VWSYF - Vestas Wind Systems A/S (VWDRY) Q1 2023 Earnings Call Transcript

2023-05-10 14:15:25 ET

Vestas Wind Systems (VWDRY)

Q1 2023 Earnings Conference Call

May 10, 2023 4:00 AM ET

Company Participants

Henrik Andersen - Group President and Chief Executive Officer

Hans Martin Smith - EVP and Chief Financial Officer

Conference Call Participants

Kristian Tornøe - SEB

Akash Gupta - J.P. Morgan

Benjamin Heelan - Bank of America

Supriya Subramanian - UBS

Claus Almer - Nordea

Henry Tarr - Berenberg

Martin Wilkie - Citi

Dan Togo Jensen - Carnegie Investment Bank

William Mackey - Kepler Cheuvreux

Sean McLoughlin - HSBC

Casper Blom - Danske Bank

Presentation

Henrik Andersen

Good morning, and welcome to Vestas' Presentation of first quarter of 2023. I just want to start with thanking, first of all, our customers, partners, suppliers and also our 28,500 colleagues around the world for working tirelessly throughout this Q1, of course, a good start of '23, which we will talk more about.

So let's therefore go into the highlights and the details of our Q1 and we had a revenue of €2.8 billion and that is a growth of 14% year-on-year, driven by higher average pricing on deliveries, higher volume, and also a 29% growth in the Service business.

Our EBIT margin ended positively at 1%, profitability improvement driven by the sale of the converter business, lower warranty provisions but also the very strong Service business performance in Q1. The order intake of 3.3 gigawatt come from wind turbines orders and that's up 12% year-on-year with an ASP of €0.89 impacted by mix which we will take you through in one of the coming slides.

A solid capital structure, now with more than €1 billion of new financing in Q1, testament to the strong credit both recognition of Vestas but also in the market there was a €500 million sustainability-linked bond issue, plus a €750 million RCF that was signed with a strong group of banks. Vestas, we're leading the industry forward with discipline. So despite driving the industry maturity, Vestas maintains a leading position in the global market. And we will give you a breakdown of that in one of the later slides.

So with that, let's go to the business environment. This slide is well known to you. On the left side, this is the one we have been working through over the last three years and we still keep repeating that. Top priority is to keep the health and safety of our colleagues around the world, but also maintaining the business continuity of all our operations. This is still our operating priorities also in the year of 2023, where we expect to still have and rather remain sort of a challenging environment throughout 2023.

We have seen the Russian exit of Vestas in Q1. And we’ve also seen that are still being combined with certain geopolitical uncertainties around the world but we're working through it. The inflation is definitely becoming more pervasive. So if we look at it, it's impacting our production, it's impacting some of our execution costs, and it’s also impacting some of our activities in the discussion with unions across some of our European markets.

When we look at the market design, and also the permitting is still a barrier to new installations. That is to us surprisingly, giving the strong need for more energy solutions, especially in Europe. But we will talk more to it but this is probably one of the disappointing factors that still remains.

If we see then also that we still have some difficult conditions for completing projects. We are doing that across all continents but we also see that there are still shortages of certain components. And we also see that still brings some stop and go on some of our factories as well.

Rest assured that we will spend this year in having our full focus on getting back in black and therefore having Vestas in profitability by the end of the year, which is still a key focus for all of our colleagues around the world.

Let me then just give you a short snapshot of the market share of 2022. It goes without saying that we appreciate we are on top of that when we look at the onshore, offshore installation excluding China. I think the other takeaway here is that we in a year from 2022 see that the global installation actually dropped from 47 gigawatt to 41 gigawatt, which for us is disappointing, in a year where probably the world needed more energy than ever.

So I think here this is what we will be working with, but also rest assured, we will drive both Vestas and also lead with the example to the industry of having that strong discipline commercially. So we will not compromise the commercial discipline in terms of, for volume, that's for sure. When we then look at the Power Solution in Q1, the commercial discipline intact, this is a necessity for, first of all, the industry wide profitability and improvement, but it also is the foundation for getting Vestas firmly back in profitable territory.

We had a strong order intake, it's up 12% year-on-year driven predominantly from Americas and South Africa. We saw in the quarter a 1.3 gigawatt Casa dos Ventos orders in Brazil, it’s the largest onshore order ever for investors. And I will also say it's a recognition of the customer, the partnership and also the personal relationship to the customers in Brazil.

We've also seen that there is a slow permitting process and also regulatory uncertainty that remains a challenge in both the onshore and offshore. In offshore now, probably more related to the PPA offtake levels that still form a challenge for the players, developers OEMs and governments have to start moving.

When we look at our ASP, it declined from €1.15 million per megawatt hour in Q4 to €0.89 million per megawatt hour megawatts in Q1 2023. That is impacted solely by mix effects from scope, country and FX. So the underlying ASP and profitability is absolutely not diluted.

This relates to that we in Q4, last year, we had EPC. We have hardly no EPC in this quarter and you will also see that you've seen the first repowering coming through in the US where there are actually no towers included, which of course are some of the main explanations in exactly that scope, country mix. We will talk more about it I'm sure in the Q&A.

When we look at the strong momentum we are having in offshore, we have now passed 10 gigawatt of total preferred supplier agreements. And we are very pleased to see that coming across also in a couple of regions and we are looking forward to that but it also forms basis of firm discussions with governments and customers in those markets. You will see the normal charts on the right where you can follow the development. And then as I said, respect the trend of where we will go also with ASP.

Then to the Service business, stellar quarter in Q1, strong start of the year. We of course appreciate all our colleagues, the continued high activity with customers forming basis on top of the normal platform and the normal portfolio of Service business, but there is higher transaction and one-off also in Q1. The Service order backlog increased to €31 billion in the quarter. Inflation indexation continues to protect the profitability of the backlog. And of course also very importantly to keep in the higher inflated environment we have in all our markets.

We also saw Convento, it’s the Vestas digital platform for aftermarket parts and services, building momentum. They are opening more markets and they're getting more of our -- both our customers but also global suppliers on that platform and we welcome more of that.

When we look to the right, we can see the service order backlog has set €31 billion. We have 147 gigawatt on the service and we have an average year's contract duration in excess of 11 years. Below you will see the breakdown per the regions. And again here really appreciate the strong development across all regions in growth.

When we then look at the Vestas Development for Q1, it's a high activity level in many of our major energy markets. But it's also a quarter where we are putting a lot of effort into, is still working with the quality of the total project pipeline we have. So in Q1 2023, Vestas pipeline of development projects amounted to 32 gigawatt which Australia, US, and Brazil being the countries with the largest project pipeline, we have.

During the quarter Vestas secured 1.1 gigawatts of new pipeline projects. Net-net, that's no change actually to the end of last year in Q4, which also is a reflection of that when we look at development, we're very disciplined and also if there are projects that doesn't make sense, then they also will drop out. So we have the two large numbers here, new secured pipeline and the overall net project pipeline, you can do your own gross and net within there. And that said, just a natural reflection of still remaining very disciplined around this business.

Finland generated 50 megawatts of order intake in the quarter, appreciate that. And that’s of course start of the year, so more to come. We look forward to share that in the coming quarters with you.

When we then look at the sustainability in Q1 2023, another quarter where we just move and work diligently forward. We are still the most sustainable energy company in the world and we are number two sustainable company in the world. And we will keep working with that and we will keep bringing initiatives from our operations. The lifetime CO2 avoided by produced and shipped capacity decreased by 21% from Q1 ’22. That's due to the lower produced and shipped turbines, natural reflection of what you can see in the chart and the full methods from us.

When you look at the carbon emission from our own operations, they decreased by 4%, due to low activity but also in the -- against that, of course, we have had a much higher activity in the Service business, so there are some underlying movements in that number. When we then look at the safety, we are now introducing a new methodology of talking about total recordable injuries.

We feel it's very, very important when we talk about total recordable injuries, that we also include anyone that is on our sites, and therefore in and under our leadership, going forward. So we now here release 2.1, which includes now contractors onsite and we will under coming quarters, follow that development, with also a little bit of how do we build that statistics, we will come back, but you will be able to follow that over the coming quarters as we go. This is also why there is sort of a little bit of a broken line between Q1 ’22 and Q1 ’23. They are not comparable in that sense. Very pleased but we still have more than 40 injuries in Q1, and that's 40, too many, so of course we will keep working hard on that discipline.

With that, I would like to pass over to Hans for the financials.

Hans Martin Smith

Thank you, Henrik. As we usually do, we start with the income statement, where we can clearly see that the profitability is improving from the low levels we had in Q1 2022. Revenue increased by 14% year-on-year, driven by higher average pricing on the deliveries by higher volumes and by increasing Service activities.

Gross margin increased by 5.7 percentage points year-on-year to 6.6% driven by the higher revenues in both segments and also the improved margins that we saw in the Power Solution segment. I'd like you to remind yourself the KK transaction, which impacts the quarter with sale of technology to the tune of roughly €150 million. This is the line you can see here to the right, that sits somewhere above the EBIT line.

And all-in-all that takes us in to an EBIT margin before special items that increased by 15 percentage points year-on-year, €40 million, 1.4%, driven by all the aforementioned reasons of gross margin, better fixed cost absorption in the quarter, but also the fact that we do not have the same types of offshore adjustments as we had in the first quarter of 2022.

Turning then to the segment overviews, we start out with the Power Solution segment where, as I said before, we can see that the profitability is improving. Revenue increased by 9% year-on-year to just over €2 billion, driven by high activities in the EMEA region and in the Americas. The EBIT margin before special items stood at negative 2.7%. But this is actually an increase 18 percentage points year-on-year driven, as I mentioned before, by the sale of the converter business, by the lack of offshore adjustments in this quarter that we had last year, and not least the activity levels that we also saw.

All-in-all, I'd say that the underlying profitability is improving. But I would also like to say that we are still also seeing profitability hampered by the execution of the low margin projects that we have in the backlog, so still some work to do there, for sure.

In the Service segment, we see strong growth and a stable EBIT margin. Revenue increased 29% year-on-year from €623 million to €806 million driven by higher activity levels overall, inflation indexation in the contracts, and also by higher transactional sales. This is then offset a bit by negative currency effects. The Service business generated €183 million of EBIT, which corresponds to a margin of 22.7%. So also there we see an improvement compared to last year.

Turning to the SG&A, I think it's fair to say that we see a level that is quite similar to what we had last year. SG&A relative to revenue stood at 8.2% on a trailing 12 month basis, which I said is pretty much the same. So I don't necessarily want to spend too much time on this page.

Net working capital increased in the quarter. However, this does reflect the normal seasonality we would be seeing. And this is driven by an increase in the level of inventory, also by higher levels of supplier payments in the quarter, which are then only partly offset by the down and milestone payments that has come in.

As mentioned, I would say that the networking capital development reflects the seasonality we see in our business where we build inventory in the first half, in preparation for a, say, a busier second half of the year. This is what we have seen for many years and this is certainly also what we're expecting to see in 2023.

That then leads to the cash flow, where the operating cash flow before changes to working capital actually increased by €560 million driven by a higher profitability in the quarter. It actually takes us to €248 million of positive cash flow. So of course, that is something positive to see.

Working capital changes then take us down to the levels you can see here to the right. And furthermore, adding also the CapEx we're seeing, we get to levels of roughly €1.1 billion. And all-in-all, that is in some ways also a reflection of the seasonality we see in the business and as mentioned, also on par with what we had last year.

Investments came in at €107 million. I would like to highlight here that the sale of the converters & controls business has had an impact by roughly €60 million. Additionally, we did see also lower investments, or investments in transportation equipment, and transportation tools. And all in all, I would say that the number you have here, you can't multiply that by four and then get to an estimate for the full year. It is artificially low and as such, you're not seeing changes either for the same reason to what we expect for the full year on this metric.

Warranty provisions remain at elevated levels, but we certainly work very hard on this and we are doing our best to make sure that we, let us say, diligently do what we can to see improvement in this area. Specifically for the LPF, it continues to sit at high levels. This is a consequence of the continued extraordinary repair and upgrades levels that we're seeing in the business.

Warranty provisions, as mentioned earlier, is something we're working very much to spring into better shape. We're seeing for Q1 a level of 4% of revenue, which is actually an improvement compared to last year where we came from 7.8%. So almost half of what we had last year. So as mentioned quite an improvement on that metric.

That then takes us to the capital structure overview where we say have a net debt to EBITDA level of 5.8. It is mainly affected by the low EBITDA levels we're seeing on a trailing 12 month basis, as we've been discussing before. The profitability that we are seeing it clearly has an impact on this metric as there's a nominator and a denominator. And when the numbers are very, very low, of course, you can see quite some swings in this.

I think important to say is that in March, we issued a €500 million sustainability-linked bond, which matures in 2026. And furthermore, we also signed a €750 million revolving credit facility which matures in 2024. Finally then, we had Moody's give us a rating of Baa2 with a stable outlook.

And speaking of outlook, I'd like to hand it back to you Henrik to talk a bit about the outlook.

Henrik Andersen

Thank you so much Hans for the walkthrough there and now to our unchanged outlook for the full year 2023. So revenue sits between €14 billion and €15.5 billion. Service is expected to grow minimum 5% of that. When we look at the EBIT margin before special items, sits between minus 2% to 3%. And of course, also, you now see the full effect of the divestment to KK, which we also said in February.

Service margin is expected to be approximately 22%. And then as Hans rightly said, don't do the four quarters because the total investment is expected to be approximately €1 billion and some of those both ramp up in manufacturing and technology, of course will affect this.

As always with this comes, the outlook here is based on the current foreign exchange rate. And it also still comes as mentioned in the operating environment, still in an environment where there are uncertainties, and there are still challenges out there. So there is a higher uncertainty than normal.

So with that, thank you for listening in but also now opening the Q&A to all of you.

Question-and-Answer Session

Operator

Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] And the first question comes from Kristian Tornøe from SEB. Please go ahead.

Kristian Tornøe

Yes, thank you, and good morning. So my first question is about the cost predictability. Sort of reflecting on our discussion last year, I recall a lot of talk about sort of unexpected costs and the challenges from supply chain disruptions. So Henrik, in the beginning, you did talk about sort of continued challenges out there but maybe you can just elaborate a bit on the cost predictability. So how much unexpected costs do you continue to see?

Henrik Andersen

Thanks. Thanks, Kristian. I think here, we can see its easing. So that also means that the mitigations we have to do are becoming less or fewer. So for that matter, I think it's easing. But we are just saying here, we still have components, critical components, that doesn't ease up from just a China reopening in Q4 and then we have a world that just operates normal. That's not the case. And we all along said it probably takes some quarters. And that's why we are here, sort of saying, we are executing on projects that are in the backlog that still will be affected by that. But it should be easing up over the year to hopefully become less and less and no one would be more pleased with that than we if that happens.

Kristian Tornøe

That's quite clear, thank you. Then my second question is on the Service business and the transactional sale. So given the fact that you don't change your guidance on growth for Service, I guess you are not assuming transactional sales to continue at the current level, is that correct?

Henrik Andersen

I think we are super pleased with the performance of the Service business. We also see they operate in an environment right now, where there is a criticality of getting the assets to operate because the energy and electricity output is so valuable. So there is a drive for transactional sales and there's there is a drive for parts and others. But I will also say here, Kristian, you're moving from first half of the year into a second half of the year in ’23, where you're comparable quarters also hits Q3 and Q4 last year, where you had respectively high 30% and into the 40% growth in Q3 and Q4.

So from a math exercise point of view, you are suddenly hitting very difficult quarters to hit with that. So I will -- we will rather say here, let's look at a business that grows more than 30% over 24 months, we are really pleased with it. And therefore we are we are very happy to see the business doing what it does right now. And as transactional sales and of course, their indexation is included in that growth number. But I can also promise you, if we can do more we will do more.

Kristian Tornøe

Understood. Thank you so much.

Operator

And next question comes from Akash Gupta from J.P. Morgan, please go ahead.

Akash Gupta

Yes, hi, good morning, everybody. I have two as well. The first one is on competition and particularly the topic of Asian competitors in the last few quarters. Can you talk about how do you see the landscape today versus let's say 12 months ago? And if there something that needs to be done to address some of the concerns, particularly on the cost side given the cost difference between you and your Asian competitors? And the second one is, I was wondering if you can update with this offshore wind situation? And I think your customers, launch customers in BW has already given final investment decision to the project. And I'm wondering if you can talk about when shall we expect a firm order from EnBW for this 900 megawatts German offshore wind project? Thank you.

Henrik Andersen

Akash, thank you so much, I will address. And I don't think we need to say Asian, we can probably say Chinese competitors in that sense. I think the world develops as the world develops, and we see China in our market. We haven't taken Chinese orders for approximately two years. We delivered quite a lot of it by end of that the last feed-in tariff environment in China, which is also why I'm saying here, there's not in our plans any planning or any expectations, or for that matter, reliance of turnover in China.

I will say, China, different game. We of course work with customers across the world. And there are some of the markets where it seems for us, even though we also have footprint across the world, that some competitors operates at artificial lower cost levels. And we can welcome that because that means that there must be an underlying company investment, or an underlying country investment into taking those infrastructure orders and that we refrain from. We run a company on behalf of the shareholders. So we don't participate in subsidizing a solution build out like that.

On the offshore, yeah, as you're rightly saying, at some point in time, individual customer discussions and PSAs will lead to firm order intake. And that is solely down to the final discussion between us and individual customers. So I will have to ask for your patience to say that we will announce it when it's a firm order and then you will see it in the in the mix of it. But you're right offshore is more transparent, in that sense for all of us.

Akash Gupta

Thank you.

Operator

The next question comes from Ben Heelan from Bank of America. Please go ahead.

Ben Heelan

Yeah, morning. Thank you and I wanted to ask the question on margin. So the performance in Q1 was pretty good. You've talked about costs through the year, and it makes the low end of your margin range look relatively unlikely. Now I just wonder if you could give a bit of an update on where you expect to land.

Henrik Andersen

We expect to land within our guidance. No, I'm saying that, come on, we have had a good start of the year. When we walk through this year, guys, you have to allow us that we are executing on the -- probably the most variated price backlog Vestas has ever had. So we will have a lumpy ride through the years of the four quarters, and we only need two or three of those projects to be from one quarter to another. Then one quarter maybe looks better or one quarter maybe look a little worse.

For us, it's about executing this year, because that means we will have a year away in the backlog where we will still have a red number around the turbine solutions in the year. And that's what we have to turn a corner with within ’23. We are doing that. We think we have had a good start of the year but when I look to Hans that sit next to me here, we are also a bit scarred from what we came out of in ’22. So we execute the year and then we will give you the update when we get to the next quarter. There's no need of changing the guidance at the current point. There are still many variables in the execution of this year.

Ben Heelan

Okay. Okay. And then follow on in terms of pricing. You highlighted the underlying pricing development has been broadly stable. Could you talk a little bit about the discussions that you've been having with customers. Are -- now that costs have largely normalized, on kind of forward look basis, are you seeing pressure from customers around pricing? Or are they -- is there still a recognition that you guys need to make money mediums and how should we think about that?

Henrik Andersen

Let's say like this, I think there is a good sound discussion. I think there are customers that are saying, well, they -- I don't think any customer picks up the phone and say, by the way, we think we will pay a bit more for the solution. So when we do this, it is tense. There are also now projects that are stalled or in discussion because either there is a delay or there is a PPA that doesn't match the project. So I think that's what is being triggered right now. As we all along said, we have had a good quarter, 3.3 gigawatts. Some of those orders have been discussed for much longer than normally, because there has been so many variables in the last four quarters for customers to then get financed and get it done.

I think the positive here balance is that in most of the markets, the energy and the electricity is still at a pricing level where the turbine price is not out of sync with the underlying value of the output. And that's important, because of course, if that was not the case, then we will be in a very different situation. So we've also seen in this quarter, huge changes in financing and the financing market, but we also able here to find with customers the good solution to that. So we’re actually quite pleased with the execution in the quarter and also in the mix of countries and other. So discipline on the commercial, nothing else.

Ben Heelan

Okay. Great, thank you.

Operator

The next question comes from Supriya Subramanian from UBS. Please go ahead.

Supriya Subramanian

Yes, hi, good morning. And thank you for taking my questions. Two questions from my end. So I guess coming back to the permitting issues and of course the environment remain challenging on that end. But do you see any change in attitude? We've seen some countries make some progress there like Germany, and Spain as well. And do you see maybe the recommendations of the EU Net-Zero Industrial Act having any impact on the behavior of the countries? I’ll start with that and then asked my next question later.

Henrik Andersen

I think we have to split a lot in between guidance and recommendation and then actually decided projects and also signed and approved permitted projects. And a couple of the countries you were mentioning, I still think it's embarrassing to see that we have larger part of auction rounds being unsubscribed. And as long as that's the case, Supriya, that then we can probably conclude that then you're not doing your job as a politician right now to make that happen. The truth, the fact of life is that ’22 in EU you had a goal of 30 gigawatts and you got 15 gigawatts basically done and executed. That's half good. No, it's not. It's really bad in a year where Europe is still in shortage of energy supply.

So I am -- and that's what I’m -- we keep saying it as an industry, we keep saying and as a company, as an executive, you keep saying it but it seems like we are running in a different cycle. We put infrastructure up for thirty years, and somebody else is focusing on potentially the storyline for 12 or 36 months in a political environment. We need to come together and fix this, otherwise, we won't get the assets to work.

Supriya Subramanian

Okay, [noticed]. And maybe a question on PPA levels, given that energy prices, have come down already. It came down quite a bit in the fourth quarter and now into 2023 as well. Do you see this as being a challenge in terms of setting, getting new deals with customers given that maybe there is uncertainty on the long term PPA level? And yeah, just wanted to get your thoughts around this, especially in the current interest rate environment, how does that impact the IRRs of clients? Are you seeing some hesitancy from clients on that front?

Henrik Andersen

I think on the energy pricing and markets, I think it's actually well working. I mean, if we look at the private PPAs, volume is bigger than ever. We see private companies coming together with developers and OEMs like Vestas putting projects up and making it profitable and financially viable for all three parties in that triangle. Super concerned when you have public PPAs at artificial levels. And there they are governments around the world that stubbornly keeps electricity prices from two or three years ago and think that the industry can build out those projects three years on, while interest rate has increased is from zero to six. And in the turbine or the infrastructure building it out, has probably gone up with 30% to 40%.

At those PPA levels, you won't get any build out. And that's probably where I'm concerned right now that we don't see governments being just as market participants. So the market participants, get the electricity build out and infrastructure build out under those market term. So I think little question mark, little concerned that the government PPAs are the other ones that are in trouble right now where the private PPAs are working brilliantly in across all the markets. And you can see that in our order intake in Q1.

Supriya Subramanian

Got it. Thank you. I'll save my rest of the questions. I'll come back in the queue. Thank you. Thank you so much.

Operator

The next question comes from Claus Almer from Nordea, please go ahead.

Claus Almer

Thank you. Yeah, also a few questions from my side and will take them one by one. Warranty information is coming down versus last year. Should we see this as a strong indication of those issues being solved? And i.e. should we expect going out this year maybe you're back to the 2%? That will be the first question.

Hans Martin Smith

Yeah, thanks for that Claus. I think on the warranty side, as you rightly point to, there is a decline from the higher levels in Q4, and at least also what we have for the full year last year where we had 6.3%. We're seeing 4% being a good number for Q1. We'll obviously have to see how the year plays out. It is fair to say, also coming back to what you said beforehand and also about the guidance range, there's still a lot left of the year, a lot has to unfold. And I think it would be foolish to sit here and say that we think all of the problems have been solved after a couple of months -- being a couple of months into the year. But for now, at least we see that the 4% that we have provided in Q1 is a level that makes sense in Q1. That's how we'll think about it for now.

Claus Almer

So it's more -- so the provision you've done in Q1 is more for what you see today, there's no extra bills to be paid from what you have installed a few years back or one year back?

Hans Martin Smith

Of course, the warranty provisions reflects activity levels that say, on one hand, we expect to see cover going forward. But of course if there are issues on turbines that have been sold in the past, that gets factored into the levels that we're looking at. So it's really a combination of those things you're looking at when you're looking at the warranty provision. So it's a reflection of what we see would be needed at the point in time, when we made that provision, so to say.

Claus Almer

Okay, then my second question goes to cost inflation. I know we have been touched upon this topic in this call. But if you look at the world today do you still need to raise turbine prices or are you happy about the underlying turbine prices or if you're actually starting a cost inflation? That'll be my second question.

Henrik Andersen

It could be a little tender to ask you Claus, do you expect your salary to go up or down because I think actually as inflation is becoming sticky guys. All around the world right now inflation is becoming more and more sticky. So I think we have to get used to right now that which is also why encouragement from our side is to look at PPAs and other stuff within indexations because there is no place to run. Electricity and the whole components going into inflation are becoming sticky. So I have to say right now, turbine prices are not coming down. The components and the raw materials, after probably a slightly lower level around year end, we start seeing some of it coming back as increases. And of course, you know, the underlying China is now fully open after Q4. So Claus, inflation is not coming down currently.

Claus Almer

For sure. Okay, that's good to hear. And maybe that's good to hear but that's the situation at least.

Henrik Andersen

Yes, that’s the situation we both have to deal with, that’s for sure.

Claus Almer

Exactly. Thanks a lot.

Operator

The next question comes from Henry Tarr from Berenberg. Please go ahead.

Henry Tarr

Hi there and thanks for taking my questions. Two, one is just on the ASP. I know you talked about the scope and the geographic content and some repairing going into the numbers. If you could give us any more detail on that that would be great. And then on the -- second question is on the Service business and is there are a ceiling on the inflation adjustment or the indexation to some of these contracts? Or do they just run with CPI? Thank you.

Henrik Andersen

Thanks, Andrew, if I take the ASP first. I don't think the difference between €1.15 and €0.89 will give a new breakdown of that. Because if you look at the quarters now, it starts, we've said that all along, it becomes a bit more lumpy with some of the larger, also now onshore developing into large orders. Which means then you can start doing, hey, that customer paid this and that customer paid that. It sits well for us, because when you have that breakdown, there is a breakthrough on some of the repowering in the US, which we have been talking about for really a long point in time. And then you have hardly any EPC in this quarter, so those two as a sole explanation.

There are then a couple of country mix, which you will also appreciate if you look at the order list, where there normally are scope and lower pricing. So it matches well what we want in that quarter. It just came out when you took the order backlog there to sort of say, it came out low in the ASP but the profitability where we are pleased with.

Hans Martin Smith

And then on the Service question. And I think what's fair to say is that we try to obviously structure the contracts so that they track whichever Index would be meaningful in the area where we undertake the service activities. Of course, we can structure them in different ways. And if a customer is insisting on a specific structure, of course, we can talk about that, but then probably there will also be a pricing discussion to be had as to what is it that it cost, if you want to have specific solutions on your contract. But generally speaking, when it comes to say the ceiling discussion, I would say that is something that we typically would not want to see in our service contracts.

Henry Tarr

Okay. Okay, great. Thank you.

Operator

The next question comes from Martin Wilkie from Citi. Please go ahead.

Martin Wilkie

Thank you. Good morning, it’s Martin from Citi. A couple of questions on the US please. First just to understand what you might be hearing about the Inflation Reduction Act and when customers could start placing orders. We've heard from one of your peers that that might happen in the second half but obviously there is still some tax guidance, all those sort of stuff that's got to get resolved. But just in your conversations with your customers, is this something that's imminent? Or how should we think about the feeling of that?

And then just a related question to that, if I look at your deliveries in the US, in Q1 is about 300 megawatts. Obviously the US, as we would expect, a quite a low level of volume and sort of what's going through the P&L. How are you managing your cost in the US this year? If we're going to get a big ramp up over the next couple of years, obviously, so then excessively negative impact because of low fixed cost coverage and then sort of reverses in for next year or so? Or is it more flexible? Just to understand your cost base in the US. Thank you.

Henrik Andersen

Yeah, a couple of observations there Martin on the US and the IRA. As we said all along, I think it somehow must be a bit frustrating for also the commercial parts to talk with customers, because probably never had more activities. But as you also know, there is no conclusion until you have had a firm order. Lots of planning, lots of discussions, lots of projects that are also then coming through that pipeline up towards also seeing when can we get the permitting and when can we get to tax equity. There are some question marks still around both the guidelines and how it works. So I think we encourage both the Treasury and others to work diligently through that and come out with that.

We see customers being some more bold in taking decisions and taking orders. But I think the sort of the big volume and the floodgate has still to come with that, because we will see some of that coming through. And we will also see a different structure, when you look ahead because some of the projects will be larger, because they will start relating to the famous hydrogen as well.

So P2X will be a point in the US when we look at the years ahead. And therefore projects are being designed to be able to build out more than what typically is to 200 megawatt, 300 megawatt, 400 megawatt. But now it will be fast approaching the several gigawatts. So that's one observation. I don't have the timing clear, Martin. I just think we are pushing a quarter ahead of us most of the time. But I can also say, we are definitely coming closer to it every quarter. So that's the positive. So discussion is progressing well.

On the US deliveries, as we've said all along, we believe in the US. We've been in the US for several decades. We would not do things to our sort of a factory footprint there but we are running hardly no shifts, as we discussed before. So in that sense, you can say the marginal cost to a asset coming out of the factory is higher, that also means that the operational levels for us in the US sits down the line where we can start doing more as more deliveries and we can add more shifts back in the factory.

So that said, that's just the nature and we definitely look forward to that. But we also can say here that it's nice that we have been able to take care, we have had some idling of shifts, but we haven’t idled totally the factories there. So they are there ready to go and we are just doing both the repowering. And we will now also do some of the early technology ramp up of turbines.

Martin Wilkie

Great. Thank you very much.

Operator

The next question comes from Dan Togo Jensen from Carnegie Investment Bank, please go ahead.

Dan Togo Jensen

Yes, thank you. First a question on the Q1 here and maybe also Q2. Last year, you did announce that there will be some slippage of orders going from ’22 to ’23 and these are likely to involve a negative margin. Can you give some flavor or some indication of how the impact of these orders are in Q1? I guess we're talking about up to one gigawatt in terms of capacity here. So what is the impact of this in Q1? And can we expect any impact of this in Q2 as well? That will be the first question.

And then the second question was bit relating to what Henrik said in the start that you are working towards regaining profitability towards the end of the year. I guess we're talking about the Solution business particularly. And it sounded like very finely, does that mean that you envisage here, say that profitability in the Solution business will not be gained until Q4 basically? Or how should we think about that progression from where you are now, towards the end of the year? And basically, also, what will decide what the profitability will be by in Q4? Is it lower warranty provisions or is it just simply that ASP or the projects with higher prices that are feeding through? That's it, thanks.

Henrik Andersen

Dan, let me try. I think we need to -- your question around orders needs to sort of be split a bit. I think for the firm order intake, we don't operate with firm order intake that has any deviations or what it drags out or anything like that. If we have orders where we have had a delay or whatever, then there is a spillover effect from Q4 into Q1. But we don't say about what kind of volume that is. But there's always projects that will be get -- from a quarter to another, get delayed.

As you also know, with looking at the trend on the ASP, the ramp up of pricing means that we have a backlog where there are huge differences and therefore also huge differences in the profitability per project. So the longer you come in time, the better it gets. And that's just the average of what you have seen over the last eight to 10 quarters, and therefore profitability will gradually go up. And that's also why when you when you when you look at the Q1 number, yes, there is a negative EBIT in the Power Solutions on the turbines. And of course, that will gradually ease out when we get through the coming quarters.

Then I won't -- we're not sitting here and guiding specifically when you will see from red to black in the turbine business. But of course we work towards the 10% in ’25. And that's therefore where we will definitely see a positive trend between where we are today and ’25. That's a promise because that's the pricing we are doing.

Dan Togo Jensen

Okay. And then maybe just some call on. Are we still going to see these troubled orders or this slippage having any impact in Q2 or are most of these orders done and dusted in Q1?

Henrik Andersen

You can't say done and dusted because as I said, slippage comes from one quarter to another. You can see we actually come out, a good start of the year. So we've done some of that that came with us from last year. But we also executed on the things that was in the plan for Q1. So we are pretty okay with that. But then there are three quarters to go and we will see how that pans out. You know there's one or two of your projects that has then been delayed for some time and that, of course, we work diligently hard to get into the later quarters of this year. Yeah, so fingers crossed for that.

But as I said Dan, bear with us, have patience over the quarters, and be careful about not doing it. We have a full year guidance, that's the average of the four quarters and that's what we really, really focused on. And as you can probably hear on the tone of voice, for us right now and on behalf of the 28,500 colleagues around, we are fully, fully focused on trying to get that to an overall black number.

Dan Togo Jensen

Understood, thank you.

Operator

Next question comes from William Mackey from Kepler Cheuvreux, please go ahead.

William Mackey

Yeah, a very good morning. Thanks for taking the time, a couple of questions. Firstly, on Service, would you be willing to share the proportion of the Service revenues that you would describe as transactional above normal. So when you look historically, the proportion of transaction revenues as opposed to normal Service revenues, because as we run through the year, I suppose it's going to be important to think about a normalization of that and perhaps a flavor of the level of inflation impact on the revenue development through the execution or the implementation of your indexation clauses. So that was the first question on Services.

And then if I can just follow up on Power Solutions, when we think about the project backlog, you've been very successful now for nearly six quarters, raising prices and actually chasing inflation. And you highlight that the margin development will improve as you execute the low margin projects. But at what point should we think that you've reached or when is your planning that the majority, I mean, and maybe 90% of the business you're booking in Power Solutions would be at levels which are fully compensating for the inflationary effects?

Hans Martin Smith

Yeah, let me start with the first question, or the first two questions on Service. So we have not traditionally been, say, giving those numbers that you refer to. I'd say the impacts are quite meaningful from both. And of course, the inflation indexation mechanisms are higher than what they have typically been. So that clearly gives you say an indication of what we are looking at. We'll think about your suggestion. But for now at least, this is not traditionally something that we have been disclosing.

On the backlog on Power Systems, I'll see if I can kind of try and answer that question. I think we have certainly been seeing pricing is, I mean chasing is perhaps not the right word to use in terms of what we have been doing things. We have obviously been trying to lift and work with prices so that they reflect what we think is adequate profitability. And as we've also said multiple times before, I think we have done quite well in raising prices, and also installing more discipline on terms and conditions into the contracts that we're working with.

I think if I get your question right, and I'm not sure that I do, so please correct me here, then. But it's not something that changes we will continue to see also that what we are doing is something that sequentially over time, but it will be very lumpy because it goes up and down. A quarter like this one, for instance, is small compared to what you're likely to see in the second half of the year. There's going to be all kinds of effects that goes into this when you then look at what manifests itself through the P&L because that jumps around quite a bit. But I would say that overall, we are continuing to work with this and continuing to see what can be done to, say, increase prices and make the margins even better.

William Mackey

Thank you very much. A short follow up, if I may, which relates to the supply chain. And if you would characterize how you see the development of the supply chain or relating to logistics or plate steel or particularly electronics over the past three to four months?

Henrik Andersen

I think there's no way. I mean, that's -- it's not a generic one. It comes down to source country of origin and company of origin but as I meant it when I introduced here, big, big, big thank you to partners and suppliers working diligently through that. And that is, William, down to clear what I will call a very much say a backlog, but also still understanding that there are criticality in getting it to site in time. So let's not spare that, there is a time, there is a there is a bottleneck, and there is also still an inflation issue in around this. So it's easing but it's not done.

William Mackey

Super. Thanks so much.

Operator

The next question comes from Sean McLoughlin from HSBC. Please go ahead.

Sean McLoughlin

Thank you for taking my questions, and good morning. Just thinking about your earnings progression through the year, do you still expect earnings to be backend loaded? And in that context, as you look through projects for delivery in Q2, should we expect no real improvement in the underlying project margin in Q2 as you work through that low priced, low margin backlog? That’s first question.

Secondly, just looking at the high inventory levels, they're up again year-on-year. You've got your high cash outflow in Q1, you've got €1 billion of CapEx. I mean, is -- your consensus is looking at positive free cash flow in 2023? I mean, is that looking ambitious?

Henrik Andersen

Hi Sean. I will say here, we’re simply in a year like this, where we are aiming to be on our guidance and also getting back in black numbers, we won't give any leads on quarters. I just gave you the biggest disclaimer on taking a quarter and then extrapolate for that because the backlog we're executing into quarters are simply too variable in terms of pricing and costing on some of those projects. When you have an average on a negative EBIT in the Power Solution still in Q1, that will be one of, part of keeping an eye on but we won't give guidance to your Q2. We will give the underlying when we say then the tone for the full year, that's what is to keep for.

On the inventory side, fully dedicated to start offloading it but again here, you have to have patience as much as we have in executing on the backlog. Because we are just coming out, it's 90 days ago since the world's start reopening a bit more than we have had. So part of our inventory is sitting at a high level for the same reason, to protect our customers and the execution of our projects. And I think here, if you have an assumption of that you're in a EBIT zero scenario, around zero, spending a billion in CapEx is able to do a positive cash flow, I will say that that will be a bit tricky for us. We are doing all optimizations we can do but we can't print the money if we don't have them.

So we will release the inventory if we can but as I said here, we are fully focused on it but positive cash flow, look, for me -- it looks like a stretch and Hans is smiling here next to me. So I know where I'm -- I know I'm on the right direction here.

Hans Martin Smith

Oh, it's fantastic. And like when you sit and talk to the details of how to generate a cash flow, but I can only agree that given what the numbers, I expect it to look like on the dimensions that you mentioned there. I think, I mean, it's -- I would say, how do I put it, Sean, optimistic to think that that would be possible. No, we don't see that, I mean, as a technical possibility, because as mentioned, that's not what the numbers would say.

Henrik Andersen

But we work -- we work on and we will promise you, we will optimize that as well every year a little but we can turn on it. If we can do now the last question is, Casper, so if we can take the last questions now, operator?

Operator

Hello.

Henrik Andersen

Yeah, hello. I just said if the operator could take us for the last question.

Operator

I'm sorry. Yes, Mr. Casper Blom, your line is open, from Danske Bank.

Casper Blom

Oh, thanks a lot. And thanks for squeezing me in there. A question regarding, I suppose bottlenecks. When I speak to different players in the industry, one of the things that a lot of people mentioned is the ability to attract enough of the right qualified employees and I know hopefully you are looking into quite a ramp up, first of all in the US and then hopefully also in, in Europe, if politicians ever get their Act together. Do you see skilled workers as something that could limit your growth or is it something that you're able to handle? That's the first question please.

Henrik Andersen

I think in reality here, we can say positivity, we invest quite a lot. We also, whatever part of the world we're working in, we put a lot of effort to look after the Vestas family of colleagues, in both good and hard times. I think some of that loyalty comes back when we also ramp back up. So generally, we get good, we probably have a good name in ramping up and down. That also means that we are able to overcome some of the shortages, may be better or easier than others.

But as you're rightly saying, Casper, we can't avoid that there is an inflation also, and wage inflation around the world, which of course, when we ramp up, we also have to be part of. This is also related back to Martin's point in the US. We didn't let all our good colleagues go but you can also see the number of colleagues in the US dropped from well above 6000 to now sitting just around 3000. So there are some colleagues to come back in the factories. That we have had a long tradition for doing in both good and bad times in places like Colorado, and we will do that again.

Casper Blom

Okay, let's cross the fingers for that. And then my second question is sort of on the more general behavior of the industry. I think you've been advocating for a while now that we need to slow down the arms race in terms of technology and launching new versions all the time. And I think recently, several of your larger competitors have talked the same language. GE is very fond of talking about their workhorses at least. And do you see this happening right now? Are people acting in a more rational way when it comes to wanting to deploy new technology and expand the commercial lifetime of products? And secondly, are you also experiencing that some of these large competitors are more selective in the markets they participate in?

Henrik Andersen

I think it's -- maybe it's not for me to comment too much on specific things on that. We are pretty adamant of the cycle we work in. We test our technology. We are very confident of that works that also gives some comfort to customers that they can join that technology cycle and journey we have. And I'm proud of -- we're proud of the technology colleagues we’re having that also do open development together with our customers to get to that. I don't think an industry can change misbehavior from a decade over within a quarter. So I think -- still think here probably we have as an industry something to prove, Casper.

We know there's -- there can be a lot of talks but it actually comes down to what is then going on. And if there is -- there's been a say and do gap in this industry for many, many years. I hope executives now stand by it and say this is closing and therefore we are seeing it happening. We keep talking to it and we will keep doing it and we also keep remaining disciplined, that's our promise to the industry.

Casper Blom

Thanks a lot Henrik.

Henrik Andersen

Okay. With that, I really want to thank you for your interest. I know we are going to see many of you over the coming days. So again, thank you for your attention and for those who we don't see, really appreciate your support and also the interest. So see you later in the year, thank you.

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Vestas Wind Systems A/S (VWDRY) Q1 2023 Earnings Call Transcript