Wärtsilä Oyj Abp (WRT1V) Earnings Call Transcript & Summary

So welcome to this Wärtsilä mid-quarter call with our CEO, Hakan Agnevall. My name is Hanna-Maria Heikkinen -- we will start this call with a small recap from related to our service business. As you may remember, we have very solid service business, net sales last year roughly [ EUR 2.5 billion ] and it's growing steadily. [Operator Instructions] Hakan, please, let's get started.

Thank you, Hanna-Maria, and welcome everybody this morning. Then as Hanna-Maria said, I'm going to do a kind of short starters update where we are with our service business and then we move quickly into the Q&A session, so to say. So -- I mean, as you know, our service business is really vital for us. It's more than half of our revenues, and we have also identified some major growth drivers, and it continues to be so. It also provides some stability in -- to balance some of our other businesses, which sometimes is a bit lumpy. And we also know that the service business tends to be a bit more profitable than the new equipment business. So services is clearly in our strategic focus. And we talk a lot in our strategy about moving up the service value ladder. So if we see here, we also communicated that 2022 will be a newbuild year. And what we meant with that is that the share of equipment sales in 2022 will be increasing relatively to services. But it should be noted that services still continues to grow in a profitable way. So this is also important as we proceed with our strategy, moving up the service value ladder. And when we talk about the service value ladder, we talk about everything from the spare parts and field service hours to the agreements. We have different type of maintenance agreements, performance agreements. And then we take it all the way up to the outcome-based agreements where we, together with our customers, identify potentials for savings, a reduction of fuel consumption, uptime and improving uptime reliability. And we actually share the upside and downside of such agreements. And we see all of these steps in our service value ladder growing and doing so in a profitable way. If we continue -- then if we look at the recent developments, we have made, according to the agreements, we see that it is clearly heading in the right direction. And especially when -- on Marine Power side, where the fleet on the cruise side is coming out of [indiscernible]. And here, I would say that it's really interesting to see also that customers are renewing the service agreements. I think that is the best feedback we can have when customer signs up for renewals. So a very positive development overall, I would say. And a couple of examples, a couple of proof points. I mean this is a recent announced contract that we have with Carnival and this is outside of our PBL contract, which we continue to execute. I mean this Carnival contract is basically we are doing a joint study on one of their cruise vessel Regal Princess and see how we can leverage data and data analytics and artificial intelligence to optimize the decarbonization journey of a specific vessel. And this -- the learnings from this study also this cooperation, will likely be applied then to the rest of the fleet. And what is really -- and this is one way we will work going forward, do these type of studies with our customers to identify what are the feasible avenues to decarbonize. And there are -- as you know, there are quite a few avenues you can take. It's now green fuels for sure, but it's not only about green fuels, it's about energy saving solutions, air lubrications, et cetera. There is also hybrid systems, I mean, combining combustion engines and batteries that will be major way forward, so to say. And I think we see some good retrofit potential here through the years, both in upgrading to the new fuels, but also introducing hybrid solutions in existing fleets. And the approach, this is an example of the approach that we are having with our customers in that journey, so to say. If we switch to the energy side, and we also recently announced our decarbonization services. And you could say it's a little bit similar approach, i.e., we do system studies with our customers, where we leverage our power system knowledge, of course, the knowledge of different generating assets. And together with our customers, we define optimal paths on decarbonization, energy efficiency, uptime reliability. And then we can take that all the way up to performance-based agreements, where we tap into savings and work and share them jointly, so to say. So this decarbonization service this is -- it's really an interesting area where we leverage our power system knowledge, but also our digital capabilities with GEMS to manage a fairly complex, you could say, microgrid or micro system. Then coming back to the cruise industry. I mean the operations are up. I mean 70% is flat for a couple of months. But when I recently traveled in the U.S. and met with some of our critical cruise customers and I would say that they are very optimistic about the summer season and people are getting back to 100% operations. And as you know, we have always stated that there is a strong correlation between the cruise utilization and our service business. I mean of course, we have -- and if you've seen the growth of our service business now, in the recent couple of quarters is not only about cruise, we see a broad growth there. But we know for our crew service business, there is a very direct correlation between the utilization and the growth of that business. Okay. I think that was a short summary, so to say. Let's -- okay, we have the vessel contracting. It's expected to decline in 2022. Yes, it's -- these are based on the Clarkson estimates. And the merchant segment still represents a clear majority of vessel orders, but the total volumes are expected to decline. And the main challenges in slowing down in vessel orders are increasing raw materials and also, quite frankly, the shipyards are fully booked. And I think this is, of course, hampering the new build activities. But it's also clear that Clarkson expects the contracting volumes to increase again after this year, driven by the acceleration of fleet renewals and steady demand growth. And so -- but this -- according to Clarkson, the newbuild side will be slower this year. Okay.

Thank you, Hakan. Now time for questions. Johan, -- yes, you have raised your hand.

Okay. Can you hear me?

Yes.

Hakan, you actually answered my questions I had here at the very end about the cruise revival and the order intake. But just on the order intake, I noted there were some expectations that cruise, ferry will sort of eventually start to improve in terms of order volumes. It looked like in the graph you showed like 2 years out or so, do you see anything of that? I mean the cruise industry, I guess, is still pretty full. Is it rather potentially on the ferry side that there might be some actions?

I think that -- I mean when I -- as I said, going -- visiting the U.S. and talking to some of our key customers, I think they are very solid -- and they have a very solid view on the demand side with the exception, of course, Asia and China. But I mean if you look at North America, Europe, very strong demand side. They are looking at coming back into profitability. They are also looking at how are they going to deal with CII. I mean the new standards that are -- or requirements that are coming out from IMO and strong focus there. Then there are a number of options, if we talk new vessels. There are a number of options that are in the pipe. And I think they -- they are spread out '23, '24, '25, '26, even sometimes all the way to 2029. And nobody has canceled anything. And so far, people are maintaining the normal on-time schedules. But if you then talk new on top of the options, I think that will take some time because the industry needs to experience at time of solid demand and regain a bit of the confidence before looking at even further orders. But as I said, on the current option programs that are in the pipeline, I don't see any deferments there.

Okay. And do you see these Chinese lockdowns going on right now, does it have any significant impact on these projects that you are currently delivering or expecting to deliver soon?

Well, I'll answer that from 2 perspectives. I mean the COVID lockdowns in China primarily certainly has an impact on supply chain and logistics problems in the world, and that affects that less to face many other companies. So there is a significant impact. But if you -- if we zoom in on the cruise industry in North America and Europe, I see limited impact, very limited impact.

And then just a final question. In Q1, you highlighted the ramp in cost inflation on lithium, for example, impacting your battery backup order development. Are you seeing any actions or our customers as hesitant to put the ink on the paper still or...

I mean we see actions. And I think the market is digesting the new price level. But there is a lot of activities, and it's not that everything has stopped.

Next question comes from [indiscernible]

I just had a question, I guess, following up on the China lockdown question. Could you maybe give us an indication on the proportion of your battery procurement from China versus elsewhere? And have you specifically in storage had any issues with your suppliers being able to deliver on their battery supply agreements?

I would say the majority of our battery sales are coming from China. And our suppliers have been affected, of course, by the raw material increases. But so far, they have maintained deliveries to us according to agreed. And so far we have towards our customer also maintained our deliveries. I think what we have done, clearly, we have increased prices.

Understood. And also, similarly on storage, could I ask what proportion of your storage pipeline is tied to greenfield storage -- solar power storage project? I know there have been some issues regarding the tariff situation there.

I don't -- I can't actually -- I don't have those figures. How much is -- if I understood your question, how much of our storage installation is related to solar power? I don't have that figure. We will have to come back.

Then the next question is coming from Daniela Costa.

Actually, a couple of follow-ups on the storage points. I think you've been clear now that you've been raising prices, but can we talk about the price versus cost? Is it sort of on a better situation than in 1Q, on a worst situation, I think we've seen your peer, Fluence, having negative gross margins. Last time you still said that you had positive gross margins, is that still the case? And then just related to that, I think you talked about the situation of the supply chain, but you had also, I guess, to deliver, you had a cash drag last quarter. And how long should we -- will we continue to see cash drags from delivering in storage in 2Q and in 3Q? And how do you see that accelerating or decelerating just the path on the storage this year would be very interesting?

Okay. Now -- so I mean, first of all, I can confirm that we still have positive gross margins. I can also confirm that we are fully compensating for the cost increases in terms of our price realization. Then of course, you have to -- in new tenders, I would say. Of course, in the order backlog, it's more of a mixed situation.

Can I follow-up there? So -- and on the fully compensating for the raw mat was that -- so in 1Q, I assume, you weren't or...

No, no. I think we have been able to, in general, to compensate for the cost inflation in storage. So -- but it seems like others have not -- I mean, based on your question and other analyst questions, it seems like there are different OEMs have different approaches. Our approach, we are compensated. So we have a discipline in the price realization. But of course, in a project business, when you have signed contracts for certain orders, then you have to live with a price level. And we have back-to-back versus our supply chain on most of our order backlog, so to say. But as I said there, it's a bit more of a mix.

But then how can maybe I didn't get it so well. You had a big cash drag for delivering last quarter. Was it all down to costs below...

Yes, no. So that -- the cash drag that is a function of the supply chain financing that we have. So we have -- I would say we have a favorable cash flow based on the supply chain financing that we have set up. But of course, if the order intake is -- and we talked about that, that reduced significantly during the price reset, then you would see this kind of cash drag.

So that will continue in Q2 or Q3 or you're seeing a little bit easier profile on the orders then...

Yes. I mean -- and -- we see a lot of activities in the market on -- as I said, the market is digesting the new price level and whether it's a lot of activities and it should be -- if and when this materializes into orders, then that the supply chain effect will kick in again.

Next question comes from Tomi Railo.

Yes. Can you hear me?

Yes.

Actually, a follow-up to the storage. Just a question. Do you think that your loss in storage business is lower this year compared to last year?

Sorry. Yes, no, it's a good question. So sorry for -- I think we are going in the right direction. I mean we -- as Tomi, we have said that we -- over a couple of years, our plan is to make the storage business profitable. And from that perspective, I think we are going in the right direction. I mean with, of course, a dent now when the -- during this, you could say, market digestion of new price level. But because as we said, before also, I mean, we are positive from a gross margin perspective. I think we see very interesting opportunities to evolve, decarbonization as a service. I talked a little bit, storage fits into that story, that story as well. And then, of course, as we scale we will have a bigger base to spread out our R&D and our overall cost structure because you and others have also asked what -- why are you not profitable on an EBIT level on storage and the clear indications, we are investing in R&D, and we are investing in building up a structure.

But direction is positive around that, that's good to hear.

Yes. The direction is positive. However, of course, when we have this market reset on price level. And of course, that creates -- I mean we haven't had the order intake in a normal pace considering the price that creates a bit of a bump. But I would say, near to long term, we are moving in the right direction, yes.

That's understood. Second question, if I may, thank you for the service update. And question also on profitability there. Do you think that -- or have you seen service profitability pressure? Or would you say that, let's say, equipment is facing more profitability pressure compared to service due to the increasing inflationary pressures?

Yes. No, I would say that in general, our price realization on the services side is fairly strong. And I would say it's stronger on services than in general on the newbuild. But also on the newbuild, we have taken measures to increase prices given the inflation.

So you don't see a major pressure in the services profitability?

Correct.

Final question, if I may. What do you see on the traditional power plant side? At least towards the end of last year, you were suggesting the pipeline is improving. Are those projects moving up forward or is it sort of a pause also on that side?

No, I think there is still a lot of activity. But as you know, these are fairly large projects and they come when they come, so to say. So it's a bit digital. But -- because if you've seen our officially announced orders, I don't think you will find so much there yet. But I can say that there is a lot of activity still, still considering the high energy prices, still considering COVID situation, et cetera. There is a lot of activity. However, I should also point out, and I have reminded everybody about, Q4 was an -- order intake was an all-time high in the history of Wärtsilä.

Then [ John Buckland ].

Am I off mute. That's the question.

No, we can hear you.

Yes. I wonder if you could explain, I'm just not understanding this idea that customers are hesitating to order battery storage and what have you because of the price increase. Where in an inflationary environment, in other industrial sectors, people are flying ahead of anticipated price increases. And -- so is it -- I wonder if you could explain that, but is it the market seems to think there's a hump and that sometime in the future, if you take the long-term decline in costs that they -- if they hold off, then they're going to get a lower price because there's 2 things in there. There's this price issue, but also they've got to install a lot of stuff. I mean there's still a lot of demand, a lot of requirements, a lot of projects -- so they can't be holding off for long because they won't get their projects done.

And I agree on that point. But I think just to give some flavor, some -- there is not only 1 customer types, there are probably 3 or 4 customer types. But let's say, looking at 1 customer types, they might be -- have entered into certain contracts for energy or contracts for balancing power and lock themselves in with a price. And now when they are buying the battery storage that has increased significantly and we are not talking 5%, 10%. I mean it's much more than that. And then of course...

Is it?

Yes. I mean, if you look at the lithium, carbonite prices, they have gone up to 350% in last 12 months. So...

What does that mean for a finished system? What's the impact on a finished system, because...

Yes. I will not go into the details of that. But the price increases are significant. And what that means is that those customers, they need to go back and revisit the whole project calculation. Does the business still makes sense for them? And people are in that mode a bit. I think they are reevaluating the new price levels and seeing that these business cases still come together for us. And I would assume that for some people, they will land in -- yes, it still makes sense. The profitability might not be as high as we expected, but it still makes sense. And some customers will say, no, it doesn't make sense for us anymore. Then -- so that is what is happening right here right now. Then coming more back to your mid- to long-term comment, which I fully agree, even with these price levels, I would still say that looking at U.S. looking at other markets, in general, there are good business cases for balancing power going forward even with the higher price levels.

It's an interesting dynamic, isn't it? Because the customer, the people need green energy, right, and they need storage balancing all that stuff. I mean, you can't just say, "We're not doing the project." because people will say, "Well, I want my electricity." And they were in a energy crisis. So they've got to adjust the price for the end customer. There's something I miss here to my mind? Everyone else is spotting the price up, electricity not. I mean that's just -- yes, I can understand individual projects assessing should we go ahead or not, but it just seems to be weird to me, anyway.

Okay. I mean the simple explanation is human psychology. I mean you have a Board, you have reported, you have this great project with a certain profitability. I could lend money to a certain rate. All the rates are flying all over the place. You are fixed in price and your -- costs are increasing. And the Board is asking, "Do you still want to do this project even if your profitability has gone down with X percent?" I think those type of discussions, I'm sure you have had them as well. I think those type of discussions are going on. And this is why it takes time to absorb -- time for the market to absorb this price reset.

So it's just really a temporary blip, isn't it?

As I said, I mean, we -- there is a lot of activities going on. And as I said, mid- to long term, we see fully agree with you. There is a lot of balancing power needed as we will turn into more renewables. So from that perspective the market will move on, absolutely.

Then Antti Kansanen.

My question would be on the services side regarding the storage business. If you think about the deliveries that you are doing this year and perhaps the longer-term visions that you have on building the scale, building the installed base. So what type of recurring service business would you, Hakan, envision in, let's say, 5 years' time from that businesses alone?

So if we look at -- when we think about the service business for battery storage, we think about you could say the more traditional spare parts maintenance piece and then you have the more decarbonization services piece. So if you -- if we start with the first element, I think this will be much less in both -- in significance compared to the thermal side because it's electrical devices, no moving parts, so that fundamental, spare part business will be considerably less. Then we move to the other bucket, which is the decarbonization as a services. And here, it's about how you provide a power system for a mine or a cement factory for some kind of load where you blend wind, solar, combustion engines and battery storage to provide the lowest overall energy cost and the best uptime reliability. And here, you get into different schemes where you can share benefits, and it's a different revenue model. And that we consider to be the interesting piece of the service business for storage. I mean there is nothing wrong with spare parts and field service, but the magnitude of that will be less than the thermal side, clearly.

But if you look at kind of the orders that you took last year on the storage side and I guess almost everything involves [ games ] and perhaps some maintenance agreements as well. From your perspective, what is kind of the lifetime revenue split in, let's say, an average order? Or how much is coming from the aftermarket side versus the, let's say, initial profit or revenue that you take on the installment?

I think the major element is the equipment still. I mean -- because the spare parts and services is very limited.

Okay. And then perhaps a follow-up on the inflation question previously. Like if you look at the tremendous year that you had in storage in '21, how did your price levels actually trend within '21? I mean was it a case of your clients anticipating inflation and that was one of the reasons why the '21 order levels were so high? Or was it a pretty stable pricing environment where overall investment decisions were easier to make?

No, I would say that the real escalation in prices and cost is related to battery. It really started in the latter part of Q4 and the beginning of this year.

The next question comes from Sven Weier.

Just wanted to follow-up on the Clarkson data and the LNG because it's been quite strong in the first 4 months of the year in terms of new yard orders. And my question is, were those LNG carrier orders in your neighborhood in terms of the propulsion 4-stroke versus 2-stroke and as gas systems, so is that something you see yourself benefiting? Because I remember when we spoke earlier this year, you kind of argue the yards are full and there is no short-term effect, but now we still see these carry orders going through the roof. So I was wondering if you had an updated view? And then maybe also if you could comment on the navy side of things, right, which was also quite important in the order intake last year? I know it's early days on the defense budgets, but I was wondering if you can see the start of some discussions there?

Yes. No, so on the LNG carriers, I think we will see even more demand for it clearly with pipeline solutions from Russia, not being the way forward in Europe, I would say. I think -- and we all know of the discussions about additional LNG terminals in Germany, et cetera, et cetera. I think there will be a demand certainly for LNG carriers. But to your point, Sven, a lot of these vessels today, they are 2-stroke. We are working on a technology where we will come back on the 4-stroke side, but that is still at an early stage. I think we see some interesting opportunity there, quite frankly. But since we are talking here and now, we are talking 2022, it's a lot on the 2-stroke side. We are here and now also on the 4-stroke side, on the Arctic LNG carriers because then you need this variable power. But to your point, mostly now LNG carriers is still 2-stroke. And yes, I think what we see there on the capacity side, I mean, Korean shipyards are certainly have a good loading level. We do see some Chinese shipyards also considering stepping in. Then on your question on navy. Yes, we clearly see an increased general demand situation. I mean navy it takes time to develop. So it doesn't result in order intake in the next quarter. But it's clearly so that more money is flowing into the navies of the world. And we see increased thoughts about new projects, thoughts about additional options on existing projects, et cetera. As you know, we don't have too much of engines in the naval because they normally use different type of engines in navy. But we do see it in other of our businesses like the shaft line solutions like in Marine Electrical Systems. So they -- I think we see interesting opportunities there, but naval takes time to develop.

Can I just follow-up on the LNG comment? Because I was wondering how important is the inert gas business for you? And wouldn't those LNG carriers, you mentioned, still have auxiliary engines that would be 4-stroke?

To a certain extent, yes, but many of those are more, you could say, commoditized. So it's normally -- sometimes we are there, but it's not like we have a dominating market share in those, so to say. There was another aspect of your question, sorry.

On the inert gas systems?

Yes, inert gas. I mean inert gas is we do have that in our Gas Solutions business on the Marine Systems. And there, we see interest. There is a lot of projects ongoing.

Next question comes from Erkki Vesola.

Can you hear me?

Yes.

Yes, good. About component availability, especially electronics has been an issue. We talk about that in conjunction with Q1. I mean what's the current situation? And then logistics costs, they have come up again, how hard will these 2 issues kick in, in Q2?

Well, I don't make any forecast for Q2. But I mean it's very valid questions. I mean if we see in electronics, it has been a major challenge. In general, I would say the following. I said that in the past. When we saw the disturbances in the supply chain and the inflation, we saw that in 2021, where we did a lot of good work from our supply team we could really deal with this and work with this. I mean in the beginning of this year, we saw an acceleration, a clear acceleration both for inflation and logistics challenges. So that is clearly the story still. Now if we look on electronics, specifically and some of our key electronics, actually, I think we start to see the light in the tunnel. So we see for certain of our key electronics that the supply side is a little bit better, which is encouraging.

It's comforting. Okay.

But we are -- just -- we are far out from the wood. It's far from a normal situation. But specifically on electronics and certain of our key components, actually, it has starting to become a little bit better.

Thank you, Erkki. Then I have received a couple of questions from Vlad Sergievskii. Vlad, I know that you have dialed in, but can you unmute yourself or shall raise the questions? We cannot hear you, so I will address the questions. So starting with COVID lockdowns. Have COVID lockdowns impacted your manufacturing facilities in China?

Yes. They have been in lockdown. They are now slowly ramping up again.

Then could you discuss the balance of execution risks profile embedded in the project portfolio today compared to where you would like to see it? On one hand, you managed to streamline execution in the past 12 months; on the other hand, you some -- on the other hand, you have some bigger lumpier projects in Q4 last year, which perhaps carry a more a bit more risks, plus there is a tight labor market inflation and supply chain disruptions and those factors perhaps add uncertainty to execution as evidenced by one of our U.S.-listed energy storage peers this month announcing on certain contracts?

So I would delineate the project risk in our portfolio in, you could say, 2 main buckets. Let's call it, operational bucket and let's call it the inflationary bucket. And if we start with the operational bucket and I think here we have worked on stabilizing the way we work our processes, our risk management and I think we are going in the right direction. And to your point, we took quite a few big projects in Q4 last year, Mexico and Brazil, et cetera. I think those have clearly an operational risk profile that we consider to be in line what you could expect from a well-run project business. So from that perspective, I think we are stabilized. Now if we then go to the inflationary bucket. And this is -- as I said, last year, we had inflation but we can work with it, we could mitigate it, et cetera. The start of this year has been more challenging, quite frankly, because we and I think many industries are facing an acceleration of the cost inflation. And this is why we have said that even with the price increases we are doing for some with this latest acceleration, it will have impact on our profitability on the short-term, I would say. Because on a mid- to long term, we will work with price realization.

The next question is coming from [ Georg von Wyss ].

If people are hesitant to buy batteries, does that mean that they're looking more at buying engines to provide the balancing power? Or is that -- yes, that would be question number one. Number two, if you're taking less battery orders this year, does that have a meaningful impact on your profitability? My assumption is that your gross margins are marginal and that you are going to be carrying a lot of cost to build up your organization and your R&D any way no matter how much or how little you sell. So I would think that we really wouldn't notice it on the profitability, whether or not you sell a lot of batteries this year? That would be my 2 questions...

Yes. Okay. So if I start with the first question, I mean we don't see balancing. I mean we talk about balancing technology, we talk about that more balancing power will be needed as we introduce more renewables to the power system. And -- but we see the thermal power plants and the battery storage as complementary because they cater to different needs, different time domains. So we don't see a strong cannibalization from that perspective. So it's not one against the other. They are complemented. So -- in this general cost inflation, and of course, we are increasing prices both on the thermal and the storage side. And that, of course, also -- I mean, coming back to the dynamics that I talked about before. I mean, people have developing projects. They have run their financial calculations, assuming certain interest, certain cost levels. And of course, when there is -- because on the thermal side, we don't have a similar cost escalation where 3.5x in 12 months. But of course, there is a general price escalation, not of the same magnitude. So of course, that leads to price realization from our side. That also goes into the project calculations of the thermal balances. And of course, people need to take a thorough look on the project cost calculation. So there could be some impact. But I would say the battery storage increase, it's a bit of a different magnitude, I would say. So it has a bigger impact. Then coming back to your statement on the battery order intake and related to our profitability. I think overall, you're right, because there is a time lag between when we get the order and then when we deliver and therefore, recognize sales and profitability.

I'm sorry, I didn't catch the last point. Can you say that again? It takes a while to deliver your order and then happen?

And recognize sales and profit.

Yes. Okay. But the question was if the contribution profit on a battery sale is high enough to make a difference whether or not you sell a lot of batteries?

Well, we have a positive gross margin. So of course, from that perspective, it's contributing. But my understanding of your question was, will it have an impact in '22. I mean the order intake of 2022, what impacts will it have on '22 sales and therefore profitability? I would say that a lot of the order intake in 2022 will be delivered in 2023. But maybe I misunderstood your question.

No, no. Yes, yes, you sort of did, in the sense that I'm asking whether or not selling more batteries at this point really makes a difference to your profits this year or next year, I understand the time for it. I guess another way of asking the question is, aren't your gross margins really low and your SG&A very high? So the amount of volume that you put through the system doesn't really matter yet?

No, I mean -- and I will not go into the details of our gross margins, but they make a meaningful contribution. So I will not draw the conclusion that you draw there.

Okay. Let me just follow up. As you know, I don't agree with your policy at all. Can you explain to me why you don't tell us more about the profitability of batteries and how much it's costing you to build that up?

Because it's a competitive space, and we don't want to give out information to competition where we are. And it's also -- we clearly stated that this is a journey of a couple of years.

Next question comes from Andrew Caldwell.

Perfect. I wanted to stay on the battery business. But on the supply side, can you just explain to us how the pricing contracts work with your battery suppliers? And do you sort of lock a price in per contract? And are those suppliers currently honoring the prices they said they would?

So I mean, we have frame agreements with our suppliers. I will not go into the details of those because I don't want to give that information to our competitors, but it's framing.

Okay. Is that sort of on a rolling basis, you have to price them up once -- how does the repricing works there?

We have mechanics for indexations, similar mechanism.

Okay. And the other question on the battery business was your message is just very different than, I guess, your main competitor. Fluence are saying the order environment is really strong, but they are declaring force majeure because they can't get batteries. You're saying you can get batteries, but the order environment is pretty weak. Why do you think your message is so different to theirs?

You have to ask them. I mean, I can only say we are disciplined on our pricing side. We have a positive gross margin, and we have a supply chain that works for us.

Okay. And just one last one. On supply chain more broadly, you said China was having a material impact. And I guess that's gotten worsen in April and May versus what you told us at the 1Q call. Given the batteries aren't impacted, can you tell us where you're seeing the biggest impact?

Sorry. I missed that -- I mean if you talk about COVID impact in China, where we see the biggest impact is on the lockdowns. And as we talked about here, our own manufacturing plants have been locked down. Certainly also on supply chain, getting materials out of China certainly has some impact on our battery storage business. But so far, we've been able to cope. It's also on the services side and on the marine, where it's hard for shipowners to do the maintenance that is normally done because the yards are not -- you are not allowed to enter ships or you're not allowed to enter the yards. So there you have major impacts.

Next question comes from Sean McLoughlin.

Can I just build a little bit on the service piece? I mean how much of your servicing is done in China on the marine side?

Currently, I don't have that. Do we have those numbers publicly?

I don't think so.

Yes. I mean the shipowner sail the world, so I mean, there are services being carried out in China. Quite frankly, we should be numbers based. I don't have that on the top of my head. But I mean, there are maintenance carried out all over the world, but certainly in China and especially for these 5 and 10 years' overhauls, the Chinese shipyards are at top class, I have to say.

Maybe we can try to find some figures for that pre-silent in COVID.

Yes.

Can I also just dig in more broadly into the 2-stroke versus 4-stroke? With, I guess, a lot of LNG going to 2-stroke, can you explain why 2-stroke is gaining market share? Is it that less vessels actually need variable power? Is there something specifically within 2-stroke development that may have closed the gap? And would there be any strategic rationale for you to look again at the 2-stroke segment?

So let's comment and maybe I wasn't clear. But I mean there is not a general increase of market share of 2-stroke versus 4-stroke, so that's first statement. And let me -- with that we will discuss in LNG carrier and when we talk LNG carriers and for those of you who has followed the industry for quite some time, LNG carriers used the big gas turbines, then the 4-stroke with Wärtsilä came in, and we really dominated that segment for quite some years. But then 2-stroke gradually came in with the gas. And they have, I would say, been the dominating solution for LNG carriers for quite a few years. This is the current status. And we are still on the 4-stroke for the LNG carriers on the Artic ones, and the ones where you have more challenging applications. This type of market we have had for quite a few years. And therefore, I was making the comment that I think it was I mean I don't know it was Sven or Tomi pointed out that there is a lot of activity on the newbuild side on the LNG carriers, and therefore, they are mostly 2-stroke. I mean that is an established technology. So it's not that they are increasing their market share from that perspective. And then I also said that we were having discussion on 2022. When I look a little bit further down our technology development, I would see opportunities for 4-stroke revival in the LNG carrier space. But that would take a couple of years and that is based on some of the technologies, including hybrid solutions that we are developing right now. But that is still very early. Did I clarify your question?

I think so.

Next question comes from Peter Murdoch. Please go ahead.

Hakan, can you hear me?

Yes.

Yes.

Can I ask 2 questions? Hakan, you've been very clear just on storage that the inflation that we're seeing is impacting the order intake or the demand for the orders. Have you got a size of kind of order intake you'd be happy with for that business this year versus the 700 you did last year? And then can I -- 2 more, if I can. The underlying thermal business, how do you see that developing? How is the quotations demand there? I know it could be very volatile. And then just the last question is just on the order intake, in general. You've guided for a similar level of orders in the 2Q versus the 2Q of last year. It was a similar level in that 3Q last year. How do you see -- can you go a bit further, how do you see the order intake developing in the second half? Do you see areas or room for improvement? And if so, where?

So I would say, I would reiterate our guidance for Q2. I would say for -- when we look at the full year, I mean, we don't guide for the demand cycle. I just -- and I said that many times, please note that Q4 last year was all-time high in the history of Wärtsilä. Having said that, I see a lot of activities on the thermal side. And a lot of -- but as you pointed out rightfully so that this is it's a bit of a lumpy business. But I can confirm there is a lot of activities. It's not standing still because of the geopolitical situation or anything else. So there is a high level of activities. On the storage side, I mean it has -- I also said that there is a lot of interest, but the market is still digesting the new prices. So there is a short term, in our view, you could say, yes, tempering and a digestion of the prices. But we do still see a lot of activities, yes. And I think the market, as we see it, is getting to a situation where the prices will have -- the price increases will have been digested.

Can I follow up 1 -- sorry, 1 more. Just in terms of inflation, you're very clear inflation something that impacts you short-term profitability wise longer term. It's not that big a focus. But just in terms of the short-term and the impact on profitability, is there a division or a business that you'd highlight or it's across the group?

I would say, it's across the group because it's the general inflation. I don't think -- yes, we can see it on the classical commodity types and also on the logistics side.

Next question comes from [indiscernible]

You viewed at my question. I don't know how to remove this hand.

Next question comes from Antti Kansanen.

Yes. Coming back to the inflation and kind of the backlog that you have and you said that you are mostly kind of back-to-back covered, but obviously, inflation will have a negative impact. So is this more about that you don't have the [ escalators ] had agreed supplier contracts in place in all of the deliveries? Is it the fact that the suppliers cannot honor the agreement because of their cost base? Or is it more about this kind of logistic expenses that cannot be hedged as efficiently as kind of a normal commodity and component inflation. So just a better understanding where the negative impact is exactly coming from?

And I would say and sorry if I'm not being able to be clear, but it's a mix of all those factors that you mentioned. There is not one key driver. It's a bit of everything. That's the best answer I can give.

Okay. And then what about kind of the delivery schedules regarding the backlog? Are you now more worried that those might be prolonged and you get less of revenue recognition for this year that you have anticipated because of the COVID situation in China, the broader supplier challenges. Is that a major concern? Or is it more about the cost?

No, I think in general -- and of course, we are also impacted by supply chain disturbances. But I think so far, I think we are managing this from a good perspective. And I think this is -- this, we are managing in a good way. So I see it more from a cost perspective.

Okay. And then last one for me would be on the parts -- spare parts business on -- especially on the marine side. If you look at kind of the performance after the initial COVID shock, the recovery and the levels of '21, is there a kind of a restocking prebuying impact in there that the customers are concerned about the capability to deliver so that it might be a little bit inflated versus kind of the actual demand that there is in the marketplace?

I mean we are looking into this very closely. And it's a little bit too early to say. But so far, I don't think we have drawn the conclusion of that there is this strong prestock effect. I mean we do see the uptick on the spare parts side. But so far, it seems it's a very broad uptick, and it's driven by the underlying operations. But we are following this very closely.

Next question comes from Johan Eliason.

Sorry for coming back on this battery storage again. But when we look into fuels and the gross margins, you claim that they are positive and so, but then the realized gross profit margins are negative now under the deliver. Can you just confirm that your gross profit margins, you're talking about they are positive both when sold and when delivered currently?

I can confirm that.

Good. And then I was thinking about another thing, you have talked about your overlay software, the Greensmith business as a competitive advantage because it enables the utility or whatever to have the best energy mix, basically. And if you look at, for example, Fluence, I mean, it's batteries and batteries and they've done some acquisitions of some software company in Switzerland recently to sort of add to this. But that tells me that this aftermarket opportunity that you were highlighting is not necessarily sort of the spare parts, but the optimization services speaking of. It sounds like this should be able to provide more value to you with your software than what Fluence and the other sort of focused battery providers are. Wouldn't that, in that sense, make sense for you to grab the market share right now and today and make sure that you have this seemingly more profitable aftermarket or am I misunderstanding this?

No. So let's elaborate on that. I think there is a logic for that. I mean first of all, I think competition also has software platform. So I don't have to point out they're making acquisitions in those directions. But then I would make the point that, yes, software is software and computers are computers, it's what you put into the software your experience, your knowledge about power system optimization, et cetera. And this is part of our DNA and part of our history. So I would say that's why -- and to a certain extent, some of our key customers confirms this is the strength, the competitive strength of Wärtsilä. So, I mean all the others, they will have some kind of software. But what you put into that software and how you work it, this is where at least we want to differentiate, so to say. Now coming back to your point, so why don't we just leverage this and take over the market because here, we have some value creation potential? Well, I mean, I think there are 2 comments to that. As always, there is not only one customer in the market. You have to segment your customer base. And there are some customers for which this -- our proposition, you could say, our core proposition is more interesting than others. I mean there are certainly customer segments that they only need a battery storage. So we need to different customers, different preferences. Now -- but we do have a strong customer need for this type of optimization that we are talking about. So why are we not moving ahead? We're actually moving ahead now because we just launched the decarbonization services. I think what is taking time there is this is a new way of thinking and we need to elaborate that thinking together with the customers. So of course, that's part of the normal sales process and that takes some time because it's about getting customers to be comfortable that you can actually optimize the system and for the customers to see the real benefits in terms of lower cost and uptime reliability. So that's, you could say a project development sales process. And we do it -- I mean, we know that projects takes time to start.

Next question comes from Karl Bokvist.

Just the first question here on the marine side, when it comes to the environmental regulation, CII, EEXI set to start 2023. Given the data you provide, it seems to be a lag in order activity first picking up 2024. Is that what you hear from your customers as well that we will wait until the regulation kicks in and then they will take the decisions, or what's happening there?

So now I think there is a lot of activities and a lot of discussions. We are engaged in a lot of discussions with our customers on the new regulations that kicks in, in 2023. And just to share some, I know many of you know this very well, but for those that are not working on this with a daily basis. I mean if you take the CII index, it's basically, you could say it's a classification system. Visually it looks like when we all go and buy a fridge or a washing machine, you have this A to, I don't know, F or G classes, some are green and some are red. Vessels will be classified according to the same scale. But the challenge there, we are not asked to year-by-year improve the energy efficiency of our washing machine. The shipowners to stay in class B, they year-by-year needs to reduce emissions. And people or our customers, they are sitting with our fleets, with Excel Spreadsheets, they have vessel per vessel. They had the years. And how are they going to keep a certain vessel in a certain class A, B, C or D? And I can clearly say that, that is triggering some very interesting business opportunities. But people start to work with energy selling solutions, hybrid systems. So I think that there is -- going forward, there will be a lot of interest for hybrid installations, retrofits. You're bringing batteries combining it with combustion engines. And then further down the road, there is the new greenfields. So this is discussion that is going on right here right now, because people are focused on the existing fleets, and they clearly see a need to move there. And of course, when they think about newbuild, decarbonization is there already from the very beginning. So I do not see this in general, this postpone until the future. Then should acknowledge among the marine customers, of course, they are the early adopters and the laggards like in any market. But I would say that there is a high level of interest.

All right. And then if I may, just on the electrification side in marine, just solar power in general, a lot of things happening there in terms of directives and then also a bit of more the shorter point-to-point ferry operations that you're also active in. First one, just electrification today, how is this a meaningful part of Wärtsilä Marine and in which part of marine, are you currently really devoting resources to being prepared for this potential?

Yes, no. I mean we are really excited about the electrical opportunities. And I mean -- but we think broadly speaking, the hybrid opportunities will be significantly bigger than the full electric opportunities. Because the full electric, it will be there. It will be there for certain ferry operations where you can refuel or recharge quickly and -- because the key challenge is then on the density. And you probably seen in -- I think we had an interesting slide in our Capital Markets Day when we compared the net tank size between different energy sources. And when you go for the battery, you talk significantly bigger volume in the ship needed for the energy. And that puts some constraints on which applications. But I mean, fully electric solutions, they will be there, but it will be more for very specific applications. We don't see it as a broad solution for the broad different type of applications. However, the hybrids where you complement the engine with a battery, there we see a significant retrofit potential, but also newbuild potential. And when I talked about this 4-stroke coming back in the 2-stroke for LNG, that is also a hybrid concept.

All right. But it's a small portion today, if I understand it correctly, I mean, solar power, in general?

Yes. I mean the solar -- okay, if you go into solar power and the charging and the charging infrastructure, this is still a small business. I mean we have solar power charging capabilities and competencies in our Norway business. We have a dedicated hybrid team. So there, we are really investing in building competencies, which is a joint German Norwegian team. So there, I would say in the hybrid side, it's [ full team ] ahead.

Next question comes from John Buckland.

I was -- my questions were going to be about this, this whole retrofit hybrid opportunity and obviously, that the need to have auxiliary power -- electrical auxiliary power when you're docking. And you also talked about 4-stroke has a revival potential due to technology and hybrid solutions. I just wondered if you could elaborate more on this? What is it -- what technology is going to cause this revival? And short-term, I mean how quickly are we going to see the shipowners take up your solutions for delivering hybrid? I mean is there any interest? How big could it be? How quickly could it come?

Yes. So if we start with a more technically oriented question, why is this coming now? I mean first of all, it's a combination of our latest spark-ignited gas engines in combination with the latest battery technology and -- using and integrating those. That is one technical driving element. The other technical driving element, and this is a little bit related to the thinking of CII. I mean the 2-stroke engine is optimized for one operating point. I mean this is highly efficient in that operating point. But as we go forward with CII, the energy consumption of the vessel will go down. And then you will move down the engine utilization curve for the 2-stroke, and it's not as efficient anymore. Whereas where we use the very latest 4-stroke, we can run our engines together with the batteries efficiently or independent on the energy consumption. So that is a very interesting feature. And especially now since power [ plant ] engines with gas have been more and more accepted in the industry, this provides significant opportunities to -- actually, especially for LNG carriers to reduce cargoes -- increase cargo space, reduce CapEx and improve the operational costs. However, I clearly underline, this is still at early stage, but we see a strong opportunity here. Then coming to your second part of your question, can you just repeat it, please?

I was -- there's an opportunity because of the requirements for reducing CO2 for ships to have hybrid solution the retrofitted for -- to allow them to an electronic controls and all that stuff to allow them to dock and be powered by electricity and to meet these CII requirements. There's a lot of ships out there that need this to happen. I mean how big is the opportunity and how quickly it's going to come? What -- are you getting orders?

Yes. I would say there's a significant opportunity. I would say it will pick up during the coming 5 years, which is rather short in our industry. And I do see a lot of industries there -- sorry not the industries -- I do see a lot of interest in this space. And -- yes, a lot of activities. And I do also see some order intakes. But that we will have to come back when they are official.

Can you size this opportunity?

Well, we -- I mean, currently, we have about 60 orders for hybrids in our order book -- in our order book or delivered.

Okay. And what could it get to then?

Multiples of that, I would say...

Because presumably, your business model to have a dedicated hybrid team is based on what the business opportunity is -- 60 orders. I mean can you now tell us a bit more about what the opportunity is?

I would say that we have significant opportunities in this area. I will not go into further details on this.

Then I have received a question from [indiscernible]. So he's asking for an update on voyage and what is the long-term plan to replace Russian R&D facility?

Okay. So if we look at the Russian situation, and -- I mean, first of all, we have suspended all our exports to Russia. And I think we have also made the EUR 200 million of provisions in Q1, as you all know. And when it comes to our software business, because we have a software team in St. Petersburg primarily working to voyage, we are looking to downscale that and build up the competence in outside of Russia. And this is ongoing as we speak. So this is a transformation that we are currently right in the middle of. And we are doing this, I mean, of course, making sure that our employees in Russia don't get into troubles. But -- and we also -- we also have Russian employees or colleagues moving out of Russia. So it's a major undertaking that is happening, as we speak. I mean so far, -- and I'm very optimistic about that. We are maintaining full business continuity. I mean we are supporting our customers. Our deliveries are ongoing. So we have a great team that in spite of this major shift is delivering in a good way. But of course, the whole change, the whole Russian matter, it has -- we have been clearly incurred additional cost, and we have made some write-downs as you know.

Then [ Georg von Wyss ] has a follow-up question.

You mentioned in the beginning the Clarkson data that merchant orders are down and you said it's because the yards are full. I have a couple of questions on that. Number one, does it matter very much for you what merchant orders are because those are largely 2-stroke engines that go into those vessels? If anything, you sell the auxiliary engines where you said that they're pretty commoditized. So I guess the question is, does it really matter how large orders are? Or in another sense, because the lower level of orders mean that they can -- well, the other way to look at it is this, if the yards are maxed out, does that mean that your merchant -- that your revenues in marine are basically maxed out because there's just not more capacity into which to sell engines?

I mean -- I think -- the first one, in general, you're right. I mean if you look at container vessels, I mean, first of all, they are majorly 2-stroke on the main driver. And the auxiliaries is a bit of a commodity. So this is not a strong segment for us. So from that perspective, I mean, there has been quite a lot of activities on the container side, and that is not the segment that we are the strongest in. Now when we talk about the LNG gas carriers, it's also a strong segment for 2-stroke, but I think we have a bigger portion of the action there. So -- but I think here, we also need to acknowledge that even if the yards are full, not all the equipment almost have been awarded yet because, first, -- so there is a time lag between the yard receives orders and when the OEMs, including the engine manufacturer gets their orders.

It all sounds very good. For you is that sounds like a good thing that you're going to be getting more orders for the gas handling systems most likely on most LNG carriers and so in a sense -- I guess the question is, why did you tell us that merchant order or orders from merchant vessels are down according to Clarkson when in a sense, it doesn't really matter to you? Did I misunderstand that?

Well, I guess, that -- I think we need to be a little bit aligned with our market communication what others are saying in the market as well. So I think it's more related to that.

Okay. So we should interpret it as a negative signal. That's, I guess, [indiscernible] for me.

No. But I said it before, and then sorry to say it again, Q4 was a all-time high record last year, so that is history. I think you need to reconsider that as well.

But the Q4 was also an all-time record in orders because of all the battery orders, right? Was it an all-time record in orders in terms of megawatts of thermal?

It was -- well, all-time high, I don't know. But I can say -- yes, for battery storage, you're right, it was all-time high clearly. For thermal, it was a very strong quarter. I'm not sure it was at all-time high, but it was a very strong quarter.

And then also Andrew Caldwell has a follow-up question.

Great. I just wanted to understand slightly on the working capital side of the battery business. As this becomes bigger, I assume you have to take these batteries onto your balance sheet during the project. Does this sort of fundamentally change working capital of Wärtsilä, I think 3, 4 years out? Or is there some way you can mitigate that?

Well, I think we use traditional supply chain and supply chain financing measures there to work with and partially offset the balance sheet impact.

Okay. So inventories go up, but you offset that elsewhere on the cash side?

Yes. I think we are all aware supply chain financing, how that works, so to say. So those are the some of the standard tools in the tool box and we used them in the storage business.

I do not see any hands raised. So if you have any questions, please do raise your hand function, we still have 10 minutes' time. Okay, [ Dominic ].

So I had one of my colleagues here slipping me note here. So coming back, we tried to dig out some of the facts that we didn't have on top of my head, at least. I mean if we looked at service sales in China in 2021 because that was 1 question that was asked, how big is the service sales in China? I think it was about -- I get the note here, it was about EUR 40 million, and that is some of Chinese yards and Chinese owners.

Thank you, Hakan. That was a good update. So then Dominic.

Well pronounced the last time, I know it's a hard one. Just a quick follow-up to Andrew's question on the -- and thanks for the comments. Are you prepared to give us a bit of an indication in terms of the size of the supply chain financing in euro terms?

No. And I don't want to do that because once again, I don't want competition to know this.

Okay. Understood.

Any further questions or anything else, Hakan, you would like to highlight from your side?

No. I think we -- I mean we talked coming back to where I started, I think the service business it's evolving in a positive direction. It certainly provides stability to the business. And we also see some very interesting growth opportunities going forward. I mean -- it's some things what we talked about in CMD, but we are clearly moving in the right direction.

Dominic, you have raised your hand once again. Is it...

No. I just didn't take it down, apologies. All good.

No problem. It seems like that there are no further questions. So many thanks for you, Hakan. And then as a reminder, we are also providing a webcast for our new Smart Technology hub opening in Vaasa. It will be on May 31. And then we are hosting a pre-silent call with our CFO, Arjen Berends, that will take place on June 20. So please join those events. Thank you.

Thank you. And thank you all for your questions.