AB Volvo's (VOLVY) CEO Olof Persson on Q2 2014 Results - Earnings Call Transcript

Jul.18.14 | About: Volvo AB (VOLVY)

AB Volvo (OTCPK:VOLVY) Q2 2014 Earnings Conference Call July 18, 2014 3:00 AM ET

Executives

Olof Persson – President and Chief Executive Officer

Jan Gurander – Executive Vice President Corporate Finance & Control and Chief Financial Officer

Christer Johansson – Senior Vice President-Investor Relations

Analysts

Alex Whight – JPMorgan

Fredric Stahl – UBS

Alexander Virgo – Berenberg

Michael J. Tyndall – Barclays Capital Securities Ltd.

Fraser Hill – Bank of America Merrill Lynch

Laura Lembke – Morgan Stanley

Ashik Kurian – Goldman Sachs

Colin Gibson – HSBC

Michael Roeg – Kepler Cheuvreux

Hampus Engellau – Handelsbanken Capital Markets

Operator

Ladies and gentlemen, welcome to the Volvo Group Report of First Six Months 2014. Today, I’m pleased to present Olof Persson, CEO. For the first part of this call all participants will be in listen-only mode and afterwards there will be a question-and-answer session. Olof, please begin.

Olof Persson

Thank you very much, operator, and most welcome to this telephone conference for the second quarter in 2014 for the Volvo Group. And if you follow me to Page #2, you see a summary slide. And I think the headings there when it comes to markets and the market developments explains it quite well.

We have seen during the quarter that the mature markets are growing and the growth markets are declining. And if we look at the developing countries or economies in Asia and South America as we then refer to the BRIC, it’s actually down 21%. That has been offset by the solid development we have seen in the mature markets, North America, Europe and Japan leaving us with an unchanged sales compared to Q2 in 2013 on SEK 73 billion.

We are reporting our results of SEK 4.3 billion or 6% before restructuring charges. In that we do have a number of positive one-timers. And we can say that if we should look at what has negatively impacted the result, it is definitely the lower volumes in China for construction equipment and the Brazilian market in terms of the trucks. And we will go through that, and I will go through that a bit more in detail during the presentation.

When it comes to the truck orders and deliveries you can see that we are in balance, book to bill 100% where the orders are down 6% and deliveries are up 2%, again big changes or differentiation between the different markets.

If you now follow me to Page #3, and starting with the trucks Europe, I would say that the quarter started a little bit slower than we have anticipated. The hangover effect from the Euro 5, Euro 6 transition did also impact the first part of the quarter. But then as we have moved along, we have seen a gradual improvement in demand. And if we look at the sequential compared to the Q1 this year orders are up with 16%.

In general, we can say that we have had a good performance of the trucks Europe operations in most aspects. We see that the reception of the new products and the new ranges are very well received. We see that in the market shares, particularly for Volvo now increasing up to almost 18%, historically a very high level. We see it in the price realization, which is also reflecting then in the margin development for the trucks Europe as a whole being positive movements during the quarter.

When it comes to Renault trucks we also there see that the order intake is picking up at the latter part of the quarter. We also see that the market share has gone down a little bit. It is because of the fact that we do now, fully introducing the new ranges and also that the so important French market for Renault trucks has been on a lower level. However, it’s important to notice that the market share for Renault trucks in France is actually increasing.

If I look at the focus going forward for the second half of this year, it is to continue to make sure that we capture the organic growth that we have as a target. That means that we are focusing on the market shares both for Volvo, but also for Renault, even if that will take a little bit of time building that new ranges up. And, of course, also to continue with the program we have in reducing the selling cost with the new structure and new organization that we do have put in place for the European sales organizations.

So, all in all, a slower start than anticipated, a gradual pick-up during the quarter. The fill rate in the factory was a little bit low in the beginning of the quarter, but has also picked up during the quarter and we’re leaving the quarter with a good fill rate in the factory coming into the fall, all that leading to a book to bill of 118%. We also keep our market share of 230,000. And as you probably know, many of you, up until May we had 91,000 registrations in the market meaning that the second half of the year will be slightly higher in terms of registrations according to our forecasts than in the first half.

If we then move to Page 4 and talk about trucks North America, again a market that has generally had a good performance. We see that the freight environment is good and improving. And for the first time in a long time we now start to see that it’s not only replacement. It’s actually moving into expansions by our customers and the fleet. Also here we have seen a good performance when it comes to market shares and profitability. It should be noted though that we are not where we want to be with the North American profitability, but it’s definitely moving in the right direction.

The market shares combined is up to close to 20%, which is a level which we have had in the past as well and its increasing as you can see both for Mack and for Volvo. The book to bill is 86% and that is a result of the fact that, and you can see that the order intake during Q4 and Q1 was quite high and we have therefore built a pretty long order backlog that we have to deliver. And therefore we then also now increase the production rate in Macungie and New River Valley.

As always, when it comes to quarterly reports and North America, we report also on our penetration on the engine and I-Shift penetration. And we are now in engines for the Volvo side about 90% and I-Shift is actually up to about 80% penetration right now, which is very good as we have talked about many times for the spare part, the maintenance and the service business going forward.

I can also conclude that the dealers in North America are performing well. We do see that they continue to invest in new facilities. They do invest in the automotive business. And we also see that the market share for the dealer side is increasing. And we keep our total market forecast of 260,000 for North America.

If we then move into page 5 and coming into a market that has been, and a region that has been tough during the quarter definitely and in particular then Brazil. And I want to reinstate that we are talking about in this quarter about the planned rebalancing of our Brazilian systems and let me go through the story a little bit here. What happened was that we saw and we also communicated the lower demand coming into Q1 moving from the 100 plus thousand market that we have seen down to 19. That meant that we had to rebalance our dealer stock.

And by doing that and the way we did it was that we capped production to making sure we didn't overflow the system, and we also lowered our own inventory. That meant, of course, that we had to take a number of stop days in the system. It also meant that our sales went down as the dealers then were selling out of their stock. And that in combination both the lower production and the lower sales had a considerable negative effect on the result if you compare to a year before.

The good news here then though is that we did it decisively; we did it planned. And I definitely think that is a – and absolutely necessary to react quickly. It has been costly, but we are now almost in balance with the new, and let me remind you, still a historically high level on the market of 90,000 we are now in balance.

I think that is very important also to remember that the Brazilian market is a big, it’s a profitable and very important market for us and therefore it’s also good to see that we are improving our market share with more than 2% compared to a year ago. So we have a good movement there. But it has been a tough quarter for the Brazilian organization in order to make sure that we readjusting the system and rebalancing it into a market of 90,000.

If we then move into Page #6 and looking into Asia and starting with excluding Japan, we can say that there is not much news. On the mining side it remains slow and has done so for quite some time. But what we see now is that we have launched the new Volvo ranges in a number of countries in Asia with very good receptions. And we can only conclude that as soon as we come in with a new range we immediately see market shares increasing and we also have a good price realization on the trucks that we are launching throughout Asia.

In Japan, we have had a continued strong demand. And we also see that our market shares are moving on the heavy duty side and we are launching also, a facelift, a new product to support the market. And the focus going forward there is definitely to improve profitability in our complete Japanese operation.

And as you know, we have lowered the cost base substantially. We are working heavily with the dealer development to make sure that we are serving our customer and also capturing the aftermarket in the best possible way and also of course then coming up with new and competitive products. So all in all we – the Japanese market is, as I said, strong, but we will have some work to do in order to improve profitability.

If we then move to Page 7, and look at the other very problematic area for this quarter, and that is the CE business in China. And here again we're talking about a balancing act in order to make sure that we readjust the system. And then I’m talking about the complete system to a new and lower level than has been before. As you can see that the total market in China is in steep decline. Our deliveries is down by 32% and the market is down 19%. And let me also here go through the story a little bit what has happened during the quarter.

As you remember the January/February market was actually up and combined with 27%. As always in the beginning of the year and slightly in the back end of last year, the industry is building up inventory ahead of the spring season. March then came in slightly down with a 5% and then we saw an accelerating decrease in the market during the quarter, which meant actually that there was not much of a spring season to talk to and therefore the whole industry had very high inventory levels. That in turn started, of course, to put high pressure on pricing and also high pressure on the whole system in terms of liquidity and the sales.

Again, a rebalancing is necessary. I am absolutely convinced that the best way is to face reality and do it as quick as possible. The team has done that. We have run the production on an extremely low level. We have focused on making sure that we are getting the inventory level into a reasonable and acceptable level. But we can only conclude that this will take some time with the inventory and the demand situation we have, combined with utilization of the machines that we see out in the market.

So it's also clear that we believe that for the industry it will take several quarters. We are committed and we will do whatever we can to do it as quick as possible. But as today it’s very difficult to say when we will be in balance again when it comes to the China construction equipment market.

Again, I think it’s worthwhile and very important also to mention that China is and will be for a long time the world’s largest construction equipment market. It is a profitable business for us. We are number one and it is very important that we continue together with SDLG to keep our position there and work through this tough time as good as possible.

If we then move into Page #8, we can see that on the bus side, we start to see a slow market recovery. Order intake is up and also deliveries are up and the result is also slightly up. I think the – from a more long-term perspective what has been interesting during this first half year, not only in the second quarter, is that we see a build-up and a very high interest and demand for hybrid and electric hybrid buses. We have a very good position there. And we are now working with a lot of big cities in order to really transform and to change the bus travel going from normal diesel power into hybrid and electric hybrid buses in a number of projects, and that’s very encouraging to see.

On the Volvo Penta side we can see that the demand for marine engines in Europe is early signs of recovery, but we should remember its coming from very low level. And I think what’s interesting this quarter definitely is that we have seen now a strong inflow in new customers for industrial engines. And that is based on the very competitive and good new range of T4 final engines that Penta has put out to our industrial customers. And that is bearing good for the future to increase the customer base in nowadays a more and more important segment for Penta on the industrial engine side.

Moving into Page #9, then just to summarize what I’ve said before, you can see that the increases in Europe is SEK 1. 3 billion, as we talked about North America up SEK 1.5 billion. Then you see South America and particular then trucks in Brazil and then Asia in particular then VCE in China has had the negative impact, meaning that we end up very much on the same level as we did last year.

And with that I will hand over to Jan who will then go through the financials.

Jan Gurander

Thank you, Olof and we turn to Page #11. Here you can see the development between the second quarter 2013 up until 2014 goes from SEK 3.3 billion up to SEK 4.3 billion. As we can see here the corporate and other bar is SEK 1.3 billion. Out of that SEK 1, 040 million are related to the one-off items. And the big part is SEK 850 million for the gain that we had on the sales of real estate and SEK 225 million which related to an adjustment of the Volvo Rents’ business, SEK 225 million – sales on rents of SEK 225 million improvement compared to what we thought.

Apart from that, we can see that – if you adjust for that that the result is more or less on the same level as last year. And we can see that the improvement in trucks cannot offset the lower results of SEK 570 million that we have in CE. Between the two years and in the quarter, we have the slight negative impact of SEK 176 million. We see that the currency is affecting us less. In the first quarter, as you remember, we had a negative of SEK 1.1 billion. Looking ahead for the Group as a whole, we think it will be fairly neutral, maybe slightly positive for the rest of the year.

Next slide. Another way to look upon the result improvement, you can find on Slide #12, where we’re then going from the SEK 3.3 billion in 2013. In 2013, we had some non-recurring items. We had, we put up a warranty reserve in Q2 of SEK 900 million. And we also then had two positive things in 2013. One was relating to Penta, a one-off of SEK 81 million and in trucks we had the sale of activities in Japan of close to SEK 100 million. So adjusting for that the result is the SEK 720 million better in 2013.

We can see that the gross income impact is a negative of SEK 630 million. That goes back to what Olof mentioned before with the lower sales in Brazil with also some pressure on margins; the same for trucks; same thing in China, lower sales and pressure on margins for CE. That cannot be offset by the improvements that we have seen when it comes to our European business and the margin improvement there in our trucks business.

We still have the effect of R&D capitalization. It is the same amount or size that we had in the first quarter. It’s SEK 0.75 billion. And as that then we can see that the improvements that we have on our operating expenses in the quarter actually a little bit more than SEK 0.5 billion relatively is starting to kick in. We had then the one-off effect on real estate of SEK 850 million and within the bar, others you find of SEK 225 million on the rents.

If we then turn to the next page, and look closer into our truck business, you can see that we have a higher, slightly higher sales compared to last year, SEK 48 billion compared to SEK 46 billion. When it comes to the operating income, up SEK 2.2 billion compared to SEK 1.9 billion and operating margin excluding restructuring charges is 4.5%. When it comes to the currency here, we have a negative of SEK 139 million in the quarter. And in this area if the currency rates are as they are today, we think that we will have a slight positive on the truck area for the rest of the year.

Turning to the next page, 14, as I mentioned, we do have one-off items, things that are affecting the quarters also in trucks. We had the lower warranty of course this year compared to last year of SEK 900 million. We also have – part of the real estate gain is actually affecting this business, the SEK 64 million.

We then have the effect of capitalization, currency and the one-off effect from the sales in Japan last year. If you look upon these pluses and minuses, it’s almost SEK 1 billion plus and it’s almost SEK 1 billion negative. And then what is remaining is that we have a profit improvement of something like SEK 300 million between the quarters. And there we have on the positive side the effects of mainly our price realization connected to the new ranges on Volvo and Renault, which has the positive effect. And that can actually offset the negative effect we have right now, mainly related to our lower volumes and also market pressures in Brazil.

If we now turn to Page 15, and look closely into our CE business. Here we have SEK 15 billion in sales in the second quarter, which is down 9%, actually 10% if we exclude the FX effects. And we can here see that there has been a gradual decrease in sales year-over-year. It was SEK 20 million in 2012, SEK 16 million last year. You can also see how the 12-months rolling figures is SEK 53 billion that we discussed. One should remember that if we walk back through 2012, the sales for the whole year of 2012 was SEK 53 billion and here we see a decrease of sales of – taking place over two years of approximately 15%.

Operating income is then of course affected by this drop of sales coming down from SEK 1.3 billion the year before down to SEK 0.8 billion and the operating margin is down to 5.1%. A little bit, a word here about the currency, it is SEK 208 million. This is due to the fact that the Korean won is strengthening towards the US dollar. And as you are aware of, we do have actually the factory in Korea and that is affecting us negatively. So this effect, I am looking into the currency effect in CE, will as it looks right now continue. So here we most probably will have a continued negative currency effect for the rest of the year.

Looking a little bit closer into the quarter for CE, I think from an earnings point of view, it is difficult to find any positive things that has happened within CE. As we said, we had the lower volumes; actually unit sales are down with 18%. We had this steep decline in China, and as we all know, it is a market with very good margins. We also sell big machines. So this affects us quite a bit. And also then we see that we have the price pressure coming in, in China as well.

We do not see a product mix change. We are having more, selling a high proportion of compact machines compared to what we did the year before. As a consequence of the lower sales, we get the lower capacity utilization. We see that the whole, not only China, but some other emerging markets, mainly related to mining that are actually at a fairly sluggish level, which means that the capacity utilization in our [70] (ph) factories are on a too low level. And of course also then when it comes to our component factories, it’s not on a satisfactory level.

As mentioned before, we also have then the currency effects of SEK 200 million. And it is also worth to mention that we have adjusted our breakeven level in our Swedish production system and actually reduced the blue collar workforce and that has the one-off effect in the second quarter of some SEK 50 million. That is not included in the restructuring programs. It is actually outside of that. So that affects also the results in CE.

One other focus area that we have in CE, and that is also connected back to China is that we will have to have a close monitoring of our dealer network. With the decrease, lower sales that we see it’s extremely important to secure that the dealers continue to be in a healthy situation.

If we then turn to Slide 17, a few words about buses. It was a good quarter in terms of sales. Sales were up close to 20% compared to the year before and going up to an EBIT margin of 1.5%. What’s positively affecting the result in the second quarter was of course volumes. You also see a good development when it comes to the aftermarket. And I think with the sales number of the SEK 4.8 billion, the profitability would have been higher, and the reasons why it’s not higher is actually due to the fact that we have a weaker product mix compared to one year ago. And we do also have had some production disturbances both in our North America production system and also in Europe.

Penta is on a stable – slightly down compared to one year ago in terms of sales, having close to 12% EBIT margin. And here I would say that most things are, from a result point of view, developing well. We have a good growth market and product mix in the quarter compared to one year ago. And one year ago, as I mentioned before, the result was actually influenced by SEK 80 million in one-offs. So if you exclude that one the result in Penta is actually better compared to the year before.

Looking into customer finance on Page 18, we see that when it comes to new financing volumes, it’s very strong year-over-year. We have also done a good development when it comes to the margins in the business. The credit portfolio is developing in a very good way, a stable and good way. And we only have one item here that is disturbing the picture and that is that we have a non-recurring audit adjustment in this quarter that relates to previous years. And if we would exclude that one, the profitability and operating income in customer finance would have been improved quite a lot actually compared to one year ago.

Looking closer into the balance sheet and cash flow – sorry, the cash flow in the Group, it is on the SEK 4 billion level, which is more or less exactly the same as we had in the second quarter last year. When we look into the investments, we have had now two quarters in a row a lower level of investments compared to what we had in 2003, which we should have of course also since we are coming out of one or two years with quite heavy investment in the Group.

It’s worth to note here that seasonally wise in the Group we have third and fourth quarter where we actually have an increasing trend over the year. So I think it will be difficult to keep the investments on this low level in the third and fourth quarter, but the ambition is definitely to be on the lower level for the whole year compared to last year. That is absolutely achievable taking into consideration the good trend we have started this year.

No big changes when it comes to the working capital and how that affects the cash flow. We can see that the total change is SEK 0.7 billion. It may be worth to mention the inventories. There, we have, I think better – we were hoping for a better development in the quarter. On the other hand, if you look upon the developments that we have had in the quarter with the situation in Brazil to take down production and adjusting inventories along the whole supply chain, not only in our own activities but also with the dealers, then of course steep decline that we saw in China and also then to be able to manage the inventory situation in such a difficult situation.

We also see that buses due to some extent to the production disturbances also have had a problem with the inventory. We have then of course a few positive sides. We are managing inventory very well in our European system and so on. So as a whole, although not being satisfied, I think it’s fairly well managed, but there are a few pluses and a few minuses.

In the bar other, this is unusually high with a plus of SEK 1.3 billion. What has been offsetting some of the negative developments on working capital or inventory in buses and so on is that we have received quite a portion of advance payment in the quarter in the range of SEK 600 million to SEK 700 million. That explains why that part of the working capital has developed so well.

If we then turn into the efficiency program that we are running in the Group for the time being and look closer into the white collar and consultants, we see that, if you remember that we had in the first quarter of this year a reduction of 900 white collar. That was, I think a very good start of the program. It was due to the fact that the program was kicking in, in a good way, but also that you get an initial effect of the fact that we are having a headcount freeze as well and tight restrictions on – when it comes to employment on new white collar employees. In the second quarter we reduced it with another 300. That is exactly according to plan so far.

We can see also that we have finalized our voluntary leave program in Sweden. This is not affecting so far the headcount figures. That effect will come in headcount in the third, mainly in the third quarter, to some extent to the fourth quarter as well. And we see that our voluntary leave programs in France and Japan is progressing according to plan. But here we’ll also see the headcount reduction coming in the third, but mainly here in the fourth quarter in 2014.

As a whole, the reduction program is about 4,400 people white collar and consultants. It runs from the second or late 2013, up until the beginning of 2015 when the majority of that 4,400 will leave during the course of this year. And as I said before, it goes according to plan.

Looking at the operating expenses on Page 21, we can see here that the trend, maybe not impressive if you look upon the chart, but the trend has been broken when it comes to selling and then also our cash R&D expenses. The decrease in the second quarter here is also that according to plan. We do have a very, very strong focus now to continue with the reductions, with the planned reductions that we have within the Group.

Turning to Page 22, maybe little bit of a summary regarding our strategic program that is running over 2013 to 2015. We can see there what we have had when it comes to the price realization, which is a part of our strategic program, price realization which means improved margins. We can see that we are actually slightly ahead of plan when it comes to that.

The second part that we talked about is that – the second part is that we are on the road of decreasing operating expenses. And if you look upon the figures here and add together the cash R&D, the selling and the admin expenses, it is actually more than SEK 0.5 billion that we are decreasing that this quarter compared to the second quarter last year. And as I said before, here we need to have a continued strong focus to continue this trend with lower operating expenses.

One area that will pick up in the second half of this year is the cash R&D reductions. We have, as Olof mentioned before, we are decreasing our activity level. That will also mean that the decrease will come more in cash R&D going forward. Maybe one remark, it’s maybe a technical remark. You can see here that the IS/IT cost reduction is there as well. It’s important that you double count that one because we have that as an indicator also that that is coming down. That is actually in the P&L, included in all the other lines. So you cannot add up all these three things together.

Then when it comes to the other parts of the program, which is actually related to the production cost and the material cost reduction, they will mainly have an effect when we come into 2015. Steps are, of course, already taken and we can see one example of that in the second quarter where we have actually concentrated our production of medium-duty trucks into one assembly plant in Europe and of course that will gradually have an effect on this year. But the big steps we have taken and the improvements in our P&L and our cost base will be seen in 2015.

By that, I will hand back the word to Olof.

Olof Persson

Okay. Thank you very much, Jan. And then I would like to summarize the quarter by highlighting the negative and the positive factors. And I think we have alluded on the construction equipment in China and sales decline for trucks in Brazil. But I would like to stress the fact that these are the two – and I am now on Page #23, sorry. And this is now the two most important negative factors that we have in this quarter. One, which we have taken care of, that is the truck situation in Brazil, the rebalancing as I talked about. And one which we will have to work through over the next quarters in order to make sure that we come back in balance. And this is the reality. This is a market change. It is something that we just simply have to do.

The low capacity utilization in parts of our industrial system, we talked about that as well. It goes for – in the beginning of the quarter for the European system; at the backend of the quarter, not so much. We have filled up the factories in a good way. But then as Jan mentioned, of course, we have in construction equipment also in the factories in the emerging markets where we have, due to the market situation, low capacity.

And then of course, as we have seen the high total costs for R&D through reduced capitalization or due to reduced capitalization is something that is no surprise, definitely not. But it is something that we have to compensate for on a year-over-year comparison, and we are committed to do that.

I think it’s very important also to look at the positive factors when it comes to where we are making headway because the cost savings through the efficiency program is now as Jan was showing, showing clear effects. We see that in the cash R&D, we see it in the sales side, we see it in the admin and this program is continuing. And we are pushing a lot and we will have an enormous focus on that during the second half making sure that we’re delivering on the different areas we have. I think it’s also important to remember that we have a market situation that we have to take care of. We do that.

And then we have more the long-term transformation on the group, which is going on according to the plan as well. So it’s the two sides of that coin. Then we have a strong North American market and a strong Japanese market where our focus will be to focus on the profitability in these two markets and making sure that we grow organically. And then a European market that is developing actually according to what we have expected, albeit the pickup came a little bit later than we thought. But now at the back end of the quarter it’s there.

The positive price realization on new ranges we have talking about. It is actually a substantial part in, and Jan mentioned that, the increase in the profitability for trucks excluding one-timers is actually then over – the positive factors are actually outweighing the negative factors coming from Brazil. And then we see an increased market share in Europe, North America, Brazil and Japan so our position in the market is there. We’ve see then in this quarter two tough, very tough markets but also a lot of positive development in the other markets. Unfortunately the positive sides could not in this particular quarter offset the negatives we had in Brazil and in China.

And with that I hand over back for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We had a first question from Mr. Alex Whight from JPMorgan. Please go ahead sir.

Alex Whight – JPMorgan

Yes, good morning everybody. I’ve got a few questions please. I’ll take them one at a time. Firstly, how should we think about the costs within the truck production system in Q3 relative to Q2? I think the dual production lines in Renault drop away. Do any other costs step up? And do we see much in the way of incremental savings versus Q2?

Olof Persson

Okay. I think that in generally we can say that looking at the capacity utilization going into Q3, as we can see it now with the order intake, we can see we are in good balance. And that goes for Europe. You know we are increasing in US. We have rebalanced the Brazilian system and the Japanese system is very well utilized due to that. So in general you can say that we have done our homework in terms of rebalancing and therefore we are well balanced going into the third quarter.

Alex Whight – JPMorgan

But you’re running to your production lines I think in the Renault brand still in Q2. Does that now cease and are there any other costs that step up that we need to consider?

Olof Persson

Okay. If you look at – the dual production is ceased and we also have actually completed the medium duty line in Danville, where we’re now producing both Renault and Volvo, as part of the efficiency program. So I think in general we are just going to continue to work on the cost efficiency there. But in terms of the production, we have sorted out the dual production in the European system and that is now gone.

Alex Whight – JPMorgan

Okay. And did the Brazil pricing pressure that you referred to in the press release, did that improve as the inventory was rebalanced or do you expect that to persist going forward?

Olof Persson

I think we rebalanced very quickly. It’s very difficult to say to start with and we work that on a day-by-day, on a region-by-region and deal-by-deal basis. I think we worked very swiftly in terms of rebalancing our volumes and production. So we will have to wait and see how the market develops now in these regions. But I would like to also point out that we are utilizing of course the brand position that the Volvo brand has in Brazil in order to make sure that we are keeping the pricing and the price increases. And I would like to stress that we are increasing prices as high as possible. But it’s very difficult to say how the market and how the pricing will develop during the third and the fourth quarter.

Alex Whight – JPMorgan

Okay. And then the final question I had was you said it would take several quarters to get inventory and China construction equipment rebalanced. I think several means more than two or three, but not many. Is the intended communication that it could be four or five quarters before it’s brought under control or do you think it could be sooner than that?

Olof Persson

I think that if we would have known or had a clear view on that we would have communicated it. The reason we don’t give any exact quarter is of course how the market is now going to settle down on a certain level, how the machine utilization will look like, and also how the industry inventory pipeline will look like going forward. But again I would come back to that we will definitely work swiftly as we can in order to balancing our system throughout the dealers. But it is a high build-up of inventory that needs to be flushed out before the system grows. So I think we stay with that forecast that it will take quarters.

Alex Whight – JPMorgan

And we can’t tempt you to help us out with the number of, say day sales or anything like that relative to Q2?

Olof Persson

I don’t think we normally disclose that and we don’t do that at this point in time.

Alex Whight – JPMorgan

Okay, sure. Well, thanks very much for your answers.

Olof Persson

Thank you.

Operator

The next question comes from Mr. Fredric Stahl from UBS. Please go ahead sir.

Fredric Stahl – UBS

Yes, hi, good morning guys. It’s Fredric here at UBS. I was going to ask on the U.S. trucks, I think you mentioned that you’re still not happy with the profitability in the U.S. What’s missing here? I mean you’ve had in a good engine penetration now for quite a while. The aftermarket business has been growing again for at least a year, maybe 18 months, very nicely. You have, as far as I understand it, a good and competitive product for the first time in a long while and your overall market volumes are good as well. So I don’t understand what’s missing to get it where you want it. Can you clarify?

Olof Persson

I think when it comes to – there are a couple of issues here and the first one is effect of the spare part business and the maintenance business due to the increased penetration, both on engines but also on the complete drive takes some time before it’s actually materialized. We see a steady increasing aftermarket portion of the trucks but it’s not where we – it is not relative to the trucks that we’re producing now, but that is increasing.

Then I think it’s also an issue about making sure that we are continue working on the competiveness of the trucks and also on the brand position when it comes to the product versus the brand position by the pricing as well. And that is something for instance we do in Mack now. We have just launched a rebranding activity for the Mack brand. We are working on the Volvo side as well and we’re working on the others.

So don’t read me wrong. My comment, which I have made a number of times, is that we are not where we want to be and that means that we are definitely making money in the US, but we believe we have more potential there when we look at our brand, our position, our dealer network and so on and so forth. So it’s continues work that we have to continue. And, to be quite honest, I would never be pleased with the profitability there are always things to be done.

Fredric Stahl – UBS

Very good. I’ll leave it at that. Thank you.

Operator

Next question comes from Mr. Alexander Virgo from Berenberg. Please go ahead sir.

Alexander Virgo – Berenberg

Good morning. Thanks for taking my questions. Just wondered on the first instance whether you would quantify the under-absorption that you’ve called out a couple of times now, as you’ve done in the past? And then secondly, just on the improvements you’ve seen on the SG&A side and you’ve quantified very helpfully in the slide. That obviously shows that you’re theoretically slightly ahead of the run rate that you described at the Capital Markets Day.

So I just wonder whether you could comment on the phasing of that, given the charts you showed there suggested that there’s something in the region of SEK 3 billion I think expected in the second half in terms of benefits from restructuring. And then lastly, I just wondered whether you could update us on the developments with the Dongfeng JV. Thank you.

Olof Persson

Okay. On the under absorption, I think I’m looking at Christer, we don’t give that number at this point in time.

Christer Johansson

No.

Olof Persson

I don’t know if you want to comment anything on that Christer?

Christer Johansson

You can say if you look at it, we have had very low capacity utilization in our Russian plant. We have had, you can say, low capacity utilization in the Brazilian system. In construction equipment, it’s been China and also in the plants around – in the BRIC countries like Russia, India and Brazil. And then some, you can say, overcapacity initially in Europe on the truck side.

Alexander Virgo – Berenberg

Okay.

Olof Persson

If we then look at the savings and the curve and where we stand, I think we will come back in the Capital Markets Day to give you a detailed update on where we stand. But the intermediate report is that we are on the margin improvement side. We are ahead of plan. When it comes to the cost savings that you have seen here and the cost savings that we’ve planned also now to materialize during the second half of the year based on the (indiscernible) effect since we do have some time in order to get all the negotiations with unions ready. It’s also progressing according to plan.

And I think the number shows, as you pointed out, shows that that we’re now starting to talk real differentiation now between the quarters over the quarters in terms of the savings. So we have a good traction on that. So as I also write in my CEO comments, we feel comfortable that we will reach the SEK 9 billion at the back end of 2015 as communicated.

On the Dongfeng side, we are still working through, and also are involved in the different processes that needs to be done in order to be concluded before we can conclude the deal fully with the Chinese authorities. There are a number of processes that are involved and we don’t have any negative signals. It’s just a process that we need to adhere to and we have full respect for that, that it takes some time.

Alexander Virgo – Berenberg

Okay. I think you’d originally said or previously said a closure at the end of H1. Is that sort of you’re thinking of that as a Q3 number or is it end of the year?

Olof Persson

We’re working through the processes now and it’s difficult to put a date on it. But what’s important for me right now is that we are working together with the Chinese authorities, with Dongfeng. We are putting it and we don’t have any negative news. And it is probably I think stuff by stuff. And we just have to see now when it’s coming into force when everything is settling down.

Alexander Virgo – Berenberg

Okay. Thank you very much.

Operator

Our next question comes from Mr. Michael Tyndall from Barclays. Please go ahead sir.

Michael J. Tyndall – Barclays Capital Securities Ltd.

Hi there. It’s Mike Tyndall from Barclays. I’ve got a few questions if I may. The first one is just a clarification. Is your entire European range now available in Euro 6? That’s, I guess, the first question. And then the second one, I wonder if we can talk about North America and the strong orders in Q4 and Q1. Was there a change in the profile of those orders? I certainly heard some people talking about the fact that historically orders were more short-term and that what we saw in Q4 and Q1 was longer term, so two-year kind of orders coming through. And perhaps I’m wondering if that’s the same case for you, so we should really not necessarily think about that as being, I guess, a big push in 2014.

And then the last question just related to staff numbers. I always get confused on this. If I look at Page 4 of your report, your total employees appears to have gone up on Q1. So I’m just wondering how I should think about the reduction in headcount versus the numbers that I’m seeing which show that actually the number of full time employees has gone up? Thanks.

Olof Persson

Okay. To start with Euro 6, the answer is very short. The answer is, yes, absolutely. We have – the full ranges are not only available, that’s the only thing we’re selling now on the European market, the Euro 6. When it comes to order intake in the U.S., I would say we haven’t really seen that as a big thing. We have a normal order mix between little bit shorter, smaller orders, fleet orders and mid-sized fleets and all of that. So we haven’t heard or seen any substantial change in that. So it’s pretty much the same mix going forward, I would say. And then on the staff numbers, Jan, you might want to cover that.

Jan Gurander

I think the white collar headcount figures that we have shown in this presentation, the reduction of 1,200 people so far, that is a net reduction of white collar. So we have excluded the effects of Volvo Rent. So this is a net number excluding the effects of Volvo Rent. As a matter of fact, we have a negative of 142 coming from the acquisition of Terex, which we had not adjusted for.

So what is compensating when you look upon the total number of employees is that we have an increase more or less of the same amount in the blue collar workforce and that is basically adjustments that takes place all the time to adjust for production rates and so on. We’ve seen an increase in parts of our industrial system for trucks, like in North America is one example. We also see an increase of blue collar headcount in buses as another example.

So that is not included. That’s the normal way to run an industrial company, to adjust up and down on the blue collar side and there we have the flexibility. The focus is to structurally take down the white collar headcount and that’s why we focus on that. And that is what you see also then in the slide with the 1,200 reduction in white collar employees and consultants.

Michael J. Tyndall – Barclays Capital Securities Ltd.

That’s great. Thank you very much.

Operator

Next question comes from Mr. Fraser Hill from Bank of America. Please go ahead, sir.

Fraser Hill – Bank of America Merrill Lynch

Yes, hi, good morning. It’s Fraser Hill from Bank of America. Three questions. Just to maybe cover top-down beyond this restructuring effort. You talked about making a lot of progress and showing effects. I think maybe you could just break down how much of the SEK 4 billion of restructuring benefits that you had identified for 2014 that you have already seen in the numbers for this year already. I think at your Capital Markets Day last year you broke the SEK 9 billion down, if I’m correct, into SEK 2 billion for 2013, SEK 4 billion for 2014 and the balance in 2015. So how much of that has come into the numbers in 2014 so far?

Second question is on truck margins into the second half of the year. Is there any reason why we should be seeing these expand? I think if you look at your order book, clearly that’s down. If you look at your Latin American order book, which is your highest margin region, that’s very, very sharply down. So why are you going to be able to see expanding margins when you’re going to be seeing such a negative mix in the second half of the year for trucks?

And then I think finally just on the guidance, you’ve talked about the profit savings, the cost savings rather, being dependent upon the business being a SEK 300 billion business. If you look at the business today, first half of the year, SEK 138 billion, order books are down. So presumably it’s going to be tough to double that rate for the second half of the year. I think that’s going to leave you needing therefore somewhere north of 10% growth in 2015. How do you get that growth and, in that regard, should we look at the cost savings as potentially at risk? Thank you.

Olof Persson

Okay. Let me start with the restructuring and the SEK 4 billion. Basically you can say that if you look at the phasing of that curve during the year, and you remember that on the Capital Markets Day I said that we had a hockey stick of this SEK 4 billion this year coming basically then from the reduction of staff in support functions and white collar reduction in general. We are following that plan very well and we do see that we will be able to meet not only the SEK 9 billion for the total here, but we also will be able to meet the SEK 4 billion savings this year.

When it comes to the margin, and I think your question was the margin development in the trucks in general and then basically, you have two things that go against each other here and we have to remember that. One is the improvement and the steady improvement that we see, and I would even say that it’s a good improvement we see in the European system, particularly then on the new ranges. We also see steady over time increase in the margins on the North America business and also we have some parts in Asia where we also see very good prices. So that is one thing.

And then you have the Brazilian situation where we can definitely then conclude that this has impacted this quarter in this rebalancing. And the rebalancing per se has done of course both in absolute terms and in margin terms being hit. Now we are through that and we will have to see now how the margin development in Brazil continues. But again I want to stress that it was a conscious rebalancing decision we did during this quarter in Brazil and we are through that. And then your last question was about the business volumes and the SEK 300 billion.

Looking at it, the markets and I’ve been very clear on that – the market is what the market is. We want to grow in the market, we are growing in the market we are taking market shares in many of the markets we are active in. And we have based our scenario on that SEK 300 billion. We are of course looking when we are judging the different activities into the reality. And again, I’ coming back to my comment that you have to react quickly when you see things happen quickly, like in China and Brazil and we do that. And then we also have to look medium term and see how can we make sure that we are fulfilling the target that we have promised to everyone that is interested in Volvo in one way or another. And that is that we want to increase the profitability.

And that is something we are looking into very carefully all the time based on the reality we’re living. And Jan was mentioning for instance the increased focus we’re going to have on the expense side during the second half of this year. That’s one example where we now see that we need to really make sure that we have everything in place to meet the targets and see that the trends on all these are happening.

And there again, I mean this is something we have communicated to you but we also communicate it internally, so every one of the 100,000 plus people in the group is very well aware of this and aligning to it. So it is something that we are monitoring very closely. And we are not working in a theoretical world, we are living in a reality world and we're going to adjust making sure that we are fulfilling the targets we have set up to 2015.

Fraser Hill – Bank of America Merrill Lynch

So on that final point, you talked about the reality of the markets and that that’s a market effect, especially in Brazil and China. But are you saying that the reality is that it’s going to be difficult to get to that SEK 300 billion, because I think it probably looks that way? Would you agree with that?

Olof Persson

I would not speculate on the volumes in 2015. There are two things I’ve been very clear. I do not speculate on volumes in 2015, I don’t speculate on absolute margins or profitability in 2015. The only thing I’m saying is that we are looking constantly into the reality and therefore we are continuously making sure that we are fulfilling our targets that we have set up in terms of margin improvement.

Fraser Hill – Bank of America Merrill Lynch

Okay.

Operator

The next question comes from Laura Lembke from Morgan Stanley. Please go ahead.

Laura Lembke – Morgan Stanley

Yes, good morning. I also have three questions please. The first one is could you quickly give us an update on what kind of restructuring charges we should be expecting in the second half of the year? I think at the Capital Markets Day you said about SEK 4 billion for the full year. I think you’re running a little bit less than that, at least in the first half. So maybe give us an update on that?

Second one is on Western European trucks. Could you maybe give us a bit of color in terms of the recovery, what you’re seeing in the different countries and regions, and also in terms of the pricing trends here? And then the last question, coming back to Fraser’s question. You said that you don’t want to speculate on either the margins or the profitability in 2015 and market levels. But I think what becomes quite difficult for us is how are we going to actually assess whether Volvo has achieved the SEK 9 billion savings target or not if we don’t actually have a base to compare it against? Thank you.

Olof Persson

Okay, let me start with handing over to – we’ll take them in order Laura. So the effect of restructuring charges first, Jan?

Jan Gurander

When it comes to restructuring charges the outlook for the whole program, the SEK 4 billion is still what we are talking about. It can be a little bit difficult to exactly put that in time so that’s why we refrain from actually putting any numbers for quarter-by- quarter. But the total amount is still valid.

Christer Johansson

Laura, Christer here. May I add a comment? The restructuring charges is SEK 5 billion and the saving did the SEK 4 billion. And what – some big programs that remains is of course France and Japan that is more later this year.

Olof Persson

Okay. And then looking at the pricing and the development of the European market in particular, I was say that with our new product ranges and I said that before, I am actually glad to see that we have had the positive price realization that we have had. The customers are appreciating very much our new trucks, the feature levels, the quality levels, the fuel economy and so on and so forth.

And that is something that is very good. I would characterize what I see right now coming from the second quarter in terms of order intake as I said, the European market looks like we are having a development that points at 230,000 which means that we will have a slightly stronger second half of the year in terms of the market. And I think we are well position both in terms of the pricing in terms of the product market shares, and we will have to focus very much as I said on the selling cost side on the European selling system.

And we will have to make sure that we are regaining market shares over time here with Renault. When it comes to the 2012 2015, I would – the strategic program, the base is there. The base is the 2012 full year that is the base, we have started off with and that is the base that we always measure against. The SEK 9 billion are measured against the 2012.

And my comment before was more related to the fact that the question was raised about what if – in our audience, what if not and what if that. And then my comment to that was only that if that’s the case then we have to look into making sure that we do the adaptations necessarily in order to reach the targets that we have set. So we are giving a reality, not a theoretical word on that. And we are committed to do that and that’s what we’re going to do. But again, the basis is very clear. It is the – all the 20 objectives that you have seen are set with a base 2012.

Laura Lembke – Morgan Stanley

Okay, thank you. Can I just follow up, sorry. For the market development I was looking a little bit for color on the different countries, like how for example, Northern Europe is developing compared to Southern Europe?

Olof Persson

Sorry, I forgot that one. If we look at it, we can – if we start from the South, we definitely see a positive development in Spain, albeit coming from a very low volume. France is still on low levels and a little but uncertain development in France. Germany is developing fine. If you look at UK, also Eastern Europe, also the Nordics are developing according to our plans I would say and also in accordance with the market development that we anticipated.

Laura Lembke – Morgan Stanley

Thank you.

Operator

Next question comes from Mr. Ashik Kurian from Goldman Sachs. Please go ahead sir.

Ashik Kurian – Goldman Sachs

Good morning. It’s Ashik from Goldman Sachs. I’ve got a quick follow-up on the price realization in Europe. Are you now able to more than offset the cost increases associated with Euro 6 or has Euro 6 become margin accretive in Europe, especially in the context of comments from some of your competitors on more aggressive pricing by other truck companies in Europe? So, if you can quickly comment on that and then I have a follow-up one Brazil?

Olof Persson

Okay. The answer to that question is yes. We manage to more than offset the cost increases for Euro 6.

Ashik Kurian – Goldman Sachs

Okay. And on the rebalancing that you mentioned in Brazil and Chinese construction equipment market, could you give us a bit more color on the level of underproduction that would have resulted in the quarter because I’m finding it hard to reconcile it with the inventory numbers that you audit cash flow from inventory because there does not seem to be a big underproduction. And if the market remains at the current level should we see a pickup in margins in both Brazil and China construction equipment because you had under-produced this quarter and that will not recur in the second half of the year?

Olof Persson

The question on Brazil again was? I didn't catch that really.

Jan Gurander

You can say we have had a number of stop days, especially in June, and we’ll have a few also now during the World Cup. We have had also in July, you can say, to rebalance the production. But the good news is that we are more balanced out now including the dealer inventory. So coming into August, September, we have reset the production rates to the new levels so then we don’t need to run any stop days or anything. So that should improve inventory this year, absorption in Brazil.

Olof Persson

And when it comes to the variable cost, that of course is improved. But when it comes to the fixed cost absorption compared to what we had before, that will of course still be there.

Jan Gurander

Yes.

Ashik Kurian – Goldman Sachs

Thank you.

Operator

Next question comes from Mr. Colin Gibson from HSBC. Please go ahead, sir.

Colin Gibson – HSBC

Hi, lots of questions so far. So just one from me please, and that’s regarding the long-term outlook for the Chinese construction equipment market. Olof, you were saying earlier that it’s important to still be in that market, it’s a big market, and go through these temporary difficulties. But just to give a longer term perspective, if we take the Chinese excavator market, just as an example, that’s still going to be over 100,000 units this year.

The EU economy is bigger than the Chinese economy; the U.S. economy is bigger than the Chinese economy. Both those territories have excavator markets of half that size. Are you really convinced there is long-term growth in the Chinese construction equipment market? Or is there a risk that the peak of 2011 in that market was dramatically higher than the long-term spaces if you like? Thank you.

Olof Persson

I definitely (indiscernible) and there is a big differentiation between the U.S. and European market and the economies is that of course if you look at the construction need in China over the coming years, it’s of course much, much higher and the plans to do construction is of course on a very high level. And therefore you definitely see that the long-term trend – and we also have to remember that the economy is growing very fast. It’s 1 billion plus people, and there are a number of correlations you can do in terms of how many excavators compared to GDP number of people and so on and so forth. And there you can see that over time it’s still a lot of excavators and construction equipment machines needed in China going forward.

Then exactly how that will pan out from a market point of view and from a peak [throat] (ph) point of view and that’s very difficult to say. But over time here definitely we will make sure that we participate in this. And, as I said, it will be for a long time, the largest market in the world and we truly believe that we have still potential than opportunities there. Where it will settle in, and I think that’s your question, where would be the going rate sort of sale of the number of machines when the economy and everything has settled in, that’s of course difficult to judge at this point in time. But that we’ll monitor very carefully and adjust our capacity and presence accordingly.

Colin Gibson – HSBC

One quick follow-up please and that is just on the same theme of construction equipment but a much more specific question. Are you making money in the Korean facility with the won at these levels?

Jan Gurander

We don’t comment on specific factories or countries. That we never do.

Colin Gibson – HSBC

Thank you.

Operator

Next question comes from Mr. Michael Roeg from Kepler Cheuvreux. Please go ahead, sir.

Michael Roeg – Kepler Cheuvreux

Morning, gentlemen. This is Michael Roeg from Kepler Cheuvreux. One of your major competitors in trucks recently stated that from their standpoint the pick-up of order intake in trucks in Europe was occurring a little bit later than initially anticipated. Is now we’re correct that this is also your perception?

And if so, what does it do to the dispersion around the mean estimate that you’re having for the market in total in Europe in this year as well as your cost savings? i.e. what I’m trying to get at is basically are you saying yes, the truck demand or order intake picked up a little bit later than you initially thought, however more forcefully than we initially thought, so we’re not changing our entire estimates for H2, neither as a spot estimate of 230K nor in terms of dispersion around that mean estimate? Or are you saying, well, we’re keeping the spot estimate, but the dispersion has increased a little bit around that and so has the dispersion about the SEK 4 billion savings target?

Olof Persson

I think the pick-up we’ve seen in the latter part of the quarter indicates then – and when we take that for the full year indicates then, as I said, given the registrations up until May looking into the full year of 230, a slightly stronger second half of the year in the European market than the first half of the year. And that means that we are looking at an unchanged forecast, which we have had for quite some time now, which also means that all savings, all the restructuring, all the activities we have in the market for the European side is progressing exactly according to those plans that we have since the market is developing according to what we set out, I think already beginning of this year or end of last year.

Michael Roeg – Kepler Cheuvreux

Okay. So just to make sure I’m getting this right, what you’re saying is basically that the risk related to the spot estimates that you’re using in your planning assumptions has not increased relative to what it was in your perception as of Q1?

Olof Persson

I would say no. The market is developing in accordance with our expectations with a little bit of a change, which we have talked about is that the hangover Euro 5, Euro 6 ramping a little bit into the second quarter, leaving us a little bit of under-absorption in the first half of the quarter. That has been corrected and we now see that order intake is picking up in a way that we feel today what we can see comfortable according the market, 230.

Michael Roeg – Kepler Cheuvreux

All right. Thank you.

Operator

Our next question comes from Mr. Hampus Engellau from Handelsbanken. Please go ahead, sir.

Hampus Engellau – Handelsbanken Capital Markets

Thank you very much. I have two questions. The first question is related on earnings. If I look at the adjusted EBIT margin year-on-year, you’re almost down 1 percentage point. And if I remember correctly, you should have an annual savings running at around SEK 2 billion moving into this year. And I know you highlighted Brazilian profitability trucks, construction equipment in China, underproduction in Europe and also R&D expenses.

I would be interested in if you would maybe pick out one of those as where we could find the major impact on earnings. Is it China or is it trucks in Brazil or even the underproduction? That’s my first question. Second question is more related to the underlying business. How did you see the service business in trucks developing in Europe and North America during the second quarter? Thanks.

Olof Persson

If we look at the earnings, and if I should try to rate the three aspects you said, I will say that the under-absorption coming from the production is the least impact. So if we start from that then. Then both the Brazilian, compared to last year in particular, if you look at year-over-year comparison, both that one and the CE one is a considerable negative impact on that one. And I don’t know. I’m looking at Jan, if we want to rank the two or?

Jan Gurander

No. We don’t rank them. But in both areas – it’s both in absolute numbers quite sizeable amounts we’re talking about and also in terms of margin, it’s noticeable in both areas as well. So you have to have both of them as number one, I guess or number two, depending how you look upon it.

Olof Persson

When it comes to the spare part business, you can say that in – in North America to start with, on penetration. Margins are also trending in a good way. So we have good margins on the spare part business in North America. In Europe, we have also seen that the spare part business is developing according to our expectations. That means rather flattish.

It’s also an effect of the, as you’re aware of, of the fact that we have had during the crisis years when you have less trucks coming out to the market and those trucks are then coming – less trucks are coming into service in the last couple of years later. But that is now coming to an end, that phase, and we see that over the next year we should have a running population which is then back to more normal levels. But again, flattish in terms of volumes and pricing is keeping up well as well. So, no worries on that side.

Hampus Engellau – Handelsbanken Capital Markets

Can I just ask, can you please repeat what you said about North America? Maybe it was my line that was – because I didn’t catch it.

Olof Persson

Yes, your line is breaking up a little bit. But basically very quickly, and this will be the last one and then we have to break. When it comes to spare parts, North America is developing in a positive direction based on the fact that we do have higher penetration. Margins are good and we are getting the pricing out of the spare parts we’re having. So step by step we’re increasing North America.

Hampus Engellau – Handelsbanken Capital Markets

Thank you very much.

Olof Persson

Okay. And with that, I thank you very much for joining this telephone conference and next time we will see each other face to face as normal in Stockholm. And with that, I wish you all a very good day and also a nice summer and see you and talk to you, if not before, by the third quarter results presentation. Thank you very much.

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