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Executives

Leif Johansson - President and CEO

Mikael Bratt - CFO

Tony Helsham - President, Volvo Construction Equipment

Göran Gummeson - President, Volvo Penta

Sal Mauro - President, Volvo Financial Services

Olof Persson - President, Volvo Construction Equipment

Håkan Karlsson - President, Volvo Bus Corporation

Analysts

Fredric Stahl - UBS

Alexis Albert - Natexis Securities

Jeremy Taylor - AllianceBernstein

Colin Gibson - HSBC

Nico Dil - JPMorgan

Jose Asamendi - Royal Bank of Scotland

AB Volvo (VOLV) Q3 2008 Earnings Call October 24, 2008 8:30 AM ET

Operator

Ladies and gentlemen welcome to Volvo's conference call to report on the first nine months 2008. It will start with a presentation and thereafter there will be a question answer session. Please note that this conference is being recorded. The conference will be chaired by Mr. Leif Johansson, CEO of Volvo. Mr. Johansson, please go ahead.

Leif Johansson

Thank you, this Leif Johansson, President and CEO of the Volvo Group. Good afternoon, good evening and good morning to all of you and most welcome to the third quarter 2008 conference call. We have as we normally have, we have our CFO with us, we have our business area leaders and we also have representatives for investor relations here.

We have also on the internet for you the slides that we speak to. And I will start speaking on the first slide, slide number two. This is group highlights and then we will switch to slides as we progress through the presentation here and after presentation comes the Q&A.

The third quarter was a difficult quarter and you remember that we came of all time high in Q2 2008 with record sales, record profits or record margins. And what happened in the third quarter was that as we progressed through the quarter we started seeing very steep breaking curve from our customers as they became more-and-more impacted by the downturn and the following liquidity crisis there.

And that mattered while the quarter started reasonably well of quarter two over the progression of the quarter it actually meant that quarter-on-quarter comparison, comparative for last year, we actually ended up with 2% growth or really in overall said all, while you see the comparison there of 21% or 6% in the Q1 on a 30% in Q2.

Operating income because we put our foot on the brake came down 37%; we will speak more to that as we go through the presentation here. But what we have elected to do is to immediately react and make the adjustments in production capacity as we see the different business areas generate slower sales and indeed also looking at order intake.

We think that's the right way to address this situation rather building for inventory and end up with both cash flow problems and potentials of margin issues. so we have decided not to build inventory. We will remain successfully in that in quarter three.

Now the business environment in Europe clearly has falling volumes and heading towards a downturn or we are in a downturn there from all of our different business areas. It's also so that we had, especially on the truck side, and I'll speak more to that in detail. We had number of cancellations of orders. We've seen some of that also in the other business areas, even though not to the extreme.

So, even customers who in the short-term who have been looking forward to take our product have actually had even to go back -- sometimes even when the products have been produced. They say we cannot them, because we don’t have the credit facilities that we thought we had because of the failure of the banking and financial system.

Now unlike what we had expected, also, second point there. North America and Japan actually declined further. You remember that in Q2 we had a little of the scenario here that order intake had actually increased a little on the truck side and that would translate it into slightly higher volumes in North America.

What actually happened in the third quarter and progressively more difficult as we went though the quarter was our North American customers ending up in an acute liquidity crisis and actually we ended up with sales down by double-digit numbers, while that has not been the case in Japan. Japan has been a more reasonable liquid market, financially liquid market. We still see a great amount of uncertainty in Japan.

Then, over the quarter you can say we still had very good development in South America and other international markets, but I think it is fair to say that in October, we have begun to see signs also, especially in India, China, to some extend also in Latin America of them being impacted by the global downturn.

If you look at slide three, that one says Volvo Group net sales. There you see sales down minus four in Western Europe after very strong quarters there, Eastern Europe still holding up, North America actually double-digit decline sales rather than the scenario we had where it would possibly go up. Asia still up but also saw very powerful numbers were down to plus three and then still a strong South America and especially Brazil there.

Now I’ll be coming back to order intake as we speak through the presentation here. If you look at the operating income there, we actually had still good performance in Europe and international. We did that as we delivered the order books that we had, but the order books obviously there shrunk in the quarter, but still good performance in Europe and international.

The difficulties we have had when it comes to Europe and international has been that in many cases we have had to reallocate production from Europe to international markets and that have put a little of a pressure on margins here and there. But in general you can say had we only looked at Europe and international we would had quite decent quarter.

Now what did not turn out well at all in the quarter and actually produced negative results in the quarter was operations in the US, truck operations in the US. Basically we had to send home a lot of more people there in the third quarter and make reductions both in Hagerstown and in New River Valley yet again.

Volvo CEE, also contributed negatively here in operating income development that also the same type of problems that you have seen on the truck side, more so also on the material costs side and then also we took in a one time cost in connection to that.

R&D expenses on comparable quarters is actually up by almost $800 million, that’s on the base of some aggressive programs when it comes to new and competitive products that we are in the midst of introducing right now. Some of which is Volvo trucks new product range. Also hybrids and of course also on the emission standards running up here, and we will see how that rolls out over the next couple of quarters.

Cost inflation raw materials was $1 billion higher, most of that of course has been offset in pricing. But some of it obviously on a real comparative only on the cost side, it was actually $1 billion higher quarter-on-quarter comparison there.

Restructuring was done in North America, as a consequence of the much lower North American market, both at Volvo Construction Equipment and Mack. We took the charge of that of $330 million.

Then just to make the point, even if it might be self evident. When you put the breaks on as much as we have here, there is no way to get rid of cost or be able to part with people at the same rate that we have put the brakes on here.

So clearly, it was a quarter of under absorption, which of course is a cost at one pace when one puts the brakes on as much as we have here. We think it’s the appropriate thing to do even if it means under absorption in the quarter like quarter three, so as not to build inventories.

Flip slides with me to the Volvo Group, sales growth over year-on-year. There you just see the impact of putting the brakes on. And we have actually parted with most of our temporary people in different countries, coming off of that base there and I said last year and start of this year. That we are now biting in and we have given notice all and all, to between 6,000 to 7,000 people so far as we progress through the downturn and in Q3, and also try to adjust to a much lower market than we had at the end of last year and beginning of this year.

With that, let me switch over to Mikael Bratt our CFO, for him to take us through first, the cash flow, slide five.

Mikael Bratt

Thank you, Leif. I will today focus my presentation on cash flow and also the funding activities for the group. Starting with cash flow then on page five, this quarter we presented a negative cash flow for our industrial operation of SEK6.1 billion.

Let me also underline that Q3 is normally a top four from a cash flow perspective. As you’ve seen in ’07 we also were negative even though only SEK0.4 billion. The negative effect could be found in inventory and payables from earnings.

We have seen an increase in inventory with today SEK2.4 billion in the quarter and this is then adjusted for currency and the reduction in payables with SEK6.5 billion, which also is the biggest factor. And this is done in immediate effect of the reduction in our production volumes.

What is the best development; we now have a cash conversion cycle of 38 days and a net debt position of SEK23.8 billion taking us to 32.4 of shareholders equity. In this net debt position, is also the net effect from the Eicher transaction of SEK1.2 billion that took place in quarter three as well?

Moving on to our funding situation on page six; starting on the asset side, which is bar to the left. You can then see that as we have the strong cash position of SEK26 billion and we have an objective here to be between 6% and 10% in cash over sales. On top of that we also have our committed facility as a reserve for funding purpose with another SEK23 billion. Those facilities is maturing in 2011 and 2013, so they are long commitment there.

On the debt side, which is the smaller bars you see here and is portfolio. And in the debt side or the Industrials side I should say is around SEK43 billion and has an average maturity 4.6 years. If you look at the maturity structure, you can see that this is well distributed with the maturity profile that's stretches out couple of quarters here. And going forward the cash flow is of course on top of the agenda.

Also in the market, you could say that we have primarily used the bilateral funding in order to manage the volatile time and that has been during the last couple of weeks here. And the normal funding sources has been used very limited and when this market returns to more normal stage, we have more than 50% ordinary program on it, so we have good results there.

And if you look also on page 7, you see the debt portfolio for commercial finance activities. And it’s a fully matched portfolio somewhat shorter maturity 1.4 year, but beside it’s fully matched against the receivables in the customer finance portfolio.

Finally on page 8, a few words on pension and residual values, which one of you have asked us about the last couple of weeks. The pension plan assets is something we primarily have in the US, Sweden and UK. And we are at this stage fully funded and we currently do not see any need for additional cash contribution at this point in time.

Residual values, I could say it here, that we use a very conservative approach in the residual values and we have much more stringent policy in place than what we have had last time around, when we saw a downturn and we are in the residual values that take into account, they use geographic area, where the truck is sold etcetera, etcetera. So there is a number of parameters taken into consideration.

And then if it’s set and reviewed on a quarterly basis where the residual value commitments are valued and a provision taken when necessary. And they are done on a contract by contract basis.

And for Q3 we have made about SEK100 million in provisions related to the US export and on a global perspective we say we still have headroom left to get into more or some territories. And as a follow-up on the question we got earlier today on during the press conference regarding the capability in the mother company to handle dividend of the size they have done in the past.

I just want to comment that we are managing the group through a group contributions and dividends up in the structure here throughout the year and it should not read only in this quarter what’s available there and there will be sufficient funds available. So from that perspective there is no formal issues related to the dividend. And I would stop there.

Leif Johansson

All right, to [continue] with us again then to the slide that says trucks and let me comment on the trucking group’s performance and operations and obviously if you look at the net sales there you can say we came off of a quarter of almost 53 billion in sales into a quarter where the actual number turned out to be 46 and that hit margins also all the way from 9.2 in Q2 to 5.8 in Q3, on the back of putting the brakes on -- slamming the brakes here in big part of the world.

First of all we had a significant slowdown in demand in Europe and most relevant perhaps to discuss a little of the order intake there. The order intake actually netted --looks like we had a 100% fall and that of course netted and in reality we had 20,000 new orders come in, in the European business. And 20,000 new orders were then offset by around 20,000 cancellations. What happened there was that, the order book then, many of our customers decided to cancel their orders or push forward orders, even sometime in the real near-term, or you can say within the quarter. And we had a number of opportunities to use production slots that were particularly aimed for Europe for international business. But the 20,000 number of course is not such a bad number for the whole of Europe.

And that means that we had -- there is life in the European market, but that is the best way to describe what’s happening here is that given the great uncertainty, frankly, the very non working financial sector when it comes to liquidity and credit promises, our customers simply just take the uncertainty as a reason to say, lets now be careful and see what’s going to happen here before we put the new orders.

Any which way a 20,000 new orders in Europe, we are looking at a very significant slowdown, compared to were we have been even in Q1 and Q2, so clearly, a declining market in that sense.

Operating income then went about a billion less than last year down to 5.8% margin. And obviously significantly lower than quarter two profitability. In the main that was driven by North America, you can say we are still reasonably pleased with the performance actually of our European truck group, but trends that we thought would be slightly on the positive side for North America coming out of the Q2 going in Q3, turned out to be very negative. And we ended actually up with double-digit minuses in North America.

And that seems to have gotten worse over the quarter. And of course for a couple of weeks there in September and also part of October, there was acute liquidity crisis in North America. Obviously aimed at impacting or had an impact in the way we were doing business and the way our customers that they could do business.

We have decided then on the truck group, as we have in other parts of the group to make the adjustments in production system and overhead costs, rather than to wait for a turnaround and we have adjusted them to lower demand over the quarter. And we will continue to adjust and we have made a number of announcements also in October to make adjustments to output in the next couple of quarters here.

Now, some of the trouble we have here, of course, is that when you have to step on the brakes as hard as we have here, and we normally have a notice time between three and six months. Those notice times in general, if you can use them for productive work, can be fairly low-cost way of cutting with cost. But obviously if you cannot use it up for productive work, they turn out to be an absorption in the manufacturing system.

If you look at, in focus, and we have production management obviously and frankly busy days with the amount of changes that we have here, reworking shift changes and getting a lot of people out of the system and with that comes all of the efficiency issues, translated with moving lots of people, trucks and happening from moving lots of people around in the productivity, production system. Cost efficiency and productivity is high on the agenda to make sure that we can deliver good cost efficiency and productivity through the next couple of quarters also.

Let me say that we have the whole of the AB Volvo Board out to visit India and there we saw the integration projects going on with Eicher and we also had the opportunity to make a real visit with Nissan Diesel. All of which sounds good and we are quite happy with those acquisitions and the way we are bringing them into the Volvo Group.

Here we have this unique issue of a couple of quarters in our Q3, particularly Q4 will be there also, where we are still trying to manage and get across to customers, some very high material cost inflation. Which is really now, will what we know now, historic numbers as most of the raw materials have started to come down. But we are still in a process there of convincing our customers to take on extra prices, because of the material cost inflation, because they can and we can’t do that. Material cost inflation actually comes out as negative in the third quarter here.

Next, I should say in general price increases that has been technology related like emission standards we have been quite successful in getting across to the market even in the down turn for example in North America.

If you flip with me to the slide 10, it’s a heavy duty truck market, Europe and that we had actually put a question mark there for 2009 numbers, really on the basis that we have no good information from which to guess or forecast in '09. So that's makes it less meaningful to forecast. We have noted that clear down trend there and we certainly think that it is the case and while all of us are now focused on that downturn, let's just remember that trended dotted line there, the dotted trend line there.

It actually shows and we expect that to be the case that we will have an increasing longer-term, medium and longer term increasing transport market. Nothing in our basic view of how the market has changed at all. It’s actually so that the greater Europe is still a very interesting market and one that will continue longer-term to grow. But, we think in '09, we are going to have to address the downturn price of which we cannot forecast.

Likewise you can see that trend line there on the North American truck market, where we have now been a couple of years very much below that trend line, and our basic forecast from last quarter was for the market to start coming back in the second half of '08 and possibly to increase in 2009.

We are making the same question mark here for 2009 in North America with little to have to go on. Forecasting is obviously very much depended on how the liquidity and credit crunch plays out and overtime also how the economic cycle plays out. But let me make the point here, again, same reasoning that we had in Q2, that even with a downturn in the economic cycle, we actually have a very low output of trucks into the North American market, and we are beginning to see a quite old population of trucks there.

So, sooner or later, the market is going to turn-up and come closer to or possibly overshooting the trend line. We also have the emission standards coming with remarkably higher cost products in 2010, and it would surprise us if everything was reasonably normal, if that didn't have a good effect on the American truck market in 2009. But, of course, it is dependent on where the whole of the economy and financial crisis takes us.

Flip with me to the trucks slide on number 12. In general, they're in a good market share development in Volvo Trucks, Renault Trucks and Nissan Diesel; slightly less good on the Mack Trucks side, because Mack is so heavily involved in construction business in the US, and obviously that is a negative industry to serve with equipment, right now.

Production adjustments being made in all parts of the group, all four brands; and as you can see here then the Japanese market also considerably down in 2008, off of a weak 2007; so, again, an effect here of the financial crisis.

Integration work actually going well on Nissan Diesel, and we are quite proud to see Mack Trucks here registering well both in the Dealer Service in JD Power. But also a 32% reduction in greenhouse gas emissions that made EPA happy with us. It made also us happy because it translates directly into fuel savings from an operating cost point of view.

And with that, let me conclude a difficult quarter for Trucks and hand over to Tony Helsham and ask him to speak about Construction Equipment.

Tony Helsham

Okay. Thanks, Leif. Let me say again and start by saying after a good Q1 and Q2 this year obviously and clearly we had a very difficult Q3. And I could overall summarize and say that the comments that Leif has made regarding liquidity around the world and the market effects are very much relevant to Construction Equipment, as well. With one exception and that is the Construction Equipment industry has also been hit hard in Q3, in Europe. Whereas, I think the comments were that the Truck business in Europe was still fairly reasonable in Europe in Q3.

So, despite lower volumes, overall. Our sales were up slightly in the quarter. However, clearly the operating income was sharply down and quite frankly a great disappointment to us all; driven mainly by us hitting the brakes hard and taking the effects there by the downturn of the business in Europe. And the combination of the effects of continuing higher steel prices for the quarter; some portion of currency effects and one-time effects taken in the quarter for some structural changes that we've announced regarding motor graders.

From a market perspective, the market conditions are not looking all that favorable. Europe now was down 24% for the quarter. And North America continues to deteriorate from a rather low level. And for the first time for a long period, we see in totality Asia also starting to decline.

And then these declines in totality cannot be totally compensated for now by the increases that we still see in region international. So, for the full year 2008, we expect Europe now to be down some 15% to up to 20%. North America to continue to decline up to may be another 20%. And if we take the combination of all the other markets around the world, we do see growth still some 15 maybe up to 20%.

So, of course, in focus and moving forward here, of course, our focus is on recession management. We have taken some tough decisions in the last few months regarding adjustments to the production systems to reduce the volumes and reduce the overhead cost; and to adjust for the lower demand.

So we, of course, announced in September. We have decided to consolidate our industrial operations in road machinery, in order to improve competitiveness and profitability and also reduce our exposure to exchange rate fluctuations, and we recorded a cost of SEK300 million in the quarter for closing down our factory in Goderich in Canada and consolidating that into our factory in Shippensburg.

And as you have seen in the press, and also in September, we announced that we gave notice to around 500 employees in Sweden affecting all our Swedish entities. And as we continue to see the demand next year continuing to level out at a lower level than perhaps what we saw a few months ago.

We as early as yesterday announced the further redundancy program in Sweden of another 850 employees. So I would say, in Sweden, as we have already done in France, and in Germany, and now also in Korea, we are taking the tough decisions to make the adjustments as we see the volumes going forward.

And then finally also we have clearly still work to do to fully integrate the acquired road machinery business, as well as the Chinese business Lingong. So there is still much work to do there. And it could focus being paid to that as well.

Leif Johansson

Okay, Tony. Thank you. Flip with us to slide 14. And Buses; and we have Håkan Karlsson, President of Buses to speak to us about that.

Håkan Karlsson

Thank you, Leif. The Bus market shows, I will say great differences between coaches and seater buses. In the coach segment, we already are in a downturn mode, I will say. While the seater bus segment still holding up, globally. And I think this reflects in our ordering take which was improved compared to last year with 14%.

The sales in the quarter was slight above last year and the profit was still weak on the same level that we had, last year. We got some significant currency revolution in Brazil, the Reais weakening with 20%, which hampered the result in Q3.

We have (inaudible) industry restructuring in Europe and according the plan in the third quarter. And that means that we are 500 people less now in the industry system in Europe.

We have launched our hybrid bus in Europe with extremely big interest, I'd say, from the market. And now we will run the field test vehicles in London and Göteborg from November this year. And we are starting selective sales then with deliveries in the end of 2009.

And focus, the global profitability program will continue to deliver during the next coming quarters. We focus hard on inventory management on the coach side. And we also there make some capacity adjustment to the coach segment.

While seeing the seater segment, we are focusing much on winning some big tenders and there build strong order book for 2009. Thank you, Leif.

Leif Johansson

Very good. Thank you, Håkan. Come with us to slide 15. And Volvo Penta, Göran Gummeson is the President of Volvo Penta.

Göran Gummeson

Okay. Thank you, Leif. The global market for marine in Europe and North America declined during the third quarter. And that was mainly due to the financing problems both these levels and also the underlying lower demand for boats. And we actually expect the marine markets to come down even further.

Sales on the contrary of industrial engines were quite strong during the quarter. But because then of these decline on the marine engine markets our total sales was flat compared to last year.

Operating income and margins were weakened due to lower sales and we had an unfavorable product mix. But also on deliberate decisions on products and process development costs.

Last week we gave notice to 90 people at our Indian factory and Vara in Sweden. We will finalize these negotiations then with the unions during the fourth quarter.

We are also reviewing the structure in both North America and Europe, as we speak. And always the total operations in these countries in order to increase efficiency and also reduce the operating expenses. We have, for instance, already restructured our operations in Scandinavia and also in South America.

We then had an acceptable momentum for our IPS systems in the marketplace and we will be able to capitalize even further on this engine range, because as we are now launching new end IPS packages with larger drive units in compare and also with larger ambience based on the Volvo Group's diesel engine platform space. So that’s everything from Volvo Penta.

Leif Johansson

Very good. Thank you, Göran. This takes us to Olof Persson of Volvo Aero. Tony was the last time I think on Construction Equipment to make a presentation. Olof is the last time on Volvo Aero, because next time he will be presenting here Volvo Construction Equipment as the new head of Volvo Construction Equipment. Olof, so you talk about Volvo Aero this time.

Olof Persson

Yes. If we start on the market side, we can see that air traffic growth is now flattening out. Basically all regions report lower growth rates and particular on US domestic market has been decreased during 2008.

However on the order book side, for large commercial aircrafts there has been an increase and continue to grow, and that shows also in our order backlog which is actually 37% higher, this quarter compared to the same period in 2007. That means also that our component business continued to grow in a fairly good manner and with good margins.

In this quarter, we have been negatively affected both on the sale side and on the operating income side by lower volumes in the after market business due to lower activity in the markets. We had in the quarter a successful test and also confirmation on our new compulsive technology, where if you remember we bought a company named ACAB in December last year. And we are now moving forward with that technology and had a successful test, together we always saw proving that we are on the right track [theoretically] on that.

We will see on a comparable basis with a natural composite structural component a 30% decrease in weight, which is quite a lot. In focus, we are now [intensified] the market profitability program, which is led by cost rationalization, but also aggressively going of the new contracts, which can help us lifting up the volumes in the after market.

Since we had very long contracts, we are continuously working on the product cost rationalization and even though we have a RSP partnership structure. We continue to work on the product cost continuously. And, of course, in quarter two and quarter three, we took large orders with (inaudible) with me and in focus right now is of course is to execute on this new contract. That was extra over.

Leif Johansson

All right we have Financial Services, President, Sal Mauro on slide 17. Sal?

Sal Mauro

Thank you, Leif. In the third quarter of 2008, we had good strong new business volume at SEK10.9 billion, 12 month rolling we had [43.3]. So obviously, in a downturn it’s a good time to have a captive finance company and we are looking to grow volume with good credit.

Our income has remained stable from the fourth quarter of 2007, obviously a bit lower than quarter three 2007, but still on a good a level at SEK391 million. After tax return on equity has come down along with the profitability from the year-over-year quarter and most of that has to do with adding credit provisions, especially in our North American portfolio.

Penetration is steady and we are looking to grow penetration as we are going into the down part of the cycle. In focus, we have heightened portfolio management as a reminder. VFS is a collateralized vendor. We secure our loans with the Volvo Group products that we finance.

We have a matched portfolio from an interest rate perspective, liquidity, currency and tenure, but we do not have any interest rate risk in the portfolio. The portfolio structure is quite conservative. We have 36% installment credit, 36% in financial lease, which carries a very small and nominal residual value, typically the last payment or under 5% and we also do dual financing at 16.5%.

We do operating leases or operational leases, where they do carry a market residual that is guaranteed by the business area and that makes up only about 10% of the entire portfolio. We do engage in fee income products. We do not have at risk insurance or maintenance contracts. We provide service there and we do that for fee only.

Taking a look at the global financial markets, obviously it's been a challenging times in the credit and liquidity markets but for VFS, it's been business as usual. We have funded every deal we have wanted to fund from a credit perspective and I think that’s good news for the Volvo group. We have seen interest cost increase from treasury, our in-house bank and we have been passing those interest costs increases to our customers.

We actually see opportunities in the downturn. We are looking, as I said for greater market share with good credit customers and opportunity also to increase margins and also look for some good talent.

We are here in good times and bad time. We're not fair weather friends as some of our competitors have proved to be. We will continue to look for good credit standards and good credit customers and we look to expand the portfolio and support the Volvo business areas and Volvo customers.

Leif Johansson

Thank you, Sal. Takes us to slide 19 and a short summary, so we're on the slide of Group summary, you see only thereafter a couple of fairly decent quarters. We obviously came down by 37% compared to Q3, '07. That's on the base of reducing sales compared to Q2 this year by 13% in the quarter and really hitting the break hard here to make sure that we don't produce inventory, especially.

The reason that are so uninterested in producing inventory is that we have seen things that not only does it have a cash flow negative aspect, did also have the margin aspect to it. We don't want to be out there with a big inventory and in the main we have been able fix that.

You saw from Mikaels, slide here that we put couple or little more into inventory in the quarter, but not very much and most of the cash flow effect was actually the payable effect of breaking as we did.

We are releasing also competitive new products, we're in the midst of the new Volvo truck introduction here in Europe. We feel great enthusiasm around those products, we likewise on the Renault Trucks, where many new products have been introduced and all of that came together to actually giving us 20,000 new orders in the European system, there.

And likewise on across the board we have competitive new products releases that includes Mack and [VC], and we think they have been well received, with their focus on fuel efficiency and greater productivity, which we think right now our customers need to stay competitive in their respective businesses.

In focus going forward, we have made in September but also during October a lot of announcements when it comes to adjusting production capacity and cost. The way we do that is for each business area or even each part of business area to workout what the numbers look like and orders intake are quite different across different parts of the group, and therefore we area announcing as quickly as we have decided what to do.

We are announcing locally as we can to make sure that we don't get tangled up in the internal workings of the group. So each business area leading but internal also the people who reported, they are charged with making sure the production capacity and cost is in line with the actual demand that we have.

We have an issue here when it comes to the global crisis, and normally in a normal down cycle the group would have had fairly big opportunities to move production capacity. With a diversified footprint we have to move production capacity from for example Europe to International.

Now we are beginning to see a global situation that because of the financial crisis is coming down almost everywhere. Hopefully as the financial crisis is coming under control, we will come back into a more normal mode of a business cycle to go through. I think what we have right now is actually a fairly normal business cycle in its own right but then, much impacted by global financial crisis.

Integrating acquisition is on track and doing well, we are happy to see how those reports are coming in and that’s not only on the truck side, this is also true on the construction equipment side. Obviously a key target for us when it comes to going through that [steeper] cycle is this is to make sure that we can deliver cost efficiencies and productivity over the business that we have still, and to be able to operate efficiently on lower volumes that we have. And obviously that becomes an issue of how to brake and get into those most, as we clearly have that on our top of our agenda.

And then of course we are the midst here of introducing environmentally friendly but in the main that also means fuel efficient products and that has met with great interest from our customers and more specifically or perhaps on the hybrid side, which you see in during 2008 is mainly as cost but we think over time in 2009 that’s going to contribute nicely to the group’s development also from a profitability point of view.

And with that operator let me stop the presentation and open up for any Q&A that you may have.

Question-and-Answer Session

Operator

[Operator Instructions] the first question comes from the line of Mr. Fredric Stahl from UBS. Please go ahead with your question sir.

Fredric Stahl - UBS

Hi, good afternoon. Can I just clarify did you say in the earlier call that you are taking out 30% of your blue collar staff or did I get that wrong.

Leif Johansson

If you take a casual number and it is very different in different parts of the truck group and it's different in different parts of the [CE]. But if you wanted a catch-all number and someone did then you can say somewhere between 20% and 30%.

Fredric Stahl - UBS

Okay. And then can I ask, do you have any order book coverage for the rest of Q4 or is it more on a day-to-day basis that we are back to the good old days when you booked an order and got delivery reasonably quickly?

Leif Johansson

No, we have quite an order book and we said on truck side, is actually back to normal and normal now means two to three months lead time still on trucks.

Fredric Stahl - UBS

So, you have two or three months, yes.

Leif Johansson

Yes.

Fredric Stahl - UBS

And then on R&D expenses, you mentioned that we will see what happens with that, are you contemplating a move pushing forward project or delaying project, so to speak and to delay it and to negate the negative impact from R&D?

Leif Johansson

Yes, sure. We are taking a look at that, if when the market comes down as dramatically as they have here, there should be [sacred cows]. So, we are taking a look at all types of cost, we have high ambition when it comes to, in connection with the emission standard changes, to also make good changes in the rest of our product ranges.

And we have said internally here, no sacred cows and therefore we are going to take a look at that also. But our basic inclination at this point in time at least is to make sure that we deliver competitive product to our customers.

Fredric Stahl - UBS

And then a final question on construction equipment maybe for Tony. You generate about a third of sales in construction equipment from emerging market, Asia and the other. Have you seen any increased presence there from the Chinese. So, what I understand is that the domestic market in China is weak and you have some very big players. Have you seen that coming into a greater extent now?

Tony Helsham

We haven’t seen it as a greater extent, we have seen over the last 12 months or so. Selective Chinese manufacturers moving into testing the markets in particularly Latin America and also Southern Africa. But we haven’t seen an increase in their exports as a consequence so perhaps this was in China.

Fredric Stahl - UBS

Okay. Thank you.

Operator

The next question comes from the line of [Alexis Albert] from Natexis. Please go ahead with your question sir. Mr. Alexis, your line is open

Alexis Albert - Natexis Securities

Yeah. Excuse me, can you hear me?

Leif Johansson

Yes.

Alexis Albert - Natexis Securities

Okay sorry. Alex Albert, Natexis Securities in Paris. I have three questions if I may. The first one is regarding North America. There is one thing I have trouble to understand because last year during the Q3 2007, your revenue in North America went down by 50% and I think this quarter went down by 10% and it looks like the burden you got from North America this quarter was much more higher than it was last year. And if I remember what last year you had saw some layoff in North America. So just like to understand better what happened this quarter in North America.

My second question is regarding Russia. Can you share with us the order intake in Russia? How down is that? And my last question is regarding the, I would say the operating guidance for trucks or rather cycle. I would like to know in your guidance for the operating margin, although the cycle was a plus and minus. Are you still worried if the European truck market is going down by 20% in 2009? Thank you.

Leif Johansson

Okay. On North America I think you are a little in between in the different quarters here in comparison. We have a real effect in North America this quarter, really based on the fact that our assessment was and our order intake showed that we should have a slight uptick in the Q3 and we actually had a scenario that said we are going to have to meet higher demanding Q4 and then over the quarter that reverse itself into actual [reloaded] in Q3 a real negative double-digit negative and on top of that hesitancy on the order book for Q4.

So we decided to take -- the consequences of that what to make reductions in Q3 much different to what we have planned and as you might say somewhat abrupt and it had a negative effect. But again, we are in the midst of making sure that we don't built unnecessary inventory in this situations. So, we had perhaps more of an effect than normal quarter-on-quarter comparison roll out would give you.

Russian order intake, I don't have the specific numbers but its clearly on the downward trend and if you do the 20 to 42, if I remember than say about minus 50% reloaded a downturn that's then Russia is about the same. So, Russia behaves as greater Europe you can say.

Then on the operating margin we have no reason to change our guidance on operating margins, but I must admit also that its very difficult to and as you hear we are not even calling what the market will be next year. So we are living in very extraordinary times. But in normal ordinary times we would not give any other guidance at all. These extraordinary times, we're going to have to swing, take the swings as they come.

Alexis Albert - Natexis Securities

Okay. Just one follow-up if I may regarding North America. Would you say that I know you don't comment on this usually, but times aren’t as usual, would you say that this quarter North America was not at break even?

Leif Johansson

Well, I normally don't quote this and even this is abnormal times, so I won't comment on that either.

Alexis Albert - Natexis Securities

Okay. Thank you, very much.

Tony Helsham

Thank you.

Operator

The next question comes from the line of [Jeremy Taylor] from AllianceBernstein. Please quote your question, sir.

Jeremy Taylor - AllianceBernstein

Good afternoon, gentlemen. Two questions please. The first one on customer financing, where you say that you expect penetration to rise somewhat in the downturn. Could you tell us a little bit more about how you are thinking about that? Does that reflect looking to stabilize new lending or would you actually look to grow lending and what sort of limits would you place on that through the cycle?

And the second question, the cleansing process that you have been through the order book in European trucks. How confident are you that you squeezed out most of the cancellations now or do you think there is a risk of further cancellations in Q4?

Leif Johansson

Lets have Sals start with the financial question.

Sal Mauro

Okay. That’s a good one. And the first thing I’d like to say is that we will hold our credit standards as we have in the good times and now in the bad times. So we have to make sure that our customers’ creditworthy. But we are coming from a level of about 28% overall as a group, and I believe we will be looking towards more 35%, 40%. And I’d say we start to top out at about 45%. So if I had to put a limit I would at about 45% is where we’d like to be. So what is on new lending, we think we have greater opportunities in the market to penetrate the different business area, customers build relevance and also increase margin and get some good profitability in to the group.

Leif Johansson

And let me, Leif here talk about the cleansing process. We have gone through a most dramatic quarter here in Q3 for that matter October also. If we take out a 100% of our reloader, intake and you actually cancel? Then I think you can say, we have gone very deep into the books, and we've done a very thorough job. So our basic assessment would be that the orders that we have now on our books have gone through not only a reel cleansing theory during one of it most difficult quarters. But also all of the impact of the financial crisis and everything else come our customers.

Even with that said, we live in very extraordinary times. We have a situation here where we hear customers daily calling us to say that credit promises today that's what they had only a week ago is no longer viable, etcetera, etcetera. So we cannot say that this present order book is without risk either. But reel cleansing is going on here. And hopefully, if that's enough, we don’t know.

Jeremy Taylor - AllianceBernstein

Okay, thank you.

Operator

The next question comes from the line of Mr. Colin Gibson from HSBC. Please go ahead with your question, sir.

Colin Gibson - HSBC

Hi. It's Colin Gibson, HSBC, again. Jeremy just asked one of my questions, so I’ll focus on the second, which was regarding R&D, again. I think earlier in the year you guys were indicating that you expected R&D to turn into a bit more of a tailwind in your year-on-year comparisons as opposed to the headwind it was earlier in this year; based on your belief about the amount of R&D that you would be capitalizing as opposed to the amount of R&D, which you would be expensing; so coming from a high level of expensing and moving towards a higher level of capitalization. Is that something you still expect? And if so, is that something whose effect is going to be concentrated in Q4? Or have something changed significantly there?

Leif Johansson

Let me say. I am looking to my philosophy of all to sort that out. There were not so big effects in Q3 here in capital.

Mikael Bratt

In Q3 the net effect was only a negative 59 million coming from R&D capitalization. So with that said, the minority is then the growth spending. And to really make a pre-action outlook, going forward is very difficult depending on how the products are developing and the timing of them.

Leif Johansson

There are consequence on how we actually start up manufacturing of products. We will try to sort that out a little for you. My comments earlier were also on the growth spending side; frankly, on the difference between the big capitalization and at the projects that they roll-out, we should not have big differences, as we move into more normal stakes then obviously you have this an unnormal device here to look at. But we will try to sort that out a little for you if there are big changes coming out. My comments earlier and Mike said that I think is more relevant. He said the actual spending per quarter.

Colin Gibson - HSBC

Okay. Thank you very much. And then related a related but slightly broader follow-up if I may. When comes to Euro 6, given these comp business climb up. Would you be in favor of bringing forward Euro 6 and has, of course, been some discussion in the marketplace, I understand? Would you be in favor bringing forward Euro 6 on the basis that it would level the playing field between SCR and EGR players because even EGR players will have to use SCR for Euro 6? Or would you be against bringing forward Euro 6 on the basis it will cost you more money right now?

Leif Johansson

I think, right now, we are in the midst of really having a big debate between the council and the European Parliament, and then industry on the side. I would probably say that Euro 6 whether it's one year earlier or later, which are really another times, when we are discussing about strategically or operationally has little effect. SCR is beginning to be the winner altogether when it comes to technology moving forward. In Euro 6, I think, as far as we know it will be there.

So, I would probably say, it's less of an issue for us. We could live with either or and would have fairly little impact. But let me make another point and that is, come US’10. And also then the post new long term standards in Japan, so relevant standards in Japan. From our point of view, of course, it would be a great effect if our different law makers on either side of the Atlantic and Japan, could actually come into a harmonized tests site because we are spending a lot of money, and I should say, unnecessarily so, on trying to fulfill different standards on different sites, in different parts of continents in the world, without it having any realized effect. If you measure the reel effect that comes out of the tail pipe, very, very little effect. So, we would certainly argue strongly for harmonizing emission standards all over the world.

Colin Gibson - HSBC

Thank you.

Operator

The next question comes from the line of Mr. Nico Dil from JPMorgan. Please go ahead with your question, sir.

Nico Dil - JPMorgan

Good afternoon. It's Nico Dil from JPMorgan. Three quick questions, please. First of all on the working capital. As you highlighted yourself, inventory was exceptionally high during the quarter and payables, maybe on the low side. How do you expect this to develop going forward, and especially on the payable side?

Second question is on the raw material impact. You highlighted about 1 billion for the quarter and even a bit more on next quarter. So I was wondering whether that will perhaps reduce to, let's say, half the size or should we be thinking of even less?

Then, perhaps the last question is, you've highlighted almost a freeze in the capital lending for your customers. And I was wondering, what you are hearing from your customers or even their bankers, when that could perhaps start to lighten up a little bit? So, when could we see these orders coming back? Thank you.

Leif Johansson

Right. On the cash flow side, obviously our desire here is to build down inventory and to have the right amount of inventory as it relates to the market that we have. And since the market has now come down, our intention is clearly to build down inventory in Q4. And you will see then we think and but it all depends on the credit crisis, just for the inventory to reduce. But, of course, over the quarter, that will in the main be translating into accounts receivables. And then, depending on how hard we have to break, you will the same calculatory effect, calculation effect or arithmetic effect on the payable side. But all of our focus is on making sure that we can get good cash flow going here, over the next quarter and over the next couple of quarters.

And let me talk a little about that too because I understand here that we have quite a big discussion on cash flow and as it relates to the dividend. And I've answered it couple of times now, and I've also done comments in media on that.

And obviously from a cash flow and dividend point of view they go together. Cash flow is on the top of our minds. And let just remind you that the whole of management of group has more than a half of their total remuneration package coming from our ability to get cash flow. So, we have this in our focus.

The Board recommends in Sweden to the shareholders was you are assembling to decide. And that's the way you can say it's going. The Board doesn't decide but the shareholders decide. But the Board recommends.

So far, when the Board has recommended, they've basically done three things: They've looked at how was the year in terms of cash flow and profits. They have looked at how is the situation in the relevant quarter, what is the situation right now. And that would Q2 2009. And perhaps you can say, given the financial crisis that rolls over quarters, obviously there now situation is going to be an important input and the Board is making that recommendation.

And then, of course, the Board also values in and weighs in what do we have in front of us? What do we know in terms of cash needs and acquisitions? And I answered earlier in the day here that I don't see big acquisitions on the horizon, right now, obviously, that's something that.

Finally, and when the decision is made Q2 in 2009, we're going to have to value it. But those three things, how was the year? How is the situation? And what do we have in front of us? Is going to be on the Board's mind. And in the meanwhile, we will do anything we can to make sure that we get good cash flow.

On raw materials, we had quite an impact in Q3, really a billion year-on-year, and that's, of course, as if we look at comparing the two quarters cost only. In reality, of course, much of that has been offsetting price increases, and then we had other things like under absorption coming into hit the P&L.

We think we have at least a quarter or two ahead of us with high levels on raw material. But as you have all seen, the raw material costs are coming down. We have been gone short in the market. And then, of course, you have the follow-through in the production system in itself. So, given a couple of quarters and I think you will see raw material actually coming down through the P&L.

Then on the increase in capital lending, I think it is very different in different countries and for different customers. So it’s difficult to give you an overall flavor that would symbolize the whole of what we see. We have customers especially those that have been banks that have gone bankrupt or whatever. They are in acute financing situation. They had to switch banks and find other ways of financing their business. And we are customers that were quite pleased with their situation and have no trouble at all in getting liquidity.

So very different in different countries very different even between customers and sometimes different between segments of customers, for example we have noted if you take the housing market in Europe and especially in Southern Europe that came down more dramatically than it has been in Northern Europe.

So I can’t give you an overall flavor there we are going to see how that works out over the next couple of quarters.

Nico Dil - JPMorgan

Give us a little bit of flavor on the Western Europe Truck market perhaps?

Leif Johansson

Yes, obviously you have seen the order in take on greater Europe there up 20,000 orders. Gross orders then offset by cancellations, but I think that the 20,000 number is a better number to look at, which means that the market is in debt. It means that it's slower than last year but its great difficulty to make any forecast there as we said. We won't make forecast for 2009, the forecast for 2008 has come down which of course with three quarters already gone that's a sign that the end market is heading south.

Nico Dil - JPMorgan

Okay, thank you

Leif Johansson

Good, should we take a final question.

Operator

The final question comes from the line of Mr. [Jose Asamendi] from Royal Bank of Scotland. Please go ahead with your question sir.

Jose Asamendi - Royal Bank of Scotland

Hi, good afternoon gentlemen. I have two questions please, I think may be for Sal, could you please talk about your truck residual values exposure in North America and Europe and maybe just the trends you are seeing in market, how the residual values in North America has stabilized after a downturn and now they are deteriorating in Europe.

And the second question could be -- in relating to European exposure. Could you give us a sense of how many trucks do you plan to buyback in the next three years?

Sal Mauro

Okay. I could talk a little about if they used truck prices from a Volvo financial services perspective. But I would just like to say and remind everyone that from a residual value or buyback perspective it’s the BA that takes that exposure and set those residuals and is responsible to remarket them and I may ask Mikael from an overall view on that from the different BAs point of view.

We've seen so far is that obviously the severity of the losses especially in North America have increased during the downturn and I would like to remind everybody that from a financial services point of view there has been a downturn in America since September of 2007. That's when we started to see it getting into a downturn. And so the severity has, which is our loss per truck or piece of construction equipment has generally increased.

Overall, for the used truck prices we're seeing some decreases in Europe. What we've been saying that we had passes about 10% to 12% in North America up from last year about 19% to 20%. So its obviously having an effect on the severity of the losses that we're taking. And now Mikael do you have any overall comments on the residual situation.

Mikael Bratt

Yeah. Sure. As I mentioned early on -- I mean we evaluate the contracts on a contract-by-contract basis. It depends on when they are done and so forth in time, and if you put the US first here. We have made a provision here during Q3 of about SEK100 million and that is taking into consideration a 25% reduction in residual values in that region.

If we now go to Europe we still have headroom left, and also both on the Truck side and also on the Construction Equipment. So there we have much better position than in the US. I mean in the US we have had some downward pressure for quite some while right now.

Leif Johansson

All right thank you Mikael, that concludes the teleconference quarter three at Volvo. Thanks all for been with us and any contacts or further questions you may have, direct them to investor relations. Otherwise we will see you next quarter here. Thanks.

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Source: AB Volvo Q3 2008 Earnings Call Transcript

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