OUKPY - Metso Outotec Oyj (OUKPF) Q3 2022 Earnings Call Transcript

Metso Outotec Oyj (OUKPF)

Q3 2022 Results Conference Call

October 28, 2022 06:00 AM ET

Company Participants

Juha Rouhiainen - VP, IR

Pekka Vauramo - President, CEO & Chairman

Eeva Sipila - CFO & Deputy CEO

Conference Call Participants

Klas Bergelind - Citi

Andreas Koski - BNP Paribas

Max Yates - Morgan Stanley

Panu Laitinmäki - Danske Bank

Antti Kansanen - SEB

Vladimir Sergievskii - Bank of America

William Mackie - Kepler Cheuvreux

Sindre Sørbye - Arctic Asset Management

Erkki Vesola - Inderes

Presentation

Juha Rouhiainen

Hello, everyone. It's Juha from Metso Outotec's Investor Relations, and I want to welcome you all to this Conference Call, where we discuss our Third Quarter 2022 Results that were published earlier this morning. Results will be presented by our President and CEO, Pekka Vauramo; and CFO, Eeva Sipila.

After the presentation, we'll have your questions. And as usual, we try to limit the length of this call to 60 minutes. And in the presentation, we will have forward-looking statements, the disclaimer in the beginning.

And with these remarks, we are ready to start, and I'll be handing over to Pekka. Please go ahead.

Pekka Vauramo

Okay. Thank you, Juha. Welcome to this third quarter call. We are very happy to report all-time record results for Metso Outotec, and it's really a great achievement from the entire Metso Outotec team globally. I mean, if we look at, for example, this year, the environment where we've operated, there's been so many moving parts in this one, closure of Russian business amongst many other things, high inflation, all the efforts which sort of made us to compensate well, the lost business in Russia, in other parts of the world, and that's really been a great, great achievement as we see later in the numbers.

It's -- we said earlier in the year that we see rest of the world start compensating, the loss of Russian market, and this has truly happened and the pickup has been even faster than what we expected, as you see in those comparable order intake numbers a bit later on. We are also delivering high growth as we speak, and this is really visible then in the EBITA margin, which is on record level at this moment.

We continue to take steps in sustainability. And if we need to say something negative about our past quarter is the cash flow performance, which is mainly due to growth of inventories, but that is very typical for the cycle in our business when our volumes grow very rapidly and strongly. We tie capital into our supply chain and inventories which we then repatriate when times get somewhat quieter past two years is a very good sign of that one when the volumes went down or were flattish, we were able to repatriate a lot of cash, more than €1 billion cash in fact, over the past two years.

But looking at numbers, really orders, really the face value shows a decline. But if we adjust that one with the one single really large order that we received last year in the third quarter, €360 million about was that order. We didn't have similar orders, any of those nowhere near of that one in this year's third quarter. And then if we adjust that one with the Russian orders, we, in fact, do see 27% increase in order intake. And I think it really is a sign how well rest of the world has been able to compensate for the loss of Russian business.

Sales, very good execution of the order backlog in a situation where there are still issues with the supply chain, though somewhat less than earlier, but still issues with the supply chain, very strong growth altogether. And EBITA margin, a nice drop-through of the volume growth here as well and turning into 14.8% adjusted EBITA margin. And that also flows through to the bottom and gives us the EPS of €0.16. Cash flow, I already commented over there is on low side. But like I said, I mean, there's nothing surprising in that one in that regard that we tend to tie working capital typical for this phase of the cycle.

Then when we look at the segments, Aggregates, strong performance continues there. As well, I mean, orders, we were in fact positively surprised of the strength of the North American market that seems to be continuing. We saw some weakness in European market, maybe not quite as soft as we thought. So order growth there, both in equipment and in services, strong growth in sales, which is, of course, delivering from the order backlog, mostly services share being 33% in this quarter, which is roughly on the same level what we have had in the beginning of the year as well. Adjusted EBITA on record level 15 point -- sorry, €57 million, 15.7% margin.

And this is now a segment where we are delivering above our target, which was 15% set for the Aggregate segment altogether. Good work done by the entire team for Aggregates business and really delivering on relatively active market.

In the Minerals side, yes, affected clearly by the situation in Russia and loss of that business. So it's visible there in the orders same as well, the big large order was partially on metals, partially on minerals. And -- but adjusting those, the orders growth would have been like 14% for minerals. So really good activity and good pickup of activities in the rest of the world. Services orders also very good strong growth of 26%.

Sales growth on equipment side, 36%; services, 39%, really strong number services share on at 65% and good drop-through on profitability, adjusted EBIT at €146 million and turning the margin of 16.3%. So we are on our way towards our long-term goal of 20% in minerals, even though we still have quite some distance to go there. Good execution, now fully visible synergies. They are, of course, contributing to this result. And then, of course, all the mitigation actions on the input side.

And now at this phase, we've mentioned since, I think, third quarter or fourth quarter of last year issues in our consumables. Now we had really solid three months of solid profitability in our consumables business and those issues that we earlier referred to, they are now clearly behind us and consumables is delivering strong results and contributing to both minerals and to a smaller extent to the aggregates segments success.

Metals also delivering strong results above the 10% target that we have set for the Metals segment order intake because of the large order that was split between minerals and metals. Face value is down, but comparable order intake really more than doubled from -- if we adjust it with that one large order. Sales growth, very strong sales growth as well. Services share, which are traditionally very low in metals, but slight growth in that side, plus also through the volume we get, in fact, quite a nice growth in services as well. Adjusted EBITA, €17 million, strong growth there, 11.9% margin.

And really the turnaround that we initiated end of '21 is clearly bearing fruit now. Now it has improved our cost position and agility altogether in our Metals business, and that's visible in the results.

Then I'll hand it over to Eeva for more detailed financials.

Eeva Sipila

Yes. Good morning, good afternoon on my behalf to all. Our CEO, Pekka went through our strong operating income statement figures already, so I'll highlight a few additional items here for you. The quarterly figures are as such, very well comparable. We had only a minor €2 million positive adjustment in our Q3 operating profit.

The nine-month operating profit includes the €150 million provision made in the end of June for the wind-down of our Russian operations. Of this, €145 million remained at the end of September, progress has been slow due to the complexity of the legal logistical and banking situation.

Net financial expenses are up, reflecting somewhat higher debt and interest cost in today's market. Our effective tax rate for the quarter and the year-to-date is on the 27% level, which is well in line with what we've indicated to you earlier. During the quarter, there was no material impact from discontinued operations. So the earnings per share for both continuing operations as well as for the total is the same €0.16.

Moving to our balance sheet. So total assets are up €1 billion from the beginning of the year and some €400 million from the end of June. Our strong growth is well visible on the balance sheet. M&A in the year has been consisting of two small businesses, which we have -- which have had limited impact on the assets. Inventories, however, are up with some €600 million from the beginning of the year and some €200 million since the end of June.

Of the year-to-date increase in inventory, the split of volume versus price and FX growth has been rather stable. We're generally seeing slightly more volume growth than price and FX. But as you well know, FX has been volatile and also impacts these figures.

I would say roughly 60% of the inventory increase comes from volume, and then the remaining 40% is then really a reflection of the inflation and FX environments that we're living in. Now inventories represented some 30% of sales in 2021, and we are now running at around 36% of sales. Whilst receivables are up in euros as a percentage of sales receivables have actually been trending down. So we're happy with our collection efforts as such. And then net debt at the end of the quarter was up to €690 million.

Cash flow then continues as expected to be the challenge in a market where we are seeing very strong sales growth combined with a difficult supply chain and high inflation. Our customers' main expectation for us is availability when they are running their operations at full speed and ensuring that availability has required investment from us. The negative change in net working capital is mainly driven by my cash tied on the inventory side. Now in the quarter, we had a few million of cash cost from winding down of our business in Russia in the form of restructuring costs.

The remaining provision continues to be treated as cash neutral in the year-to-date column of this table, so negative in the profit row and then added back in the change in net working capital row. Looking ahead, we don't expect a quick improvement in working capital, although the supply chain is easing, and we are able to lower our availability buffers and have been doing so for a few months already. This will support the release of cash going forward as well the expected slower growth in Aggregates.

Moving to my final slide, the main points on our financial position. During the quarter, we signed a new €100 million term loan, otherwise, funding was raised through commercial paper markets. Liquidity at the end of the quarter was at the same level as at the start of the year. An update on our average interest rate may be useful for your Excels. So 1.37% is what we're on average paying out. Debt to capital stands at 31%. And finally, there were no updates on our ratings in the quarter.

So with that, I will hand it back to our President and CEO. Pekka, please.

Pekka Vauramo

Okay, thank you. And I'll take a view on our strategy implementation, sustainability. And then last, the outlook comments on that one. On the portfolio side, we continue the metals business review. We expect the review to come to a decision point during the first quarter of next year.

We want to be ready at the time when we take the final decision on the metals, and that's why it's taking some time. And the business performance currently in metals is very supportive for the process. And there are clearly some high-potential areas within metals of really are great interest at this moment.

Yes, we are active in the M&A side though there's nothing major in the pipeline but quite many smaller targets that we are currently looking. We've moved ahead with one small M&A. It's a technology relating to service and service of heavy mill gears. It is a North American-based business, that does have a quite a lot of potential when globalizing that one.

It is a technology and that will profile our services more towards expertise and expert services as well as it will give us a window as well as to customers a window on future planning of maintenance activities in relevant products. We continue to grow our planet positive sales. There is -- the latest figure is nearly €860 million for the rolling 12 months, so good growth since May this year in that area, and our plan really is to grow this rapidly.

We have launched several new products in different areas, and this offering consists of closer to 150 different products or technologies already in this offering. We also -- as a part of the planet positive, we've introduced a recycling service for used mill liners, and this is now available not globally yet, but will be available globally later on in some areas for both metallic and rubber mill liners. And this is a development work, of course, recycling metallic new liners, it's relatively easy. But we have developed a way to recycle also the rubberware liners, which have been problematic waste up until now for our customers, but now we do have the capability to take it back and reuse when making new mill liners. And we are in process of expanding this one and first contract with customer exists already in that area.

The market outlook, we expect market activity to remain at the current level. Mining market being relatively -- or remaining strong as it has been strong and the Aggregates market to decline due to softening of the European market. The softening was not quite as sharp as we thought in the beginning of last quarter. But of course, the European macro picture doesn't look that promising. So therefore, we feel that Europe will continue to soften.

We also have to remember when we look at our upcoming numbers that fourth quarter is seasonally also always lowest when it comes to order intake in our Aggregates business. So we will see that impact definitely. And then anything that comes more than that is then because of the market softening. We still see that the North American market for Aggregates continues on a high level. But there as well, we do see seasonally a slower season right now ahead of us.

And next time, we will see maybe some indications maybe in December, but mostly so during the first months of next year.

With these ones, we're ready for the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] The next question comes from Klas Bergelind from Citi.

Klas Bergelind

I wanted to start with the cash flow. You're making great progress at the earnings level, but all of this is wiped out through a major increase in working cap, and free cash flow is negative against a similar level as in the second quarter. A lot of companies struggled with inventories in the second quarter, owing to China lockdowns and so forth, but reporting improved cash flow this quarter as bottlenecks ease. That is not happening at MOCORP. I'm just trying to understand what's going on here and if this is, Eeva, accelerating your work on regionalizing your supply chain?

And if you can comment to what we should expect into the fourth quarter? I'll start here.

Eeva Sipila

Sure, Klas. So I think it's really good to understand our growth profile. I mean, obviously, perhaps some of the other companies who are seeing less pressure are also seeing a declining sales growth. I think this we're really at the sort of height of many of -- at what raw materials, components and fixed products -- finished products, I mean, in order to as said, ensure the availability to our customers.

So in a way, I share, obviously, your concern, but this is something that we're quite used to in this business that at this point of the cycle. We see the inventories growing and now really the supply chain challenges, I would agree, are easing. But again, I would be a bit cautious on saying that all the issues are behind. I think we're still in a very volatile world where small external shocks can sort of play a bit of havoc on that.

And so fully not out of the buffering period. But as I said, sort of there are certainly areas where we already are able to ease and do you expect an improvement or less capital being tied as we go forward. But still a bit cautious, perhaps on the Q4, these things don't sort of change overnight, obviously. It takes quite some work for us to sort of have a sort of a visible impact for you guys.

Klas Bergelind

Yes. I guess let me ask this in a different way. So you say that this is 60% volume and 40% inflation and FX. And I think Pekka, you said that this is normal at this stage of the cycle. And I appreciate there's a lot of growth.

But if you do a 15% margin and the negative free cash margin, I'm just trying to understand, at this stage of the cycle, shouldn't investors expect more cash.

I mean, I'm just trying to understand what is the underlying free cash flow level, you should operate if we didn't have these bottlenecks because you were talking before, Eeva, about the supply chain effort, regionalizing it, et cetera. So I want to understand the self-help around this. And if we can improve the trough cash flow, if you like, at this high growth level?

Eeva Sipila

Well, I think there are certainly things that we can and need to improve the -- we would obviously hope for a bit more normal supply chain situation in the world. But we'll -- it is what it is, and we have to then act against it. You're absolutely right in saying that we have been working already since the COVID-related lockdowns and challenges on a more regionalized view. And I think you've seen a few investment announcements in the past months also underlining that story.

It does as said, structural things do take some time. And I think it's also where you're balancing act are in a situation where our customers are running sort of almost flat out. And their primary concern and only concern is really on availability that we -- that there is nothing that would sort of stop their production, and they are ready to invest in that.

We need to be ready to invest in that to support that. And we all know how sort of a missing spare part can then create havoc if it releases stops circuit from operating. So this is, in a way, the balance. And if it was easy, we probably wouldn't be discussing it a sort of fully aware of the challenge. But as I said, we're -- we think we have good sort of reason to it.

We think we have the actions in place, but it's absolutely sort of needs to be a focus, especially considering the volatility in the world around us.

Pekka Vauramo

Then there is a slight impact of Russia here as well. First of all, the deliveries that we are still capable to deliver to non-sanctioned customers in Russia and nonrestricted products. Those deliveries have been delayed. And therefore, we are carrying material in the inventory for those ones until we are able to deliver. And then secondly, we do not -- we have not seen these bigger packages where we get good advance payments and advanced payments in these bigger packages that sort of -- it's longer money than what we get in those bigger packages than in smaller orders where we as well do have advanced payments.

But typically, the cycles are shorter in these smaller orders, and that has, to some extent, exhausted the cash flow as well.

Klas Bergelind

That makes sense. My second one is on the operational gearing in minerals, I mean aggregate. How should we think about the margin here into the fourth quarter? Typically, minerals move up and aggregates down a bit on seasonality, and you would likely have higher equipment sales into the fourth quarter, particularly in minerals, which could weigh on the mix? If there's anything out of backlog or looking at price cost that would prevent you for not having at least the same margin here as in the third quarter?

Pekka Vauramo

Yes. Well, mix is always that can, on a quarterly basis fluctuate to some extent. So that might cause cost numbers to go, I would say, either way at this moment when we look at the year-end. But I mean, in the aggregate side, we are delivering our backlog. For sure, there is still plenty of orders that we are delivering in there.

Maybe the services side could be somewhat thinner considering that in the Northern Hemisphere where we're heading towards winter and the quarries are maybe not operating quite as they used to operate or as they do operate during the summer months. So maybe some minor in that part. I do not sort of see this kind of seasonal pattern too much in the minerals side happening. What about you, Eeva, can you?

Eeva Sipila

Yes, maybe kind of went through the backlog just recently. So I think mix-wise, we're more equipment driven in Q4 as we now sort of see it. So that will have a bit of an impact, but nothing else really to add, Pekka, to that.

Klas Bergelind

One very quick final one on the strong service growth, 20% in minerals, and it looks to be flattish in aggregates. But I guess that reflects demand seasonality. But was there a big price component quarter-on-quarter, Pekka, that help the growth here in minerals? Or is this an underlying improvement on the aftermarket?

Pekka Vauramo

There is both, there is both. Pricing, yes, we have been active in that area, but there is true physical volume growth as well. Now probably for the first time, we see the physical growth still in the second quarter, it was mainly the inflationary and pricing that provided the growth, but now there's also physical growth.

Operator

The next question comes from Andreas Koski from BNP Paribas.

Andreas Koski

It's Andreas Koski from BNP Paribas Exane. So I have three questions and I can take them one-by-one. And I would like to start with the outlook on the aggregates market. So you lowered your near-term outlook for the aggregate market despite Q3 developed better than you expected. Does that mean that you did see a sharp drop at the end of the quarter?

Or why did you lower your outlook for the aggregates market?

Pekka Vauramo

Well, two reasons in that one, one is that we are heading seasonally low season in aggregates in the Northern Hemisphere. So that is a fact that we won't be able to escape. And then secondly, of course, the European news are not really encouraging at this moment, even though we don't feel it. We didn't experience any sharp drop at the end of the quarter or anything like that. But we are just cautious and aware of that things may start to happen and then become visible during the quarter.

Andreas Koski

That's clear. And then I know large orders can be lumpy. What were the in Q3? And how did that compare to, say, the last three- or five-year historical average, where we're at an extremely low level in this quarter in terms of large orders?

Pekka Vauramo

Yes, don't necessarily have sort of a five-year background on this one. But the large orders truly are lumpy and forecasting them time-wise is almost impossible task, so to say. We do have large orders in our pipeline. We will see them coming through in future. We didn't book any in this quarter.

And this, I would say, is something that we -- in fact, we like the big orders, nothing wrong with them.

But then when we look at the orders that we booked in the third quarter, we are very comfortable with a big number of smaller orders, less risky from many perspectives as the smaller orders tend to be. So maybe it's untypical that we didn't book any of the major ones considering that cycle has been relatively strong, but that's how it goes, and that's what happens.

Andreas Koski

Good. And then lastly, on your margins. So you were close to your margin target for the group in this quarter. And it's great to see that the margins continue to improve. But you are still close to 400 basis points below your margin target for the Minerals segment.

I guess the gap will be closed through aftermarket growth, improve scalability and maybe also higher sales volumes overall. But could you please help us understand how this gap will be closed and when we should expect the Minerals segment to reach its margin target?

Pekka Vauramo

Yes. I think we opened this a little bit in the Capital Markets Day. We will have continued focus on the aftermarket. Secondly, the growth, both organic and inorganic growth. But both growths will be -- efforts will be intensified in the areas that will support strengthening of our aftermarket side of the business.

Then the fact is that we really haven't seen any normality for the past two years in our business, going through the COVIDs and now the war in Russia and related issues, supply chain issues that we had and inflation and those things.

And many of these have affected mostly our Minerals segment. So we need to see some more stable environment in order to reach out to those, that sort of numbers. But we are on our journey. We don't give up with those ones now with healthy development in all the businesses that we have within mineral service, good growth, strong margin, consumables now back in a strong margin area where they should be and the potential to grow the equipment business and focus on right things in the equipment side. That will be our path to continued improvement in this area.

Andreas Koski

And the time frame for when we should expect you to reach?

Pekka Vauramo

Yes. We know our actions, but we don't know when the normality will return into this business, but, yes.

Operator

The next question comes from Max Yates from Morgan Stanley.

Max Yates

Just my first question was coming back to the services business. Obviously, we've seen for all sort of mining equipment companies, some pretty sort of unusually strong growth rates. So I just really wanted to understand how much of your service business today would you say is more sort of discretionary work. So things like equipment upgrades, debottlenecking and maybe the part of services that will be a bit more cyclical if we start to see sort of mining companies become a bit more cautious. So if you could just give us how that split looks between kind of the truly recurring part and then maybe the bit -- that's a bit more discretionary?

Pekka Vauramo

Yes. Okay. The recurring part, I would say, is our -- mostly our consumables business or our life cycle business. And that altogether, if we take the contractual businesses, both from services and consumables side, I think they are close to €1 billion already. So that is -- that is what I would call is as long as customers are operating and contracts stay in place that revenue will be there.

Then the remaining, I wouldn't call it discretionary either because there are always spare parts and spare parts, especially the breakdown spare parts, which customers will have to buy if and when the equipment breaks or parts do wear out, that's several hundred million altogether in our equipment altogether.

And then we have a few hundred million of modifications upgrade sort of engineered to order, type of things that are typically the modifications on upgrades where customers may have an option to do it either now or later. And that is the part that we will see then moving up and down more than the others.

Max Yates

Okay. And just a follow-up question around your energy costs. I mean, we've seen some companies sort of struggling this quarter with higher energy costs. It obviously doesn't look like it's had an effect in your numbers. So I just wanted to understand, when it comes to energy costs, is this sort of partially linked to you buying contracts forward?

So maybe we haven't sort of internalized the spike that we've seen in energy prices, particularly in Europe? Or is this just you have -- you've been able to compensate with price or you've produced more outside of Europe? Just a little bit of kind of color around what you're seeing on energy and whether your numbers do reflect kind of the latest spike that we've seen in Europe?

Eeva Sipila

Yes, Max, I think this is really related to our footprint that we have a footprint where we have a very small footprint in Europe. And hence, we are clearly less affected than some others, where we have -- I mean, we've obviously seen, I'm sure, a similar sort of tremendous increases in percentages on price.

But then if we think that sort of year-to-date energy and gas bill is around €30 million for -- at Metso Outotec then even with a sort of high percentage increase in Europe. It doesn't really massively move the needle. And then again, we are sort of side of our consumables business, very little energy -- small energy consumers.

Max Yates

Okay. And just a final one. I mean maybe Pekka, if you could give us a little bit of color around kind of how -- what your expectations are for the gold market? I think kind of everyone is sort of fairly comfortable with the drivers of copper and the demand needs there because of a lot of the energy transition. But how are you thinking about the outlook for the gold market in the next couple of years?

And what is it specifically that should keep sort of driving gold CapEx higher on a sort of two- to three-year view?

Pekka Vauramo

Obviously, if times get more uncertain, that normally is a positive for gold. So should that happen in sort of more global scale, then of course, the outlook for gold should be quite good and prosperous. But I think this uncertainty would still have to be probably on a higher level than where we currently see that one in order to see gold really starting to drive the business. At this moment, it's still copper and it's the battery metals that are driving the business right now, plus then naturally the iron ore in the pelletizing and more in the sort of a -- more in the metallurgical side of the iron ore business in the steel industry.

Operator

The next question comes from Panu Laitinmäki from Danske Bank.

Panu Laitinmaki

I have two questions. Firstly, on the consumables business, just to clarify, did you say that it's now back to normal profitability, as you earlier commented that it was like several percentage points below the normal profitability?

And then the second question is on EBIT -- adjusted EBITA for the other and head office functions, there was quite a bit of increase in Q3. Can you kind of -- can you give a guidance what to expect on that line going forward? And what happened in Q3?

Pekka Vauramo

Yes. Consumables, yes, it's a correct understanding. We are back in normal profitability where we expect consumables business to be and that is every month during the third quarter was like that, and that's a very good development. And Eeva, can you take the...

Eeva Sipila

Yes. On the group cost, it's combination of very many things. Obviously, we have quite a bit of currency related issues there right now. We have some Russia wind down related issues there that were causing the cost that -- and I would expect in a way that we will be on a higher level also in the fourth quarter then again, obviously, the FX side is super difficult to estimate on. But those are the type of items that really then come through there.

Clearly, sort of Q3 was on the high side in our view as well.

Panu Laitinmaki

But can you give a number, what would be like the normal run rate if you don't have any on exceptional sort of things?

Eeva Sipila

Well, I guess it comes back to you tell me when we get back to normal. So haven't exactly seen that. But I would say that certainly sort of half of the Q3 was -- were items that were sort of I guess, in some words sort of not part of normal operations. So we've usually been in the sort of €5-or-so million range.

Operator

The next question comes from Antti Kansanen from SEB.

Antti Kansanen

It's Antti from SEB. A couple of questions regarding minerals growth going into '23. Could you comment a little bit about the phasing of your backlog in minerals, how much do you expect to deliver in '23? And then secondly, on the services demand growth. If you kind of look at the more cyclical portion of it, which is not driven by kind of production volumes, the more indications and such what's the starting point right now?

I mean have we seen a very strong recovery after COVID? Or are we kind of running still below normal demand?

Pekka Vauramo

Yes. Eeva, do you have anything on the backlog?

Eeva Sipila

Yes. Yes, I don't have any exact numbers on the top of my head. I would say it's fairly sort of a fairly normal sense since it is more sort of broadly based and smaller business driven. So I think the sort of majority of the backlog is, hence, for next year, but then the challenges on the supply side obviously mean that what we're selling now is really for 2024. So a bigger part of in '23, but there is a sizable chunk for '24 due to the supply chain limitations.

Pekka Vauramo

Yes. The second part of the question was about services, the more sort of a cyclic parts of the services business. There's, in fact, two parts. One is these modifications upgrades that we call engine-to-order or manufacture-to-order type of orders. And then the second part is really professional services, which is our sort of labor component in that one.

And we started to see the modifications and upgrades really to -- order intake has grown already several quarters. But since there is a lead time with today's supply chain on these ones, we started to see the growth only in the second quarter of this year in these businesses. So we can still expect to be on a high level despite of what happens in a sort of bigger picture in the economy for a couple of quarters at least and then it starts to depend on new order bookings after that one. Professional services, the utilization rates have been strong for several quarters already. We don't see any sort of change in that picture yet at this moment, and we'll expect that one to continue to run at high utilization rate.

Antti Kansanen

Yes. Maybe a follow-up then on the consumables, which you already mentioned. I guess the impact has been some tens of millions annually regarding the cost headwinds and -- did I understand correctly that all of the part of the work is now done, and we should expect this kind of a reversal on your EBIT for the next three quarters as well as it started on Q3, so kind of a mid-high single-digit per quarter?

Pekka Vauramo

Yes. We are back in the normal levels that we expect from the consumables. And currently, we don't see similar pressures right now there. But you never know in this volatile world, what happened. And it's not a guarantee of, but we're on top of the issues -- of those previous issues for sure.

Antti Kansanen

And just a final check on the consumables regarding the Czech Foundry. What's kind of the latest on that one? Is it kind of profitable to operate it? And what's your views on that?

Pekka Vauramo

Yes. We have scaled down the production there. We do have some special items that we continue to produce there, there the recent news are that, in fact, the natural gas prices started to go down. This is very recent development. And of course, we at one point, we really need to look at critically how long we can run in that sort of operation, considering how volatile the natural gas has been there.

But so far, we continue.

Operator

[Operator Instructions]

Vladimir Sergievskii

Vlad from Bank of America. I'll start with an outlook one. So what are you hearing from your key mining customers with regards to the next year budgets, are they -- and they are planning to spend? Are they flat? Are they up?

Are they down? And also related to that, are you seeing any signs of, call it, hesitation and sanctioning new projects or the pipeline you have still converting into orders with the same speed as before?

Pekka Vauramo

Still very little about the next year budgeting that we hear from customers. And normally, we don't really get very direct feedback on that one. We do get feedback on our proposals, which obviously is reflecting the sort of abilities to proceed with the investments or other types of activities. We do hear that customers are concerned about inflation. So there are some customers, some projects where they have -- where they are reconsidering doing their budgets.

Again, the project budgets, again, and making sure that the numbers stay together, but this is not a sort of huge phenomenon at this moment. And I didn't get quite the second part of the question. Did you, Eeva, get that one?

Eeva Sipila

Yes. I think, yes, it was around -- similarly, I think you were on the same line in a way that is there any change in the speed of orders converting what we see in the pipeline and know that, hence, our sort of outlook being exactly the same as it was three months back. So we're still seeing for the next six months, certainly a strong market to continue.

Vladimir Sergievskii

That's great. And if I can dig into inventories a little bit, right? Obviously, the increase in Q3, you explained that. I'm thinking more, is this increase driven by you basically deliberately deciding to carry safety stocks of components, which then you unwind while supply chains get more reliable? Or they are driven by like higher work in progress, higher completed equipment, which you are still yet to deal with the customers, if you can provide some of those details, please?

Eeva Sipila

Sure. So yes, I would say the bigger element is the higher work in progress like you referred really what I said about the sort of us having the strong backlog and a very strong growth in the sales in the quarter and something, of course, we expect to see to continue based on the backlog. But then additionally, the challenge really has been to have the safety stock, stay safety buffers in a way to be mindful of the fact that we don't get deliveries necessarily in the time we expect or -- and it may -- as a whole host of issues that are there the total challenge that you just can't run the operation with as tight just in time philosophy as you could some years back, unfortunately. And I think that will take some time really for the supply chain to a globally balance.

Vladimir Sergievskii

This is super clear. Last one from me. Any update on the Saudi project and when this one could be handed over to your clients?

Pekka Vauramo

Nothing really new to report on that one. We are -- we continue the ramp up there. We are, of course, in discussions with customers on sort of a future and ending that one, but we don't have any news on that one at this moment. We will be the first ones to tell about them when we're ready.

Operator

The next question comes from William Mackie from Kepler Cheuvreux.

William Mackie

Yes. It's Kepler Cheuvreux. My first question would relate to aggregates. I mean, can you give us a sense of where you think your distributors are with their backlogs of inventory, so in North America and Europe? Do you think that they're running positions which need to be replenished that they're happy replenishing?

Or do you think there's -- if you sound out the distributors, are there any early signs that they're thinking of changing their stock levels for aggregates going into the year ahead?

Pekka Vauramo

Yes. Yes, they are adjusting their stock levels, but that's because of season, mostly because of the seasonality of the Aggregates business as such. And this is happening every year this time of the year. But -- and European distributors, yes, they are ordering less than what they did a year ago, clearly less. But the activity, on the other hand, in North America has been surprisingly strong.

William Mackie

What were the sort of -- what is your thinking behind why you've changed the view on the European aggregates outlook? What were the sort of inputs that led you to provide that new guidance or commentary?

Pekka Vauramo

Yes. Seasonality number one, is one reason. And then secondly, is really the European macro, which is clearly worse than what it was some time ago.

William Mackie

Okay. And then maybe following up from Vlad's question around mining. Could you perhaps maybe throw a bit more light on the scale of the tender pipeline? There was one or two questions about potential large orders, but at least how would you characterize the tender pipeline for small, medium or large-sized orders within minerals going into Q4 and into next year?

Pekka Vauramo

Yes. At this moment, the small and medium size are as strong as they've ever been. The bigger ones, maybe not quite as many what we had, say, two years ago or when the sort of things started to clear after the pandemic, say 1.5 years ago or so, but there's -- and that's mostly because of lack of any potential in Russian market, which we have closed for new orders already earlier in this year. But we do have nice projects, they're cooking up and warming up ready for decision. But like I said, difficult to forecast when they come through.

William Mackie

Within minerals, have you seen any efforts by the customer base to, if you like, offset the loss of supply from Russia by accelerating or proposing the acceleration of green or brownfield sites, which would benefit maybe in 18 or 24 months' time within North America, South America?

Pekka Vauramo

Difficult to say if they are just because of Russia, but the -- if we just look at our numbers and order intake outside Russia now in this year and particularly in the second and third quarter, so the compensation effect has been really tremendous there. We've grown the business outside of Russia, 27%, adjusting, of course, for that one big order in Indonesia with that one. So some compensation must have taken place, but nobody really talks about that they are investing this one because Russia cannot supply. No, we don't hear that as a justification for an investment.

William Mackie

Understood. Maybe for Eeva, coming back to the discussion around net working capital, I can hear you hope that the teams can release some of the inventories. You called out aggregates. And you sort of indicated there was a potential to release some cash in Q4 from working capital and inventory. I mean can you scale that?

Do you have some sense of what you would hope to achieve as you move towards close at the end of Q4?

Eeva Sipila

Well, I wouldn't be sort of super optimistic so that we have two months to go. And December is always a tricky month when everybody in the supply chain, including our customers is trying to optimize their balance sheet figures. So even if they're paying well now, they usually stop well ahead of Christmas type of thing, so that always makes sort of estimating what happens in December, difficult. I think we're on the right trend.

It's more the sort of impact than for next year. But as I said, it's more that we're sort of on top of it, managing the actions and making them deliberate decisions in one or the other way around the buffers. And of course, much is dependent also on that if we're able to have such a sort of stellar delivery performance like we had now in Q3, then obviously, we really get deliveries out of the inventory. And that's, of course, the -- that's where it all starts from in a way that to have flawless execution.

William Mackie

And the final question for me would relate to service, net pricing versus cost. In the first half of the year, your margins were affected by particularly across your foundries and consumables business, the high energy and material cost and the delay between price changes and input cost adjustments. When we think about 2023, I mean, are you now fully offset? Or is there a more positive carryover to come through into Q4 and next year with regard to the price/cost mix in service consumables?

Pekka Vauramo

Yes. Most of that work has been done already, so we cannot really expect too much out of that one. But we are introducing new concepts, new products, the recycling of consumables and things like that, which we feel is a great addition to our offering. And those are the areas that will sort of carry our consumables business forward.

Operator

The next question comes from Sindre Sørbye from Arctic Asset Management.

Sindre Sørbye

There are actually two. First, I think in your second quarter report, you mentioned that your EBITA was negatively affected by €34 million due to what you described as FX volatility? And then you actually, on your call described it as kind of two separate, but still related items. My question is more -- are there any kind of reversals from -- or part of that effect from the second quarter and generally the FX impact on the operating profit in this quarter?

Eeva Sipila

Sure. So as you well know, U.S. dollar obviously continued throughout the third quarter to appreciate. And this means that we've certainly from -- again, from a mark-to-market point of view had negative impact from -- in an accounting sense from that appreciation. Then again, as we described in Q2.

So the point of hedging is obviously -- it is largely a timing issue. So we did deliver on businesses that were still -- that we were hedging in Q2 and then hence, saw a positive impact in the sales margin from those deliveries.

So whereas in Q2, we kind of only had one side of the coin when -- after a period of stability, we had sort of a tremendous jumps in the FX market. This Q3 has more been a continuation of those trends. And then obviously, you start to see the pluses and minuses. And hence, our comment in the report that's still the sort of net impact is negative, but not in the magnitude that as it was in Q2. And hence, we didn't sort of specific -- raise it more than that.

But everything, obviously, is dependent on that volatility creates sort of by definition, then some accounting implications from hedging.

Sindre Sørbye

Okay. So my interpretation is that assuming stable FX rates, you will get a slight tailwind from here and onwards. My second question is related to the level of OpEx. I mean if you look at your quite impressive margin improvement at least compared to a year ago. It appears that it all stems from the gross margin.

And is it so that -- I mean I appreciate that it's more travel and if the service share increases your expenses, sales expenses might increase more than sales, but the service share is quite similar. So from here onwards, should we expect some operational leverage on the OpEx lines? Or would it be a fair assumption that the OpEx increase in line with sales?

Eeva Sipila

Yes, that's not an easy question. I think what we are seeing is certainly inflation in some of the spending uncertainty, I think part of the labor inflation is yet to come visible at a third party or our own. But the bulk of our efforts has really been around to improve gross margin and really to sort of ensure that we have the right actions in place and what comes to pricing, what comes to really fighting against the higher input costs and has been mentioned during this call already.

So good work done in that in many areas, helping and then that -- in that sense, the sort of helps, of course, the leverage. But let's say, yes, as I said, I think some -- this inflation is a bit new at these high levels, and I think we're yet to see sort of the full impact of that. But obviously, sort of the fighting for to continue to improve the leverage in line with our -- reaching our financial targets.

Sindre Sørbye

Okay. So there is no, let's say, at least no significant, let's say, further synergies or positive impacts related to the merger yet to come on the administrative expenses and sales expenses? And also, by the way, it seems like other operating income and expenses are actually increasing from 11% last year up to 31% this year. So that might be a kind of a one-off.

Eeva Sipila

Yes, the other income row is partly impacted by the hedging mark-to-market. So the volatility is really a result of that. And then as I said, the other slide is in gross margin. So that may be sort of not so rewarding to look at that line alone. But no, I think you're right that we sort of closed the synergy actions at the end of 2021.

And obviously, the sort of they run through then the final ones towards the end of this year, and we're pretty much there. So now it's really focusing on the topics that we discussed in our Capital Markets Day really around the business improvements as we go forward from here.

Operator

The next question comes from ErkkiVesola from Inderes.

Erkki Vesola

Erkki Vesola from Inderes. Still regarding the SG&A and especially, I would like to hear what's the outlook in admin and also R&D expenses going forward? Any absolute terms or share of sales, you, Eeva, talked about inflation. But do you see the current or year-to-date numbers are sustainable in admin and R&D?

Pekka Vauramo

I think let's -- I want to just remind whatever Eeva mentioned already earlier on that we do have significant U.S. dollar strengthening impact in our SG&A. Our organization is heavily in sort of countries where the currencies are either in U.S. or backed with the U.S., and that is clearly visible in our sort of SG&A side in this year. We also booked things like agent commissions on this line, and that is somewhat sporadic number.

And with the activity level as we see right now, that particular item is inflated on the SG&A. And Eeva, other comments from your side on that one?

Eeva Sipila

No. I think it's a net. I mean, obviously, sort of a big -- there was a significant element of synergies, which kind of was meant to reduce the SG&A number then as sales growth comes through, then we start to see positives in a way these commissions sales-related activities, even trade fares are back let alone travel. So that kind of a normal part. R&D costs this year are a bit on the low side.

People have been very, very busy with the customer delivery.

So I would -- to your question, there, I would certainly sort of expect that we're pushing them back higher up as we go into next year. But otherwise, it's really around the sort of inflationary dilemma on how to best predict and sort of you have good guesses on your side, and we try to make good sort of assumptions on our side, but none of us knew then, of course, what exactly will happen. So it's really reacting then on the -- on that is kind of the overall agility just remains essential.

Operator

The next question comes from Joel Spungin from Berenberg.

Juha Rouhiainen

All right. It seems we don't have any more questions at this point in time. Thanks for participating in this conference call, where we discuss our third quarter results, and we'll be back with fourth quarter, and that will be early next year 2023. So in the meantime, enjoy the rest of the year and see you soon, bye-bye.

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Metso Outotec Oyj (OUKPF) Q3 2022 Earnings Call Transcript