Wärtsilä Oyj Abp (WRT1V) Earnings Call Transcript & Summary

Hello, everybody, and good afternoon. Welcome to this pre-silent call. The quarter 3 is almost ending, and we have a great pleasure to have here Arjen Berends, our CFO, to discuss the recent trends on the quarter. As earlier, there will be no new significant information on this call, but I think this is good and equal opportunity for everybody to discuss the recent development on the market. So Arjen, please start with the key messages.

Thank you, Hanna-Maria. Yes. Welcome also on my behalf. A few key messages upfront before moving to Q&A. First of all, let's say, on the positive side, I think our guidance of being better year-on-year on the quarter, I think we hold that one. We see good performance in the service business. We see also good performance in basically the newbuild side. In particularly, storage is moving well forward also again after, let's say, this price we said that we have been talking about in Q1 in, we could say, springtime. There are, of course, also concerns, clearly. Let's say, I think we are not the only one. I think all capital goods industry companies face the same, let's say, concern about cost inflation, which we thought flattening, let's say, at the -- towards the end of Q2. Now in particular, coming somewhat back through the energy prices, which is quite severe in particular for, let's say, our suppliers that have quite intensive energy production processes, like forgings and castings. We see there, let's say, energy cost in as part of their product costs going up, let's say, double or triple or sometimes even more than that. So that's a concern. Another concern is, of course, let's say, the whole salary inflation, which basically can only go one way, and that's basically up. And okay, how do we mitigate and how do we cover for that also in pricing and continuous improvement efforts? So those are concerns. We are working on that. Let's say, we are working on that continuously. Pricing adjustments, I would say, since -- I would say, last year, beginning of this year, when all this cost inflation kicked in, are really high on the agenda and extremely frequent. So we are really on the ball here. But certain things, let's say, you cannot avoid. So that's a challenge. Outlook for operating cash flow, we had 2 negative quarters in the beginning of the year. I'm confident that it will be better, let's say, this quarter. I will not go into further details there, but it will be better. Then if we look at second half of the year a bit, let's say, yes, we will face, let's say, items affecting comparability. A bit difficult to say how much. But clearly, and I think you all understand the Trieste case, we'll give something. We also put that in the announcement when it went out in July. But let's say, timing-wise, it's a bit difficult to estimate how much it will be for this year and how much will flow over to next year. Processes in Italy, in this case, are quite slow, so not so easy to predict. If we look a bit at the markets, Marine Markets, okay. The contracting is down, even though there is anticipation by Clarkson that it will go up next year. Despite the market being down, I think our order intake still goes pretty okay, considering this fact. So I'm not totally negative, but it is, of course, let's say, a concern that the market is not going up, but let's say, on a low level. Cruise fleet. At the end of August, about 6%, 7% was still idle, which is not, let's say, extreme. Most of the vessels are sailing and that we also can clearly say, I said already, service business moves well forward, and that we also see clearly the contribution from cruise. Running hours correlate with service business. That goes both for Energy as well as for Marine. New cruise vessel ordering, I don't see on the horizon, at least not significantly. Definitely not the really big cruise vessels. I think that's all, yes, to be for later years. Smaller vessels, let's say, call it, expedition cruise vessels that you see here and there. But the big cruise orders, I don't think they will come in the near term because most cruise companies are quite heavy debt -- they're on quite heavy debt burden, and they are focusing on getting lower on that. Contracting for LNG carriers is solid, also supported by the whole Qatar expansion project, so that's moving well forward. Offshore oil and gas, we see more activity. So that's initially on the Service side. Contracting is not that much, but we see more and more of these offshore vessels being utilized, of course, driven by the high energy price environment, and that also firms the vessel demand consequently. Fuel price spread, let's say, when we think about scrubbers, it was quite high at the end of July. Came somewhat down towards the end of August, but still, what is it, about $250, I think it was at the end of August, dollar per ton. It's still a very good fuel spread to make, let's say, a scrubber business case. And we also have now, in quarter 3, received first retrofit orders on scrubbers as well. So that's a positive sign. Energy markets. In general, I would say that despite, let's say, the business is moving more from, let's say, baseload to balancing power, slowly but steadily. We see engine running hours still actually increasing. There's a lot of power plants even for -- that were, let's say, call it tanked the balancing power, they are making quite high running hours at the moment. So also, on HFO, actually. Storage business, I commented already in the beginning. Good development really taking on. Let's say, good pipeline and also you will see good orders also in quarter 3. And going forward, I'm pretty confident with that as well. I think that's what I had in mind to say upfront.

Okay. Thank you, Arjen. Then we will continue with the Q&A. Daniela, you were the first one, raising your hand. Please go ahead.

Just a couple of -- 3 things, if I may. So on that point on storage. Can I just double check now? I think a couple of quarters ago, we talked about like difficulty in passing through the big price increases in lithium. But now to a point that from a pass-through perspective, you're able to pass through everything? Or are we still sort of seeing some dilution basically from that lag?

I would not say so. Let's say, we -- okay, if we talk about the existing contracts that we had at that point of time, of course, we have the challenges still there. But let's say, for new contracts, we have been able to, let's say, raise the prices. Also, the tenders that we are outstanding, we have been [indiscernible] direct [indiscernible] for a better price. Let's say, for the newer contract, this is accepted. And actually, the whole market is quite well accepted in the [indiscernible] high prices. It went out that I think there was one of the slides, I think in the material that Hanna-Maria [indiscernible], we have to look at the number of euros booked in Q2 versus the megawatt hours, you can clearly see the delta. I think that was published as well, if I remember right. Wasn't it?

Do you want me to show them?

Yes, you can show that graph. That might be a good one to show.

Just a moment.

Give us one second.

Can you see it now?

I don't see -- yes, now I see it. So here, you can see quite nicely on the bar of Q2 2022 that, let's say, number of euros, you get a lot more on the megawatt-hour bar, it's on a lower level. Normally, that correlates. So there is clearly, let's say, a price reset in the market, and I think it is well accepted, I think.

And just one follow-up on this. What's the amount of, like, fixed costs that you have that you say go -- they are specifically dedicated to storage? Is it like -- is this structure -- is there a separate structure? Or is there -- I'm thinking about what's the breakeven point that we should think about you need on sales.

I will not comment on that, because I will not open up on the profitability. Like I said before, we have a positive gross margin. We have also synergies between, let's say, storage and energy power plants, you could see project [indiscernible] we are cross-utilizing resources as well. So I -- we said we will be going to [indiscernible] even in a few years, and I think we are on track to make it.

Okay. And final one for me. By the way, I don't know if it's just me, but the line is really breaking down, but maybe it's just from my end. Just one final question. I think ABB is spinning off the turbocharging business, I think, lists next week. I think you have some overlap as both a customer, but also you do some turbochargers as well. I was wondering, just in terms of like a market setup, if that was an adjacent area that you've thought about? Or does this imply anything in terms of like competitive landscape for you? Just curious on if you have any views there.

Okay. ABB Turbo is, of course, a key supplier to us. We are also having, let's say, quite tight cooperation. But let's say it's not the only supplier for us. And if your question would be, okay, are we interested to acquire them? I would say no. That's backward integration for us. We don't see the need and we don't see the benefit either, nor do I think that the price they want to have is something we want to pay. It's, of course, always a balance between, let's say, the price and the benefit. Of course, on the service side, there could be lots of synergies. I absolutely agree. But let's say the -- I think the price tag for ABB is higher than what we are willing to pay for.

Very clear. Sorry, it's just really, really final one, I would rather miss. But why do they have a very -- a much higher aftermarket share than you have? Is there a structural difference between like edge? Like how can they -- why would they have 75% of the business being aftermarket and a very -- a much higher retention than you would have in engines?

I cannot say because I let the confidence on their structure and their component composition. Difficult to say. I cannot say. But I know that we are doing also a lot of ABB Turbo overall. So the part that they don't have, we might do.

Thank you, Daniela. Next question comes from Sven Weier.

The first one is actually on, Arjen, what you mentioned in terms of the additional cost on your suppliers, the wage inflation. I mean, to what extent is that also then impacting your legacy contracts, especially where you have EPC? I mean, is that inflation so much higher that you have to recalculate, or how should we put this into perspective, what you said?

I think for, let's say, EPC contracts, we typically have already, let's say, contracted our subcontractors, so to say. So there, I don't see too much of an issue. When it comes to, for example, the cost inflation for, let's say, components that are used in an engine, and there are thousands, then, of course, it's an issue. It's not an issue immediately, but it's an issue over time. Because through the logistic chain, okay, part goes to warehouse, warehouse gives it out to the order, production is done, then it's delivered to the project and then to the customer. So there is a time lag. There, we are really, let's say, very keen, as I mentioned, to make sure that there is a very tight link between our supply management organization and the organization that is really making the quotes, in particular, for engines, for other equipment like thrusters that are, let's say, certain assemblies of components and parts that you buy externally to make sure that, let's say, early enough, let's say, the price is adjusted to what we expect, let's say, a couple of months down the line. That's, of course, a quite cumbersome exercise and it's also, let's say, hampered by, let's say, the high volatility. Because if you look at gas prices also, okay, now look to just past month, it goes like this. So what will it be? Let's say, the supplier is -- and it's also on the energy contract that the supplier has. Where is the supply low? Whether the European one versus an Asian one? There are lots and lots of factors to consider. But the fact is that, let's say, I think, globally, there is more pressure up than, let's say, pressure down, so to say. So we need to be very close in the link between supply management and quoting departments to make sure that we are anticipating what we think will come. That's the most [indiscernible] -- but you never say never.

That's fair. And I think what you also said earlier, I mean, I think in the last couple of quarters, you have made more progress on pricing in general, right, on the OE side, that you sounded more happy about your ability to pass it on.

Yes. And let's say, I think our competitors are doing the same. So that, of course, is also helpful. If you're the only one doing it, then you price yourself out of the market. But I think everybody is -- these extreme cost inflation ratios, everybody is facing it, so everybody is raising prices. So it's not odd anymore either.

Yes. And the second one is also on the battery storage business. It's basically a twofold question here. First of all, I was just wondering on the inflation reduction at U.S., business momentum there, I guess, quite a positive for storage. I mean, are you seeing this already? Is this behind the momentum you have? Or is that still something that's coming? And the other question on storage was also, when I think about mix impact from storage, first half, sales contribution was still a bit lagging behind on the delivery. I mean, is this strongly picking up in Q3 so that we should be mindful of the mix impact from that?

On the first part, let's say, the IRA, it's strange abbreviation though. But on the IRA, the -- yes, for sure, let's say, we will benefit on that one and that we can clearly see also in customer negotiations that there is, let's say, clearly a stimulus in the background to invest actually. Half of, let's say, the IRA is designated basically for energy. So it's a bit too early to say, okay, yes, we have already this, this and this. Let's say, this is not so long out, so it's rather fresh as well. But let's say, all the signals, discussing with customers are entering into a positive direction as a stimulus from there. On your second question, will we see more deliveries of storage in the later part of the year? I can only say the answer is yes.

Thank you, Sven. Next question comes from Antti Kansanen.

It was a bit of the same theme as Sven already asked about regarding the cost inflation. So I guess this is predominantly a European supply chain thing. So could you remind -- and perhaps you can talk about -- you mentioned engines, but how much is this impacting kind of services, the spare part portion of that? And could you talk about your exposure in general to European supply chain, and how can you kind of mitigate that by using alternative supplies?

I think if you think about, let's say, key components and in particular, let's say, forgings, like engine blocks, thruster hubs, et cetera, they are mostly, I would say, almost only coming from Europe. And there, like I said, it depends very much on let's say, a few suppliers. Let's say, these components like crankshaft, blocks, et cetera, there are in the world only a few suppliers that can make it. So you're basically, let's say, booked with them. There is not so much, let's say, room to play on price either and play suppliers against each other. As the majority of our supply chain is European, in these particular cases, we face this issue. And yes, that is not easy going away either. I think, let's say, as long as this volatility and uncertainty about energy prices continues, my estimate is that it will be at least throughout the winter. Let's see how it moves. Once again, I think for us, it's key to be alert on, let's say, any signals from the market and translate it as quick as possible down to our, let's say, quoting and sales departments.

Do you think this is more of like a price cost issue, or are you seeing kind of a lack of availability recently? I mean, I guess your suppliers' suppliers could be kind of struggling with getting materials. Steel plants are taking downtime as well for it, so.

I don't hear that much or at least I've not heard anything actually on, let's say, a shortage of raw materials for them. I think that's not the issue. I think it's the energy price that's really bothering them at the moment.

And this was basically a new equipment thing. So spare parts, are they impacting?

In spare parts, let's say, you buy from the same supplier, so it's not any different. But of course, there you have much better possibility to price it immediately at a different level, right?

Sure. Okay. And then maybe secondly, on services, on the energy side. What have you, kind of -- it's pretty extraordinary environment. So what have you seen regarding kind of capacity utilization of your installed base, spare part demands and so forth during the quarter?

Actually, that goes very well. Our installed base is really running at a very good level, actually, and it has been increasing over the past as well, so really moving in the right direction. In line with, let's say, our strategy, moving up the service [ ladder ], and let's say, as you could see also in Q2, let's say, service business was significantly higher than 1 year ago. I think that trend will continue or at least, in the foreseeable future, we see that, let's say, continue.

Thank you. Next question comes from Johan Eliason.

Just a question on sort of how to think about the margins. You have warned about this big power plant installations and the energy volumes -- storage volumes that will go up, which is sort of detrimental to your margin. But now, we have suddenly a very strong dollar for you, and I guess that's mainly related to the service business. But could that strong dollar have an even more positive impact, as you say, service revenues is also doing very well right now. How should we think about this move for you?

I don't want to go into, let's say, how much or how little. I think, in general, I think, it's positive. Let's say, basically the most of our capacity is in Europe, and we sell also in dollar. Having said that, of course, we are also hedging many of the newbuild contracts. So at that point of hedge, it's fixed. So if further changes happen, it's not benefiting you. So -- but in general, I would say, positive effect, not negative.

But this hedging, I guess, you don't have on the service and spare parts?

Not on the spare parts, no. No. But then it's, of course, let's say, if you think about, let's say, vessels, where are they when they order the spare parts? Is it -- are we then invoicing them in euro or in dollar? There are different agreements also with different customers, so it's not a one size fits all here either.

Okay. And you think your storage orders are doing quite well here as well. Are you sort of taking share, you think? Or is it just that the whole energy storage business is now accepting this lithium base prices basically?

I find it very difficult to answer. I can see on our volume that it's going well up. Are our competitors doing the same now in quarter 3? I cannot say. I simply don't know. But our pipeline is strong. And let's say, also, what comes out of the pipeline, in my view, is also strong. We're very well in line with our expectations. So are we #2 now or #1? I don't think we are #1. But are we #2 now or #3? I don't know.

And the software business that you have in the power side, is that a significant driving force for you, you think, right now in the orders you are winning?

I think it is. Let's say, the energy management software, the GEMS software that we have, that's making or breaking the economics of the customer. And that software optimizes very strongly between the so-called the lifetime of the equipment. So if you charge and deplete, for example, the battery too fast or in a wrong pattern, then of course, you destroy the battery quite significantly and very quickly. So it optimizes the lifetime of the installation together with the economics. So let's say, in certain part of the day, you might have a higher price in the market, then it utilizes that as well. So I think the GEMS software is one very critical selling component in our business model. Not just for storage. I mean, it's for the whole energy system. So if you're balancing power or any other, let's say, power source in the system, it does the optimization for that at the same time.

Yes, that's what I wanted to get to. But do you think it's good for the whole of the business and not only the storage sort of management?

No.

Then giving back to Sven Weier. [Operator Instructions].

A few follow-ups, if I may. So the first one is also on storage. And I do remember that higher freight rates, logistics cost, obviously, a big ingredient. Then -- we, obviously, know that things have come down quite a bit. How soon are you going to benefit? Are you locked in on the contracts there? Or how soon can this be a tailwind?

I would say that's pretty flexible. Let's say, the transportation is often ordered, let's say, just before, so not too far in advance. And that is also for the reason that -- let's say, when the peak came in the cost inflation, let's say, nobody -- no transportation company wanted to commit. Let's say, if you go back to March, for example, or April, nobody wanted to commit for a freight rate in August or September. So it was, let's say, you work with day rates or next week, I would almost say. That's still a bit in the market. So let's say, ordering of transportation is later and later and later, which also means, let's say, when the prices come down, you benefit, right? Otherwise, you would have locked yourself a couple of months ago for a very high price. Now it comes down. So I would -- the transformation or let's say, transition to us, I think, is quite short.

Okay. And it's a major -- it's not a small item in the overall cost, right? It seems to be substantial when it hits you, basically.

Big equipment often, let's say, to transport it to, let's say, port of destination, you need a special ship. It's not that you just put it in a lot of containers, and that's it.

That's clear. And the other one I had was, coming back on the dollar, but looking at it from another perspective. I mean, we knew in the past, whenever the dollar was so strong, especially against the emerging markets currencies, it's a problem for your thermal clients, right, in terms of also getting the project financed. I mean -- but at the same time, you said activity on the OE side is very good. So it doesn't seem to have an immediate impact, at least.

We don't see it. Yes. No.

And the last one from my side is really coming back to your Marine comment. I mean, it's maybe more rhetoric question, I think I know the answer. But I mean, at the beginning, you said Clarkson data, obviously, coming down. We all saw that, and yet your business is okay. I mean, isn't that -- it's not a surprise, right, because you're exposed to the specialty segment that you went through and they have a different dynamic, right? So you didn't benefit much when container orders were going up, so you're also not suffering too much now that they are coming down. Is that the right way of looking at it?

Yes. Let's say, for the big container vessels, let's say, basically, our scope is more limited. Let's say, the main engine is not our -- in our scope of supply, it's a 2-stroke engine. So let's say it's the auxiliary engines, propulsion systems, bridge systems, seals and bearings. This kind of equipment, what you need to think about. So yes, from a total perspective, call it, share of the ship. Containers is less impacting whether it's up or down than, for example, cruise or gas carriers, et cetera.

And on offshore, you said, I mean, you see more service demand. But at the same time, we also now see FPSO orders coming back. That is also something you're exposed to in general, right?

Yes, yes. And that is also an area where I believe, okay, the volumes are not that big on newbuild side yet or hopefully, it will go up. But there, we have a very strong position in my view. Also like in the past, offshore was, let's say, booming in, but this is 15 years ago, I think.

Thank you, Sven. I do not see any thumbs up. Do you have any further questions? I think, Panu Laitinmaki, do you -- were you willing to ask a question?

Yes, I was. Sorry, I kind of dropped my hand already. But I have 2 questions. Firstly, on the cost inflation. So just to understand, what is kind of the lag from whatever the quote prices are? And when do you see it in your P&L? So if the energy cost is going up for your European suppliers, is this something that you will see towards the end of this year in your own costs? Or how does it work? And then secondly, on the Marine orders, would you have any ballpark figures, like, what is roughly the average order for cruise ship containership and a gas carrier?

The timing between, let's say, energy costs going up and let's say, we seeing it, I would say, it's a couple of months, might be half a year. There is a quite significant time, like, let's say, the -- of course, the -- and it might be even a bit longer than that. Let's say, the purchase order that's -- or the purchase orders that we have placed, they are at a fixed price. They typically don't change. But of course, you're constantly ordering, let's say, engine blocks, et cetera. So the new purchase orders that you put out, they go higher. Then they are delivered, let's say, I don't know, 6 months from now. We just take an example, then they come to our factory, then they are going into the manufacturing process or the assembly process testing, ta, ta, ta. So when it hits your P&L, I would say it's probably 8 months, 9 months-ish, because it hits your P&L when you deliver it to the customer. So there's a lot of steps in between. On your second question, I forgot what your second question was.

It was about the orders. Like if we see a cruise order or ships -- cruise order, what has been in monetary value for you?

It's a bit of difficult because it can be quite big, actually. Let's say, if you take a cruise vessel, it's several tens of millions that we can do per vessel. I would say it's the same for a gas carrier, so -- but it depends very much on, let's say, what's in the scope? Let's say if you take gas carriers a couple of years ago when we also did the main engines, main engines today are too strong. It could be really high numbers for one vessel, because you also do, let's say, all the regasification, reliquification plans on board the vessel as well or cooling equipment, et cetera.

Okay. And then for a containership?

Containership is less, I would say, below 10-ish.

Thank you, Panu. Then I received one question by e-mail. You have talked about thermal balancing as key part of the optimal power plant with renewables and battery. Your battery storage orders are growing strongly. Is similar growth being seen in thermal balancing? Do customer order thermal balancing when they order battery storage?

To start at the end, it's typically not happening at the same time, and we have no contracts where storage and thermal balancing power are combined. They are always separate contracts. What we have seen though is that, let's say, customers that have ordered storage first are now coming for balancing power, because in their system somewhere where there was coal probably as back up, that is being switched off. Then they need something else in addition beyond, let's say, just the battery because the battery is for hours back up, and we need something for the longer time, which is then the thermal balancing power. So yes, we see both in increasing demands, also the balancing power, because more and more coal is being turned down and people realize that they need something else instead.

Thank you. The next question comes from Tom Skogman.

Yes. I would like to continue on that subject. So you have said many times that the regulation is not really in place in Europe to support balancing power orders, but the regulation is better in the U.K. and the U.S. But you have never, at least in the meetings where I've been, you've never really opened this up. So what is -- I mean, how should this market be structured? And should it be the utilities, or should it be the grid company that should order these engines? And I mean, if you -- to take a Board decision to order a power plant from you at the cost of, let's say, EUR 200 million, and then you present the business case to the Board that this power plant will run 25 days per year, no one will order it basically. I mean, there needs to be some totally different pricing mechanism, to my understanding, for -- to support orders for balancing power. And the whole of Europe understands the need now, but please help us to understand this. Is something changing, or what change do you want to see?

For sure, I think regulation is supporting. Let's say, many countries in Europe have committed themselves to, let's say, go to carbon neutral or carbon-free even, by a certain date. And that will not happen if you're not investing in, let's say, new technology, renewable technology. So energy from sun or from wind. You have batteries to back it up for hours, you need something for the additional part. And yes, it doesn't run that many hours, fair enough, and it might be several millions of investment to have it. But if you face the blackout, your cost is significantly higher. So I don't think they have much choice either. Yes, today, you can say, okay, that balancing power plant is also thermal and is not contributing to, let's say, carbon-free or carbon neutral either. And that's also exactly the reason why we are developing, let's say, engines running on renewable fuels. Let's say, the ammonia, the methanol, the hydrogen. And I must say that, let's say, looking -- I was just earlier this week, I was in our STH in Vaasa, Sustainable Technology Hub, and also, in the test labs, et cetera. This is really going well. I'm very, very proud on, let's say, what these people are doing there. We are making big steps.

I understand all of this, of course. But the problem is that Fortum doesn't even mind to have staff at their coal-fired power plant because despite record-high energy prices, it's -- you run them too few days during the summer months, and it's the same with your product basically. So shouldn't there be like a different market for balancing and one for kind of the renewables behind it? Or what do you want to see as a market for balancing power to really take off? It's not enough to run your power plants 30, 40 days per year. The business case is not going to be strong enough, there needs to be some kind of a supportive kind of framework politically to really take off.

I think the first step to take is switch off coal. If you switch off coal, I think there will be a lot of need coming for balancing power, thermal. Secondly -- yes, sorry, go ahead.

Yes. And it's the utilities that should order it, or who should order them?

I would not give a firm answer on that. I think it's anybody that is producing energy. If it's a utility or an industry, it doesn't matter. Let's say, you need it all, right? Let's say, carbon neutral is carbon neutral. So I don't think it's, let's say, the utilities or industries or -- it's all of. Everybody needs to do this. Otherwise, we will not get off the coal. And at the same time, that was my second point that I wanted to mention. Let's say you need balance -- sorry, you need to switch off the coals, so that will generate, let's say, balancing power demand. But then, of course, you also -- if you want to make that, let's say, carbon-free or neutral, you need to make sure that the infrastructure is there to, let's say, supply the new fuels, the neutral fuels, so to say. So the ammonia, the hydrogen, the infrastructure. Not only the infrastructure but also the production of the fuel itself.

But what is better in the U.S. regulation than in the European Union for your business? You get orders from the U.S., but nothing really from the EU countries.

That is difficult for me to answer, right? I'm not an expert in, let's say, local legislation of all these countries. But clearly, let's say, and again, I refer to my visit to the STH earlier this week and Sushil Purohit was there as well. He said clearly, the U.S. understands much better than Europe what is needed to get off the coal into a carbon-neutral situation. And is that then also driven by regulation more than in Europe? At least, I don't think it's that big element in the whole equation, actually, because also Europe is pushing for the same. I think it's more difficult in Europe probably because it's a combination of so many countries that cannot always agree on anything.

Thank you, Tom. Next question comes from Erkki Vesola.

Arjen, you talked about wage inflation throughout the supply chain. I mean, what kind of percentages are we talking about? I mean, how much of that you already see in your own sourcing prices, and how long will it take to pass that on in your own prices on average? What I'm after is, the inflation rate and the lead lag from your source into your customer deliveries.

It's an extremely good question and extremely difficult to answer. I think everybody has been struggling with it because, let's say, how do we know what our supplier in Hungary or Czech or Italy or whatever will do to compensate -- or doing collective labor agreements or salary cost increases? It's extremely difficult to estimate. So you lean a lot on, yes, general -- more general statistics. Of course, we have a lot of contacts with other companies as well in certain regions and -- or in talks with suppliers, et cetera, that what is happening on your end? And what we do to mitigate? And that's why I come back again to what I said in the beginning, the link between our sourcing organization and the quoting departments is extremely critical. Not only the signals on energy, increases in production processes, salary inflations, raw materials, whatever. And that has been really intensified, as I mentioned earlier, and we need to keep that going. The world is, I think since the beginning of this year, is so extremely volatile. At least I cannot easily recall a similar time. And it's also very difficult to predict.

But considering the lead lag, would it be erroneous or would you agree if we raise the share of employee costs of sales, at least for the latter half of this year?

Yes. I think you need to make your own assumption based on, let's say, what you feel is realistic in the average mix in Europe, I would say. Let's say -- like I said, for the most of our supply, especially on the engines, comes from Europe. So that makes some salary inflation will have an impact on us as well. Can we then pass it? Again, that depends very much how early we are to raise the prices and then, it comes back the link to quoting department from the supply management organization.

And finally, could you help me out with -- would a 5% increase in salary levels on average be kind of a reasonable ballpark figure year-on-year?

I will not comment on the percentage.

Thank you, Erkki. The next question comes from Antti Kansanen.

Yes. I wanted to follow up on Tom's question regarding kind of the European situation. Like, wouldn't you say that they wouldn't -- would need to be more robust kind of a capacity auction system across Europe, so that kind of your clients would be paid to have that reserve capacity? Or do you think it's just enough that the peak prices are so high that they can compensate that, that is kind of the mechanism? That the low running hours don't matter because the peak prices are so high?

Yes. But that's today, Antti. Let's say, today, the prices are very high, but that might be different tomorrow. So I think the ultimate goal is, in my view and should be in my view also, to decarbonize, let's say, the world, right? And then the European Union is doing that through their Fit for 55 program. Yes. Of course, you can make a lot of, let's say, suggestions on, let's say, what could be better in the European energy market. But it's still a group of, I don't know, 27 or something countries that needs to align on this because there's a lot of cross-border transfers as well of energy. So it's not -- of course, we can recommend, but it's not happening overnight. It will take a long, long, long time. And we are talking to politicians, I would almost say, weekly to influence them, to make sure that they are aware of what the reality is, et cetera, et cetera. And hopefully, they take that along. But even if they take it along, it will take a long time.

Okay. Then the second question was something you mentioned regarding the software, the GEMS, that is a real value add to your clients. So how do you get paid? How do you monetize that value add, if you look at kind of the backlog that you have delivered and the backlog that you have coming? What kind of revenue streams, earning pools will that generate for you over the lifetime of those batteries?

We don't sell this GEMS software stand-alone, so it's always coming in combination with the storage deal, typically. Certain occasions, we have also applied it in combination with thermal contracts. But let's say, stand-alone, we are not doing that because, let's say, we would also like to drive, let's say, additional business, just not only the software. Of course, let's say, when the software is implemented, there is a software fees as well, so that model is there. But stand-alone software sales, we are at least so far not doing.

Yes, but how long are you from the fact that the installed base of the software is sizable enough so that we can actually see the license payments really coming through your, let's say, energy service numbers or energy revenues or?

I think you will not notice that for quite a long time because the equipment portion in a contract is so much higher than the fee. It's already there today, but it's small in relation to the rest.

So is it, from your perspective, just mainly a tool for market share gains and kind of market share on the newbuild side?

It's really a differentiator.

Thank you, Antti. The next question comes from Tom Skogman.

Yes. I still wonder about this cost inflation a bit, that -- I understand how it is in EPC program and so on. But when you get -- book a smaller engine order, so I don't really fully understand why it is a problem. I mean, don't you get kind of costs and price list from your sub-suppliers on, let's say, a monthly base or so, and you use those costs when you make your own quotations. And then you can close in immediately, if there's a deal or not? I don't really understand why it is a problem.

No. But if I take the example again of an engine book, let's say, what we have been doing, let's say, with indexes, et cetera, in the pricing model, our suppliers have not been sitting still either. Let's say, definitely, the ones that have faced raw material challenges or now, let's say, energy challenges, they are not committing to price list anymore for, let's say, one year from now. That's history. They want short term. And there are even, let's say, suppliers that are thinking of, let's say, just closing the factory for a while and restart later on. So it sounds simple, but it's not that simple.

But how long? I mean, if they gave a price commitment just for 1 month, I mean, that's the month you can give quotations to your customers, in my view or...

I will say, if we make calls to our customer, and say, okay, an engine cost EUR 1 million, I just throw a number here now. And that is based on the current structure that we know. Let's say, then when the order comes after negotiation, then we start, let's say, really purchasing, right? And in fact, for, let's say, smaller engines, let's say, this purchasing might happen. Let's say, it's not that -- let's say, an engine has 1,000 components. I don't know exactly, it depends also by engine, but let's say, 1,000 components. These components are not dedicated purchased only when the order is booked. Let's say, all the time, based on the total demand of a certain engine configuration, we acquire parts. So it's not that, let's say, all the prices are fixed. Let's say, they are also moving all the time. So there is always a delay in what you face. So that's why I say, when we already smell a little bit, let's say, from a supplier on whatever, fuel pump or crankshaft or block or whatever that is a quite high likelihood that in 3 or 4 months from now, let's say, they will increase the prices, we go to our quotation system, adjust it already there. So that the engines that are going out for offers, some we score, some we don't at the right price level so that supply cost match as close as possible to the sales cost.

And then -- yes. Okay. And then finally, I guess this is nothing new either, but it's what I get from our customers all the time. You operate one of the hottest markets on the planet, energy storages with batteries. And in most growth markets where you have extreme growth like this, then you have a very strong pricing power and a very high profitability initially, and then it starts falling over the years. But you are kind of satisfied with selling these at an EBIT loss, even if you have gained market share, as you said. So it sounds like -- I mean, it sounds like you should just take up your prices 10% or so for storage products. I mean, if you make a loss now, we cannot really trust that it will never turn into a profitable business when the strong growth phase is kind of ending then?

Yes, I cannot comment on that, Tom. Let's say, I'm not going to comment on profitability. I can only say that we are -- we have a plan, and we are working according to the plan. And that plan works out quite well. And we have said that in the few years, we will be profitable, and we will be.

Thank you. Next question comes from Johan Eliason.

You said you won't comment on profitability, but I would make a try anyhow. So I mean, if we listen to you now, it sounds like the Service business now also on the Power side is getting back to sort of pre-pandemic level, and we heard Cruise is back, et cetera. So it sounds like, okay, at the end of this year, Service business should at least be order intake, why sort of back to the level you were before the pandemic? And is there any reason why the margin shouldn't be back in the service business to where it was for the pandemic sort of maybe not '19, but '18 at least?

I would say margins are developing in a positive direction. Yes, we had a challenge for some years, but I think we are moving in the right direction. I will not comment on, is it on that same level or not. But it is going in the right direction, let's put it that way.

Yes. And then you have explained to us that storage right now loss-making, and one day, you will make an EBIT positive, obviously. But you have also highlighted this year, you have this big Latin American power plants to deliver, which will be dilutive on the margins. But, I mean, over time, you should have equipment orders and services that basically takes you on to this 12% level again. But apart from storage, what is missing really on the equipment side for you to be on this target and the historical level you have sort of been close to before?

I think that the main thing on the equipment side is all the misery that we have been facing with, okay, first of all, Russia cancellations, moving out of Russia but also, let's say, the whole cost inflation. And that's not done, and I think that will still be around for quite a while. If you just -- if you take, let's say, next year as an example, I'm talking out of my head. But at the end of March, when all this cost inflation kicked in, we had, what is it, EUR 500 million, I think, order book newbuild booked for next year? No chance that you can reopen that contract. So whatever happens in pricing, along the way now, will hit us there. So this all cost inflation and stability in the market, I would say that's definitely a requirement. We need more -- much more, let's say, stable market. Less of this volatility in different elements. I mean, let's say, is it raw materials? Is it energy prices? Is it -- whatever. That needs to stabilize. Because unless that's there, then it's a very difficult environment. And also, very difficult to predict, let's say, what you think goes down today, it goes up tomorrow or the other way around.

But that sounds -- so maybe 2024, if the things settle down around the Russian aggression, et cetera, maybe then material markets could sort of balance again. You get more...

I hope it is sooner. But like I said in the beginning in my introduction, I think the first thing is to get through the winter, right? Let's say, there is so much uncertainty around what will happen. First of all, with the war, of course, but that has a spin-off to so many things. Prices being definitely the biggest one. How will it work? Will we be in the cold in Western Europe in the wintertime or not? I don't know. Will the people in the European Union be able to afford, let's say, cost of energy? I think many, not. So I would say it [ varies ].

But I mean, the pandemic was a bit special, obviously. But if we look at the financial crisis, 2009 and '10 sort of, you stood out being very, very solidly profitable at the good margin. And this time, you are not. And obviously, there was a huge cost inflation in 2007 and '08 as well.

But it was profitable, which we just talked about.

Yes. Yes. Okay. So that was what you had been benefiting from, actually on the offshore side. Okay. That's fine.

Order book of -- at that point of time. And when it was canceled, we actually made money on the cancellations. Remember [indiscernible]. So it was not making money, okay, it was also making money on normal business, but also a lot on the cancellations actually.

Thank you, Johan. Tom Skogman has raised his hand.

I have no further questions. I'll try to take it away, but apparently, I missed.

That happens every now and then. Does anybody else have questions? I do not see any hands up. [Operator Instructions]. Thank you for comments and answers. Arjen, do you have anything to elaborate anymore, or anything to add?

No. I think, like you say, good questions, sharp questions as well, but that's, I think, fair enough. And I must say, I like them also. So no, nothing from my side. It was a good session.

Yes. Thank you, everybody. It's always a pleasure to work with smart people, so thank you for active participation.

Thank you very much. Have a good weekend. Bye.

Take care. See you.