from our supply chain program and other efficiency measures that we're taking. We also have There are many things that are happening, like the divestment that we announced in June.
Yeah. Okay. Thank you.
Sure.
Perfect. Thank you very much.
Thank you.
Thank you very much, everyone, for taking the time to listen to this call and asking good questions. If you have any, please reach out to the IR department. All of us are happy to help. By this, we conclude the call, and we wish you all successful investments and a very great summer. Thank you very much. Thank you.
Thank you so much.