Earnings Transcript for WEIR.L - Q2 Fiscal Year 2019

Operator: Ladies and gentlemen, welcome to the Weir Group PLC Half Year Results Call 2019. My name is Terry, and I'll be coordinating today's call. [Operator Instructions]. I will now hand over to your host, Jon Stanton, to begin. Jon, please go ahead.

Jonathan Stanton: Thank you, operator, and good morning, ladies and gentlemen, and thank you for joining this webcast. As usual, I'm here in Glasgow with our CFO, John Heasley, and we'll be delighted to take any questions you have after a short presentation. We'll start with a brief look at the highlights from the first half, before John goes into more detail on the group's financial performance. I'll then return with a look at our markets and how we are positioning the business, including some exciting new technologies we've been developing and we'll conclude with the group's outlook for the rest of the year. Let me start with our top priority, the safety of our people. Pleased to report an 18% like-for-like reduction in the group's total incident rate to 0.58%. And we've also seen a further decrease in the severity of incidents, including the number of people who required medical treatment. This progress is only possible because we have a highly engaged workforce and a healthy culture of caring for each other. To me, that is a big competitive differentiator, and it's one that I'm certain will take us to our goal of becoming a 0-harm workplace. Turning to the trading highlights. We continue to see encouraging momentum in mining. The acquisition of ESCO means our mining-focused divisions now account for around 75% of the group's revenues, with almost 80% of total revenues from recurring aftermarket sales. Across the commodities we work with and around our regions, we are seeing, as we highlighted for the past few quarters, a strong and growing pipeline of original equipment opportunities, which are increasingly moving from the drawing board to the order book. At the same time, our customers are driving more production growth, which with continued declines in all grade is supporting record aftermarket demand. These trends reflect both the positive fundamentals in mining market and Weir's global ability to help our customers produce more for less from the pit to the processing plants. Both Minerals and ESCO delivered on their margin expectations against this backcloth. As was widely expected, oil and gas markets in North America were challenging when compared to the same period last year when we were dealing with a surge in refurbishment activity. The oversupply in pressure pumping markets that subsequently materialized in the second half of last year has yet to work through the system, and equipment refurbishment has largely dried up for now. Despite the market, I'm pleased with the performance of the business and delivery of our first half profit guidance. And while short-term conditions will remain tough, the positive long-term fundamentals for shale growth in North America remain intact. The first half also saw the group deliver strongly on our portfolio transformation objectives. The sale of the Flow Control division was successfully concluded for an enterprise value of £275 million. Meanwhile, ESCO delivered annualized cost synergies of $20 million and a 300 basis point year-on-year improvement in operating margins. I said back in February that I've never been more excited about the technology platform we're building at Weir. We see lots of opportunities to make our customers' operations smarter, more efficient and more sustainable. In recent months, we've seen increasing engagement around our newer technologies, which gives me great encouragement that we're on the right track. And I'll give a little color on that later on. So in summary, that all that adds up to a first half of good progress with performance in line with our expectations and supported by the recent portfolio changes that have made Weir simpler and stronger. However, my personal highlight for the first half of the year was the launch of Weir Share Builder, our global all-employee share plan that aims to give every member of staff the chance to become a co-owner in our business. It had a great reaction from all our people around the world, as you can see in these images from our recent global celebration. I'd like to thank investors for supporting this important plan as we seek to make sure all our people are aligned with our strategy and share in our future success. With that, let me hand over to John for the financial review.

John Heasley: Thank you, Jon, and good morning, everyone. Results for the first half of the year have been in line with our expectations with good order, revenues from continuing operations increasing by 17% and 22% respectively, while operating profit increased by 2% I'll come on to provide the like-for-like breakdown by division, but in summary, strong growth in Minerals and a strong initial first half contribution from ESCO was offset by the expected year-on-year slowdown in Oil & Gas to leave like-for-like orders, revenues and operating profit more than the prior year. Profit before tax at £147 million was in line with last year, while EPS at 42.2p per share was 11% lower, reflecting the spill weighting of shares issued during 2018. Cash from operations at £54 million was £85 million lower than last year, driven by an increase in working capital, which I'll discuss shortly. Starting with minerals market conditions and commodity prices remained favorable throughout the period, with customers continuing to focus on maximizing production and efficiencies, resulting in continued strong demand for our aftermarket products and integrated solutions. This held true across most geographies with the exception of Central Africa, which was impacted by planned tax changes in Zambia and other customer-specific issues in the DRC. Our ROE project pipeline for brown and greenfield projects continue to build in the period, with opportunities across copper, iron ore and lithium throughout most of our regions. That said, pipeline conversion is still taking a bit longer than we would like. Against this backdrop, Minerals once again showed strong performance with order growth of 5%. Aftermarket orders were up 8% and original equipment down 2%. Aftermarket orders, again, recorded an all-time record in quarter 2, demonstrating the strength of our products and strategies. After a slower first quarter due to phasing, OE orders showed 7% growth in Q2 as a number of project opportunities converted, including a number of HPGR orders as our technology and sustainability leadership starts to gain traction. Revenues increased by 6%, broadly in line with orders. But as you can see in the top right chart, we continue to build a strong order book in the period, with a book-to-bill of 1.13. As you look back over the last 2 years, this is a trend that's been developing with order book filled in each of 2017 and 2018. A number of these OE projects are now in production, leading to an absorption of working capital. EBITDA increased by 5% to £121 million with operating margins within our target range of 17.2%. Moving on to ESCO. ESCO experienced the same mining market conditions as Minerals division and also saw supportive conditions in North American infrastructure market. While there are no comparatives for ESCO given we only took ownership on the 12th of July last year, on a pro forma basis, revenues were up 5% driven by favorable markets and continued share gains with strong net conversions in the period. We saw especially strong demand across North American infrastructure, grades and Canadian oil sands markets, with again central Africa being the only real point of weakness. Operating profit at £40 million resulted in an EBITDA margin of 14.1%, another 110 basis points sequential improvement on a strong H2 last year and showing continued progress towards our medium-term target of 17%. Profit growth has been driven by pricing gains, underlying revenue growth and cost synergies, with the annualized synergies run rate now at $20 million, well ahead of schedule on the way to our $30 million target. Looking at Oil & Gas. Market conditions through H1 transpired broadly as we expected, albeit with a now more cautious outlook for the second half. There remains significant excess capacity in the U.S. frac fleet, which is being driven by E&P's focus on free cash flow and efficiency together with last year's significant refurbishment activity. Therefore, while there has been modest growth in completions activity through the first half of the year, this has not translated into increased equipment demand. We also saw a modest reduction in rig count, driving down demand for pressure-controlled products, while in Canada, we continue to see muted demand as off-take constraints were compounded by an extended spring breakup. All of these factors together with E&P consolidation mean that our market-leading position and technology leadership will prove critical as the industry continues to develop. While smaller in scale for our business, international markets continued to show steady progress. Looking at the half year, specifically, North American orders remain broadly at the Q4 2018 run rate with a step-up in Q1 driven by continued success with new product sales before reducing sequentially in Q2 through Spring breakup. Overall orders reduced by 27% compared to the prior year, mainly due to the higher level of refurbishment activity experienced last year, our revenues followed a similar trend, down 19%. Operating profit of £29 million represented an 8.5% margin and was broadly in line with the second half of 2018. While there are some puts and takes on pricing by product line, in the round, pricing levels have been held flat through the first half. As I'll touch on shortly, the E&P's focus on cash and our more cautious outlook for the second half has had a negative impact on working capital in the period, with customers taking slightly longer to pay and payables being lower as our production runs at lower levels than the prior year. Turning briefly to discontinued operations, trading was relatively weak in the first half with a £2.9 million loss compared to a £5.5 million profit in the prior year, with project delays across a number of businesses. As previously announced, we completed the sale of the division to First Reserve on the 28th of June for an enterprise value of £275 million, and after adjusting for debt and debt-like items, received cash of £263 million. After accounting for costs, foreign exchange and tax, a net loss on disposal of £20 million resulted. The cash proceeds will be trued up through the second half of the year, following a normal complete accounts process. Moving to cash and working capital, we had a £181 million increase in working capital in the first half of the year, of which £157 million related to continuing operations. This was made up of a £51 million increase in inventory and a £102 million reduction in creditors with debtors broadly flat. The increase in inventory was in line with the growth in the Minerals order book and left tonnes broadly consistent with last year. The flat debtors position masked a good underlying performance in Minerals, which was offset by a relatively significant hold by a number of major customers in our North American Oil & Gas business with E&Ps and therefore our customers, the service companies, are increasingly focused on free cash flow. This amounted to around £20 million of holds over fielding in excess of normal levels. Looking at creditors. Around half of the reduction reflected normal phasing of various payments, including group-wide annual bonuses with the other most significant factor being in respect of oil and gas production activities, which was reduced as the market outlook became more cautious, thereby resulting in lower material and component purchases. As we look ahead to the year-end, we have clear plans to assure a partial unwind of the first half movement with normal phasing of payables, shipping of a number of Minerals projects currently sitting in work in progress and close management of the oil and gas receivables in North America. Turning to the next slide. Our free cash outflow of £198 million was driven by the working capital outflow and the increased 2018 final dividend payment following the removal of the scrip dividend. The increase in net CapEx reflects the addition of ESCO and further investments in technology across the group. Exceptional cash flows of £26 million mainly relate to prior year acquisition and integration charges. Net debt finished at £1.3 billion, up from £1.1 billion at the end of December. This includes £215 million for the cumulative impact of IFRS 16 accounting, excluding which, net debt reduced by £26 million with a free cash outflow of £198 million and exceptional cash flows being offset by the Flow Control disposal proceeds net of cash cost to date of £253 million. This led net debt-to-EBITDA on a lender covenant basis of 2.6x with an expectation of around 2x by the end of the year as we see our working capital unwind over the second half. Finally, I'll leave you with a few items of financial guidance for the balance of the year. Based on the end of June exchange rates I've included in the appendix for this presentation, there will be no further translational FX impact in the second half of the year. However, clearly exchange rates have moved a bit in recent days. And therefore, as a reminder, each 0.10 move in sterling to U.S. dollar equates to over £10 million operating profit impact on a full year basis. Interest will remain broadly in line with the first half, including an £8 million full year impact related to IFRS 16. CapEx is expected to be around £110 million with second half spend in line with H1 and CapEx depreciation, excluding the depreciation in respect of IFRS 16 of 1.5x. Lastly, the full year underlying effective tax rate is expected to be around 25%. So in summary, a good set of first half results in line with our expectations, with strong momentum in our Minerals and ESCO businesses. While current market conditions in oil and gas are more challenging, our technology leadership continues to ensure that we outperform in relative terms. While minerals growth in oil and gas market conditions resulted in an increase in working capital, we will see that partially unwind in the second half. These factors together have resulted in the Board recommending a 5% increase in the interim dividend. Thank you, and I will now hand back to Jon.

Jonathan Stanton: Thank you, John. Before I move on to the business review in detail, let me quickly remind you of the role we play in solving some of the world's biggest challenges. The global population is on track to hit 9 billion people by 2050. At the same time, other structural trends, such as urbanization and carbon transition, require more metals and energy and, therefore, demand for natural resources is growing. Of course, the challenge is how to support these structural trends while also managing Natural Resources responsibly and sustainably, and leaving the planet in better shape for the next generation. The solution is innovative engineering. And that's why our mission is to enable our customers to sustainably and efficiently deliver the resources needed by a growing world. This is the fundamental driver of our expanding technology program that will deliver a different way of doing things for our customers and create long-term value for our shareholders. So with that context, let's walk through each of our markets and divisions, starting with mining. Here, market conditions are positive with demand underpinned by global economic growth in spite of ongoing trade tensions. The latest IMF projections for global GDP growth are 3.2% in 2019, strengthening to 3.5% in 2020. This will broadly drive demand and, therefore, oil production growth. On the supply side, the picture is encouraging for investment with the decline in the expansion CapEx from 2012 to 2017, creating emerging shortages. This is particularly the case for copper, our biggest commodity exposure, with a structural deficit predicted in the 2020s, just as electrification of transport and charging infrastructure gathers pace. If we look at commodity pricing in exposures, copper, gold, iron ore and coal are all comfortably above incentive levels, even with the current macroeconomic uncertainty. These market conditions have translated into a strong project pipeline with customers clearly starting to evaluate and approve LIBOR expansions to fill the gap created by depletion and increasing demand. Within that pipeline of expansions, we see a bias towards combination of mill circuit processing, which is the sweet spot for Minerals. This builds on the brownfield theme we've seen over the past couple of years, while continued production growth and declining ore grades are supportive of strong aftermarket activity for both of our mining equipment businesses. So conditions are good, and we plan to execute strongly on the opportunities we see. In the Minerals division, that means continuing the thrust of our integrated solutions strategy that puts more engineers on customer sites, helping optimize current assets and supporting smaller brownfield expansion. I saw this in Western Australia last week, where, as you can see, I was on hand for the signing of a total asset management contract with a mineral sand dredge customer that will reduce their maintenance costs by 20% while securing a long-term revenue growth opportunity for Weir. Our early and proactive investment in process engineering and project management capability will also allow us to benefit from larger expansion projects that are in our pipeline. And while our OE orders can be lumpy, the pipeline for the second half looks strong with the value of outstanding firm quotes up 23% year-on-year. To take full advantage and deliver on the scale of the current opportunity, we need to make sure our business is really match fit. And that's why we're continuing to implement our plans to optimize our global manufacturing footprint, including long-term foundry capacity, upgrading our systems and rolling out shared services to create an ever more scalable business. In this environment, we're also very focused on maintaining the right balance between investing for growth and delivering robust profitability and cash generation. For now, the project pipeline is creating a margin headwind, but importantly, we're selling the original equipment fees from which we grow attractive aftermarket revenues for many years into the future. The same is true in ESCO, where more than 90% of revenues are from the aftermarket. In this business, we gain market share by winning conversions from OEMs where we can clearly demonstrate the superiority of our ground engaging tools. We'll do that by continuing to invest in technology leadership and extending into new machine classes, while also leveraging the mineral service footprint to help geographic expansion. At the same time, we remain focused on executing the cost synergies and operational improvements that will support margin progression towards our target of 17%, building on the 300 basis point improvement already delivered. And we continue to make good progress building the pipeline of revenue synergies that will deliver further top line growth. We're also working through our operational improvement plan, including optimizing manufacturing capacity to manage future growth, while also investing in safety improvements that will bring ESCO up to the world-class standards we've achieved in Weir. Of course, core to our offering is the strength of our technology, and we're seeing great engagement from our customers on solutions that make them more productive and sustainable. Take our high-pressure grinding rolls technology. Its job is to help crush rock in the comminution circuit, the most energy-intensive part of minerals processing, itself one of the biggest consumers of energy in the world. As a result, any saving is valuable, but our Enduron HPGR technology is proven to reduce energy consumption by around 30% as compared to a traditional milling process. In addition, it can also support dry processing, which reduces dependence on scarce water resources and therefore reduces wet tailings waste. As you know, mining is a conservative industry, and it can take time for new technology to be accepted. But we're seeing demand for HPGRs accelerate with 3 large orders secured in Q2 for greenfield sites. But one was for the York potash fertilizer development in the U.K., another for aggregates in North America and thirdly, an iron ore development in Africa. Significantly, we recently secured the engineering order for HPGR and GEHO pumps at the Iron Bridge magnetite project in the Pilbara, Western Australia, which we hope will convert into a substantial order later in the year. The innovative product design includes the use of a dry crushing and grinding circuit, delivering an industry-leading, energy-efficient operation. These are not easy jobs to win. The sales process for these larger projects can take years and requires a big upfront investment in people and time, but the reward is a long-term stream of aftermarket revenues, and that's why we're so focused on converting the current project pipeline. We're also getting great traction further upstream, ESCO's Nemisys lip system technology has been validated over the last few years, with more than 500 conversions on large mining machines since it was first introduced to the market. The technology has now been launched as the N70 into the front end loader market. The one in the picture is one of the largest end loaders in the world, but the technology is also being trialed in smaller machine classes. The market is normally dominated by OEMs, but we're winning share because customers like that our technology lasts longer than competitors, and it's both safer and quicker to install and repair, utilizing the Nemisys proprietary locking system. Let me now turn to oil and gas markets, where conditions in global oil markets remain balanced with demand expected to increase by 1.2 million barrels a day in 2019 and by similar amounts over the next several years. Growing oil demand requires additional supply, and the U.S. is currently filling that gap. But at the same time, capacity constraints and increased focus on cash flow means E&P spending is expected to fall by around 10% this year, which you can now see feeding through into the current rig count. That's impacting demand among pressure pumpers, with frac fleet utilization at around 60% and service company pricing continuing to be under pressure. Overall, visibility remains low, but there are no signs of a significant pickup in underlying activity in the second half of the year that would materially change equipment utilization, with completions forecast to stay flat from here. In the medium term, however, the attrition we see today will generate good opportunities for future growth. At the moment, pressure pumpers are stacking worn-out units rather than replacing or refurbishing them. Inevitably, that's a temporary measure. In time, those power and fluid ends will need to be either refurbished or replaced, and we have the go-to technology. For now, the other self-help of the pressure pumping market needs a restructuring. And we're already seeing some mergers and talk of capacity coming out of the market. And of course, in the longer term, global tight oil production is expected to double by 2035, with most of the growth coming from North America. Meanwhile, international markets continue to pick up with rig counts and drilling activity now on the increase in the Middle East and ASEAN regions. So how are we managing these market conditions? Firstly, we're continuing to rightsize our cost base across the division, with around £10 million of annual savings delivered over the last 12 months, and this remains a constant focus. We're also carefully balancing volumes and price to maintain market share and operating leverage, keeping the business profitable, help keep close to customers and ensure we maximize aftermarket opportunities, we continue to invest in our Weir Edge service capability, where in the first half, we increased our number of active mobile units by 90%. In international markets, we are now on the approved supplier list for wellheads for 3 of the largest national oil companies in the Middle East and have secured our first orders. And of course, we remain committed to leading the technology change in the market, which will be a feature as it continues to mature. This includes producing the industry's first continuous duty, 5,000 horsepower pump, specifically designed for electric or gas turbine driven operations. It is the only pump of its kind in the market today, and it builds on the success of our QEM 3000, which has an excellent performance record validated by over 1 billion field cycles. The move from diesel power tracking to electric is being discussed a lot and will be driven by 2 big themes. The first is cost. Bigger and more powerful pumps means fewer are needed on a typical frac site. A traditional fleet would require 20 2,500 horsepower pumps. With 2 EM5000s, that number can potentially be reduced to just 8, a 60% reduction. The second driver is environmental performance. An electric power pump has the potential to reduce emissions by around 90% compared to its diesel alternative. And having launched a pump last week, we've already secured our first order. We intend to take full advantage of our leadership in this area. When customers come to renew their stacked fleet, they'll have to decide to replace and refurbish them with legacy technology or adopt electric fracking operations. Whichever they choose, we'll be there to support them with technology they can depend on to deliver the continuous duty performance that modern fracking operations require. So we're gaining great traction with our new technology, helping our customers to achieve their operational goals and positioning the group to benefit from the structural growth trends across our markets. So let's now take a look at the outlook for the rest of the year. Assuming no material change in mining markets, we continue to expect Minerals to deliver broadly stable operating margins and good growth in constant currency revenues and profits. In ESCO, we also anticipate good constant currency revenue growth with operating margin progression supported by integration synergies alongside ongoing operational improvements. In Oil & Gas, while the first half played out largely as expected, we no longer expect to see any meaningful improvement in the second half, and therefore expect operating profits for the division to be towards the lower end of our 55 £million to £95 million range. Despite this at a group level, we continue to expect to deliver good constant currency revenue and profit growth. Let me finish with the key takeaways from the first half results. We delivered a good first half performance, supported by our portfolio transformation. Mining markets remain positive, supporting a healthy and growing project pipeline and both Minerals and ESCO are delivering strongly. Oil and gas in North America is currently challenging, but its medium-term fundamentals are positive. And we're making great progress in developing the solutions that help our customers operations become smarter, more efficient and more sustainable, enabling Weir to deliver long-term value for all our shareholders. Lastly, I'd like to invite you to our Capital Markets Day, which we'll host at our GEHO and Enduron HPGR facility in Venlo in the Netherlands on the 5th and 6th December. It will focus on our expanded mining offering, and we'd be delighted to see you there. With that, John and I would be happy to take any questions that you have. So thank you, everybody, for listening, and back to you, operator.

Operator: [Operator Instructions]. So our first question today is from Lars Brorson from Barclays.

Lars Brorson: Two quick ones from me. Number one is on ESCO. If I could start there, 1% growth in the first half, I'm presuming you're seeing some good pricing since volume is down. At the order level, notably volumes down, it looks like in Q2, that's against, I would have thought some revenue synergies maybe starting to come through. Can you help me understand a little bit better? I can appreciate there may be some tough comps from last year, but it's a little bit weaker than I had expected and maybe forward looking, Jon, with iron ore being the biggest revenue exposure, I see some pretty significant production ramp coming through from some of the major iron ore producers in the second half. How should we think about the forward-looking growth profile for ESCO piece?

Jonathan Stanton: Yes, I think I would encourage you to look probably more at the revenue growth in ESCO than the order growth, just given the short -- very, very short-cycle nature of the business. The revenue number is probably a better indicator, which you'll see is mid-single digit, which is, frankly, our expectation, and that's what we expect to see for the balance of the year. It is inherent in our full year guidance, specifically the 1% in orders reflects some actually -- some fairly chunky, for ESCO, OE orders in the first half of last year, which didn't repeat this year. But in terms of the underlying consumables, just the growth is coming through and the revenue is the indicator that you should really look at.

Lars Brorson: Understood. Secondly, if I could just finally on the implied guidance for the second half in Oil & Gas. I wonder whether you can help us a little bit with the bridge, say, from last year, the £33 million, second half last year, the £20 million, £25 million or the £25 million needed to achieve to get to your low end, help us a little bit with the pricing, volume and cost assumption behind that in terms of working through the bridge from second half last year.

Jonathan Stanton: Yes. Okay. So I think when you step back, the implied guidance says that we are going to be sort of broadly flat, H1 to H2 this year, and therefore essentially broadly flat with the second half of last year. In terms of the key assumptions there, we're assuming essentially that the second quarter is sequentially -- sorry, the third quarter is sequentially broadly in line with what we've seen in Q2 in terms of underlying activity levels softening a little bit in the fourth quarter, which I think is broadly in line with what we've seen, what our customers are saying to us and with what we've seen from the service companies in terms of their Q2 results announcements. But offsetting that softness, we've got some things that are within our control, which we see playing out in the second half of the year. And that's really around, first of all, the new technologies that we brought into the market, including the simplified frac system, the large-bore manifold trailer, which we're expecting to see further good progression over the second half of the year. And also, there is a little bit of fluid end market share recovery, following on from the warranty issue that we had in the fourth quarter last year. That's been picking up through Q1 and Q2, but we expect that trend to continue in the second half of the year, and that's really based on conversations that we've had with our customers from a demand planning perspective and tenders that, frankly, we bid for the second half of the year over the course of the last few weeks. So that's looking pretty solid. From a pricing perspective, as John said in his speech, we managed to hold pricing broadly flat in the first half of the year, and we're not expecting any really sort of significant movement from that. Again, a lot of the tenders that we bid for H2 volumes, the pricing is locked and within the product lines, it's a mix. As I said on the last call, i.e, good margin progression for the new technology products, fairly robust margins in the flow iron space and pricing tougher in the more commoditized product lines, such as the legacy fluid ends. So I hope that gives you the moving parts, Lars?

Lars Brorson: It does.

Operator: Our next question today comes from Jack O'Brien from Goldman Sachs.

Jack O'Brien: So my first question, just following on from the Oil & Gas question there regards the EBIT split that you saw between the first quarter, second quarter. I seem to remember, first quarter was broadly similar to the fourth quarter. So I'm just interested to see how that evolved through the half, given your comments that actually orders sequentially declined through second quarter. That would be my first question.

Jonathan Stanton: Yes. I mean, they're broadly similar between Q1 and Q2, Jack, was probably slightly higher in the second quarter.

Jack O'Brien: Great. Second question, just on your Minerals margins. Obviously, revenue growth sort of coming through quite nicely, driven by the robust aftermarket, which should have beneficial sort of mix impacts. Can you just explain -- you talk about increased investment slightly weighing on margins. Can you just give us a bit of color in terms of sort of size there? And how we should think about that?

Jonathan Stanton: Yes. I mean, fundamentally, I mean, there's no change to where we've been for a little while in terms of the Minerals margins with -- we're in an expansion phase at the moment, and therefore, we expect Minerals margins to be towards the lower end of the guidance range that we get for the business. In terms of specifics around current margins, you've got a couple of factors. There's a bit of mix within mix with the OE that is coming through now is coming through in larger chunks and with bigger projects, they tend to be more competitive. So slightly lower margin in the OE compared to the sort of much smaller brownfields piece that we were seeing maybe a year ago. So I think there's a bit of mix within mix within the margins. But it's also that cost that we're carrying in the business, and we had a step-up, if you remember, in 2017, which put a lot of sales and project management, engineering into the business to support the sort of rising tide of projects that we see coming through. And so we're carrying costs in the business at the moment to take advantage of the project pipeline that is out there that are incremental and that typically tend to fall away when we were in a weaker market and really just focused on farming the installed base as it were rather than growing it. So our indirect costs, if you think about the selling costs, they're up, probably slightly higher than the revenue increase that we're seeing, but I really see that as just phasing as we go through the year. And as I said in my speech, we are expecting a pretty strong second half in terms of original equipment orders and the variable cost that we're carrying in the business today is commensurate with capturing that because the opportunity is significant. And as I said in my speech, we're out there trying to create the installed base that will drive great aftermarket opportunities for the future.

Jack O'Brien: And just 1 final question. I guess, there'll be a bit of focus where you've discussed the free cash flow during the first half. The reduction you saw in sort of creditor payables, that to you is really just a reflection of kind of phasing of projects and more timing as opposed to, perhaps, customers becoming tighter or more demanding? Is that how you see it?

Jonathan Stanton: John, do you want to answer that?

John Heasley: Yes, Jack. So on the creditor side, it's really a couple of things that I touched in my speech. The first is the unwind that we saw in the first half of the year of £100 million. About half of that was normal phasing of accruals and creditors just in the ordinary course and that's non-trade-type creditors, And then the other -- the biggest portion of the other part which really in respect of Oil & Gas, specifically, where as you think now as we look forward, given what we've just discussed in terms of the market outlook, then production levels in our factories are running at lower levels. And therefore, we are buying less raw material, less components and, therefore, have less -- a lower level of payables. So really, those 2 factors together were the main driver of the payables reduction. And clearly, the phasing aspect of that, we would expect to reverse by the end of the year. And then we'll see what happens with the oil and gas production levels, but that's probably more of a sort of permanent step-down for the next few months, at least.

Operator: Our next question today is from Matthew Spurr from BNP Paribas.

Matthew Spurr: Matthew Spurr from Exane BNP Paribas. If you can carry on with cash flow, please. I thought you said on the cash, some of it was down to North America oil and gas customers not paying. I didn't see that necessarily in the receivables. I thought in the cash flow, looked like it was an inventory build and the payables that you just talked about. Can you talk a little bit more about that, whether there's any risk around that? Can you tell us whether it's sort of blue-chip customers that are doing it to you? Or it's some of the smaller mom-and-pop type shops?

John Heasley: Sure. No problem, Matthew. So you're right, the debtors movement, as you look at that in the cash flow, there was no significant outflow there during the first half. But as I mentioned in my comments, there's really 2 moving pieces within there. One, the Minerals business actually had a good underlying performance with improvements in collections during the first half, and that was offset by the delayed payments over the half year from our oil and gas customers. As I said, that amounted to about £20 million above the normal level of receivables that we would expect to have over a period end. In terms of risk then, our customers are clearly across the board, but we do have a bias towards those major service companies. And therefore, from a risk perspective, we don't see any credit risk on that customer base. And indeed, I think it was really just a hold over the period end with a significant portion of our cash coming in shortly thereafter.

Matthew Spurr: Okay. And my second question was on the covenant definition. So the -- has the headroom moved up with the IFRS 16? Or has that stayed the same? Have the lenders taken -- not taken into account leases?

John Heasley: No, the covenants are on an existing GAAP basis. So whenever we enter into those then it's based on GAAP and covenant of 3.5x net debt to EBITDA, that excludes any IFRS 16 impact. And then, clearly, as we go through refinancing, as everyone else does then, we'll assess how that's dealt with at that point in time. That's definitely the existing covenant on a pre-IFRS 16 GAAP basis.

Matthew Spurr: And then one final quick one on the guidance. Why do you keep the top end of the Oil & Gas guidance? What scenario could possibly get you to £95 million?

Jonathan Stanton: What we're doing, Matthew, is referencing the previous guidance that we've given. So I think like you, I would say the top end of that is highly unlikely. But we just wanted to reference the guidance that we gave at the end of February to demonstrate where we were in that range.

Operator: Our next question today comes from Alexander Virgo from Bank of America.

Alexander Virgo: Alex Virgo from Bank of America. I had a couple of quick questions, if I could. On Oil & Gas. I appreciate that frankly next year could be anybody's guess. But I wondered if you could talk a little bit about customer behavior in Oil & Gas, how you think that shapes up for next year? I'm not asking for guidance. I appreciate you don't do that, but just trying to understand a little bit some of the moving parts and whether or not you think the cost structure is in the right place for that business. And then secondly, just on QEM 5000. You've always historically talked about anything larger than 3000 having to be stationary. So what is it that enables the higher power per footprint or enables you to get the 5,000 horsepower pump on the back of a truck? And frankly, given you're talking about it being continuous versus intermittent, that's obviously pretty key to the aftermarket profile. So just wondering how you price the equipment and what the difference in price is or some kind of indication as to how we think about how that plays through in the aftermarket business.

Jonathan Stanton: Okay. Thanks, Alex. Yes. So you're quite right. We are not going to give you any guidance for 2020.

Alexander Virgo: I tried.

Jonathan Stanton: The reality is that our customers are really not going to set their plans for 2020 until January. So we're just not going to be in a position to say anything until we see how they're planning, how they're planning for the year. I'd just go back to some of the comments that I made in my speech, that we're in a tough market at the moment. But as we think about the medium and longer-term for the business, both in terms of growth of tight oil production, the technologies that are going to be required to extract it, I think we are in a great place. Clearly, there is -- as we're seeing through this year, there is very little refurb work that is happening. So as equipment is worn out through attrition, it is just being parked up at the moment, and there's a degree of cannibalization going on. So as we've seen in past cycles, that is storing up a future opportunity for us when that equipment either needs to be refurbished and brought back into an active mode or indeed, needs to be replaced with new equipment. So it's very difficult to predict at what point that will -- the excess capacity will get soaked up. But there are things to be positive about as we look forward. Timing, again, very difficult to put a finger on until we see our customers are thinking about next year.

Alexander Virgo: Jon, sorry, I just -- sorry to interrupt. What is your best guess on horsepower being used in horsepower part?

Jonathan Stanton: Well. So if you think about it, total 24 million horsepower is probably 60% utilization at the moment, so that's around 14 million. At the start of the year, there was probably 1 million cold stacks, I would say, that's growing. I don't know -- I couldn't put a finger on the exact number today, but there's probably 3 million to 4 million of excess capacity that can be utilized as we sit here today, and that's what the industry has to burn through. That might come through attrition, but as I also referenced in my speech now, we're hopeful now that we've seen the C&J-Keane announcement come through. We're hopeful that, that will be the first of a little bit more of consolidation, which might helpful -- might take out some capacity as well as the customers use those kind of merger situations to reassess and rightsize their fleet, so that could give us a bit more tailwind in terms of soaking up the capacity alongside the attrition. So on the QEM 5000, there are going to be multiple ways that people will play into the e-frac theme. So one thing that we're working on with a partner is whether you can basically fit a small gas turbine on the back of a trailer with a QEM 5000. Turbine is obviously much lighter than a diesel engine so that offsets the greater weight in the pump. It might be that you could just put 2 pumps on a trailer and then have an electric motor, a large electric motor, either on another trailer or installed on a permanent basis, if it's a massive pad site. So I think there are lots of way -- lots of -- we are looking at different ways of configuring this, the packages are looking at different ways of configuring, the service company is the same. But the underlying theme is that if you want to play in this space and get to the kind of efficiency that I talked about in my speech, i.e. going from 20 to 8 pumps on a completion, you need a very high horsepower pump, and we have the only proven high horsepower pump in the market at the moment. And as I said, the performance track record of the QEM 3000 with our customers has been absolutely outstanding. So whatever configuration industry participants go with, we're in really great shape to participate and the QEM will fit into any of those kind of configurations that I talked about. As far as the -- your point, which is, I think is getting to aftermarket cannibalization, there's a number of things there. First of all, because at the moment, we're well in advance of, I think, our competitors from a technology perspective, we stand to make market share gains. Clearly, as the product gets acceptance and performance continues to be demonstrated, we would expect to be at a premium pricing situation. And I think the other thing to say is that over the years, we've been under intense pressure to increase the life of our equipment, reduce wear. And every time we do that, our customers just use it harder, and you get an effect going in the other direction. So we have to go there. Our customers are demanding it, this is the way the industry will go over time. But I think there are plenty of reasons why we think that our overall economics will continue to be strong. Now that said, you've got to remember that there's still 24 million horsepower out there, which is, by and large, 100% diesel driven. And that's not going to go away overnight. So I think there's not going to be a sudden conversion here. I think over time, you'll start to see more and more e-frac type fleet adoption. And whether customers go down that route or go for legacy and refurb their existing equipment, I think we're well placed. So I'm very happy how we're positioned to take advantage of that, whichever way it goes.

Operator: Our next question today comes from Mark Jones of Stifel.

Mark Jones: Firstly just to pick up on one of the comments you were just making about consolidation on the fracking side. To be clear, those of you hoping that others will buy each other effectively and take capacity out that way, Weir is not looking to get involved in that process? Or is it more a question of some of the weaker players actually failing.

Jonathan Stanton: Mark, I was specifically talking about consolidation among the service companies.

Mark Jones: Okay. Fair enough. And on the mining side, obviously, we've given a fairly strong message about acceleration on the OE business through the second half of the year. Just looking at some of the timing risks around that, how sensitive do you think that is to continuing turmoil in the macro news flow? Or are we sufficiently down the line in those projects that they've reached a point of no return, they're going to carry on spending pretty much regardless of the backdrop?

Jonathan Stanton: Yes. I mean, I think that's a good question. And as you saw in the first quarter, then it can be pretty lumpy, and we've seen customers being very disciplined in that continuing theme as they go about approving projects. And there's still clearly a little bit of risk that things will move around and phasing could be slightly different. But even with that said, I think we're looking at our pipeline of order -- potential orders over £5 million that could come through in the second half is something like £300 million, and that's before all the onesies and twosies. And I specifically made reference in my speech to the Iron Bridge projects as well, which we have the engineering order, but not the full order yet. So there's some quite big ones in there. So in terms of in the round, am I confident that we will see a strong second half in terms of original equipment? Absolutely.

Operator: Our next question today comes from Ed Maravanyika from Citigroup.

Edward Maravanyika: John, just had a question on Oil & Gas. So with the sort of new way that E&P companies are looking at free cash flows and budgetary discipline and focusing on cash returns. And also, if you look at the advances on the productivity and efficiency side, also meaning your customers are looking to do more with less. Do you think the profitability possibilities in oil and gas have structurally lowered in both absolute and in margin terms? I'm just thinking of your previous peak of 25% EBITDA margin in 2012 and the more recent one of 16% in the first half of '18.

Jonathan Stanton: So as far as that previous reference point, yes, they have structurally changed. And we -- and we've said that previously that we don't expect to see divisional margins at the 25% operating margin level that they were at the previous peak. We have moderated that to 20%. And I think there is still a pathway that we can get there in a strong market with higher volumes and the operating efficiencies, and leverage that we would see in our manufacturing plants plus a tighter market, where there is an opportunity to get a little bit more pricing back in and around, we're still only about sort of 5% up from the floor that we've reached of more than 20% down. And of course, the international businesses, which have been up until now either loss-making or breakeven, where, as I said in my speech, we're seeing some encouraging signs, particularly in the Middle East, where the national oil companies are back to drilling. So we're seeing an uptick off the back of that. And our self-help strategy is taking the OEM wellhead products into the Middle East, which is gaining traction as well with no approved supplier status for the 3 large NOCs, meaning that we're going to see some uplift there. So we need to get our business, the international business back to profitability. But you can see the moving parts still to get to 20%, but 25%, I think that's too much of a stretch.

Operator: Our next question today comes from Amy Wong from UBS.

Amy Wong: Couple of questions from me. The first one relates to kind of a medium-term outlook on how we should be thinking about cash flow and working capital up from down. I appreciate it's always going to be lumpy. But clearly, we saw the absorption of the first half. And as you call out that minerals that was -- we're quite in the early stages of expansion here with the OE ores clearly pointing to that as well. So how should we think about that kind of cash flow absorption of working capital over, say, the next 12 to 18 months? Should we kind of modeling structurally higher working capital absorption over this period? That's my first question. And my second was a quick housekeeping on exceptional cash item guidance for the second half, please.

Jonathan Stanton: I think I've got two questions for the CFO there.

John Heasley: Amy, so in terms of the medium-term outlook for working capital, then I think we said in the past that somewhere over the medium term, our aspiration would be to get towards the low 20s in terms of working capital as a percentage of sales. So I think as we go through this growth phase, you're right, as we sort of, especially with some of these larger projects coming through that Jon has been talking about, then clearly that will have an impact at various points in terms of extra work in progress and receivables. So I think over the growth cycle, probably in the sort of towards 25% range and then as we get into sort of more normal steady state then into the low 20s would be the objective, so somewhere between 20% and 25% over the cycle would be where we would expect to be. And then in terms of the exceptional cash flows through the second half of the year. Then, I think, broadly at similar levels to the first half, Amy, with the final elements of the cost and respective integration for ESCO, et cetera, coming through in the second half as well as a portion of the cost in respect to the flow control disposal, where we've taken some of the cash cost in the first half, but there's still an element of that to come so at a similar level to the first half.

Operator: Our final question today comes from Robert Davies of Morgan Stanley.

Robert Davies: The first one was just really around, I guess, the Minerals outlook you gave for the second half of the year. I know you said you're expecting some pickup in activity. But you do face notably stronger comps in the second half, so I guess, given the sort of timing and the view you have on the project into the second half, just wanted to get some idea how you're expecting sort of 3Q, 4Q spend all, I guess the risks that things don't necessarily -- I know you made some comments on that, but a little more detail would be helpful if you could. The second one was just around the simplified frac system. I know you've mentioned on previous calls, you had some, I guess, sales growth benefit from that. Is there any benefit from that coming through in the second half of this year? And how is that progressing? And then, I guess, the final one is just some of the recent M&A activity that we see -- or potential M&A activity we've seen in the mining space. How do you think competitive dynamics are shaping up there, as you look through next year and into the medium term?

Jonathan Stanton: Robert, thanks very much. So in terms of the Minerals outlook for the second half, I mean there's probably not much else to say. I'd say our pipeline is kind of at record levels. I gave you the stat that is sort of 300 million of potential projects over 5 million each, which we are working on, and hopefully, you will get over the line in the second half. There's a couple of really big ones in there, which are looking very, very positive. And some of those larger ones, our customers have actually committed -- they've announced the projects and some of them are on quite accelerated time lines because they are very valuable projects to them to get over the line. So actually, I've had direct conversations with them on some of that. So that -- things could move around a little bit, but I think we're going to see a year of good growth from an original equipment perspective as we get through the second half of the year. Yes. As to the simplified frac system, you will remember that's the large bore system, which substantially reduces the amount of flow iron on the site, taking the sort of traditional 3.5-inch pipe up to 7 inches, with a significant reduction in joints and leak paths and a seed reduction for our customers in terms of rig-up time. So notwithstanding the capital constrained environment at the moment, given the benefits of that, we've seen a very strong uptake in that from standing start last year. We've had strong deliveries of that through the first half, and we're expecting that to continue through to the second half. Yes. And in terms of the M&A question. So I think there's been speculation for a long time about who might not come together, particularly in the sort of Scandinavian framework. So probably no surprise in the recent announcement, and I can't say anything other than we wish them well in their endeavors.

Operator: We have no further questions. I'll hand back to you for any further remarks.

Jonathan Stanton: Okay. Thank you, Operator. Thanks again, everybody, for joining, and we appreciate the questions, of course. Steve and the IR team are available for any further follow-ups you have over the course of the day. But for now, thanks, again, and we will catch you soon.