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Executives

Leif Johansson – President and CEO

Mikael Bratt – SVP and CFO

Patrick Olney – President, Volvo Construction Equipment

Håkan Karlsson – President, Volvo Buses

Staffan Zackrisson – CEO, Volvo Aero

Martin Weissburg – President, Volvo Financial Services

Dennis Slagle – President and CEO, North American Trucks

Analysts

Nico Dil – JPMorgan

Frederic Stahl – UBS

Laura Lembke – Morgan Stanley

Yann Benhamou – Exane

Sebastian Gutale – Société Générale

AB Volvo (OTCPK:VOLVY) Q2 2011 Earnings Call July 22, 2011 9:00 AM ET

Operator

Ladies and gentlemen, welcome to the Volvo Q2 Report 2011. Speakers today are Leif Johansson, CEO and the Volvo Group.

I’ll now hand over to Leif Johansson. Please go ahead.

Leif Johansson

Good morning, and good afternoon to all of you, and welcome to this Volvo second quarter 2011 conference call. I have in the room here, aside from our IR people, we have our incoming CEO, Olof Persson; we have Mikael Bratt, CFO; and we have business area leaders, and we will take you through a number of slides that you can get on our web page. And I will, beginning with Slide 2, with the one that says Group Highlights.

We had a very decent quarter, the operating income amounted to SEK 7.6 billion and sales were just close to SEK 80 billion, operating margin at 9.2% and a cash flow of SEK 5.2 billion. If you look at business environment, Europe we have put altogether here as improved and what’s happening here is that Northern Europe and Central Europe notably Germany perhaps is doing reasonably well even though they are still between 10% and 20% below where the peak was in Q2, 2008.

Then Southern Europe is doing very – it’s very weak of – you can say it’s still two-thirds down compared to their peaks. But at least we can say they are probably from these very low levels, probably now slowly improving with more of an emphasis on slowly than on improving. But then we have Greater Europe, you can say Poland, Russia, Turkey and Eastern Europe that seems to be coming on quite nicely. And altogether than that provides for a improved total characterization of the European market.

In Asia and in China I think we have said the number of quarters that will probably be good if there was a slight pause in the hectic growth that we had in China. We think that’s what’s happening now; we see no reason to think that the market in China will be less important for us or as a market as we move forward but that there is a plateauing in the Chinese market. And I think Pat Olney will speak more to that vis-à-vis Construction Equipment especially.

In Japan, we are obviously in the quarter we have had significant impact with about 300 million in operating result effect on Construction Equipment, the 100 truck side, 400 altogether. Most of that seems now to be behind us and we are looking at Japan, as with recovery from Q2 levels, but also with a slightly higher expectation of demand as Japan comes into a buildup phase after the earthquake events in the second quarter.

In India, you can see a reduction in growth rates, but still South America is the same here. We’ll look a little more into some detail in Brazil here, but South America remains a strong market for us.

Interestingly to note, you can see that North America now is coming up, if you look at order intake quite well, the more long-haulage and the more industrial production the better, the more construction or even home construction, the worst of market, but still as you will see in the presentation North America is now bouncing back quite nicely.

If you look at Slide 3, the one that says Volvo Group there you see us clucking in – clocking in sales stand that where 50% higher in sales between Q2 ‘10 and Q2 ‘11 that actually translates into 29% if you clear that for foreign exchange changes so 29% real growth there.

And if you look at it in operating income there traveling at a speed closer to 10% and 29. if you look at the pie chart, you can see that if the whole of the Group grew by 29%, it’s almost stable between on the one hand North America and Western Europe and on the other hand, you see Europe, South America, Asia and other markets, which means that we are actually in a situation where the whole world grows reasonably, equally and quite well. And of course indicates the North America and Western Europe also at very, very low levels. But a good geographic footprint there as we see it.

Interesting to note also you see that we have noted here on the plus side increase sales of new products. You remember that we took a fairly heavy investment in R&D for future products during the crisis. That seems to be paying off quite nicely now as we have introduced a number of new products, both on the truck side and also on the Construction Equipment side, efficient, more productive but also in some cases architecturally from a Group point of view better products. And they seem to be doing well in the marketplace and with that we have an overall impression that we are gaining share in the different world markets and across the different business areas, where we are operating.

And obviously, the operating income benefits from that increased volume both in terms of new products and from the market demand and the sales. We have a 100,000 people plus who have contributed to good improved productivity with the number of people coming in for assembly lines much lower than the actual production output. And we have said as before that we are focused on making sure that the cost decreases that we announced and made during the crisis would be held onto and we think we can tick that off and say that’s been done.

With that, let me hand over to our CFO, Mikael Bratt and Slide 4, the one that says cash conversion cycle.

Mikael Bratt

Thank you, Leif. I’m happy to report here that we have managed to shave off one more day from our cash conversion cycle. I would say despite some inventory buildup, as you have seen in our – mentioned in our report and the work of course continue here and we should get below to 20 days within some timeframe here. And so the goal remains here as we move forward.

Moving on down to Page 5 and the net financial position. We have the early quarter seen a change in the net financial position. We had a negative $1 billion coming from positive cash flow, but also that we actually have paid out a dividend to the shareholders, share of $5.1 billion in the quarter and some currency headwinds here. I would say that also in the quarter here we had “an extra payment day” here as our payment cycle ended up in connection with the end of June here. So we got some negative effects from that also. But I would say that this of course repaired by itself over time here, but that of course impacted in the quarter of course. So we have cited back then above the fourth year, which is a temporary thing. So we should get back below to fourth again within short term. And that’s against the – it’s of course not a straight line here, but we are moving in the right direction overall.

Going forward down to Page 6, and here we have the currency detail for you here. I will not dwell on this. You have seen it before, but I think you could summarize the currency impact in just two sentences here.

First of all it is really related to our flows in the quarter. You see this both criteria stands for 1.7 out of – of the total here. We have also seen very limited impact between Q1 and Q2. So sequentially it has been stable. And as we mentioned before also here, this is taking about 50% of the fact here and I would say in absolute demand I would say of magnitude the rest is really the Truck segment even though in some of the other business areas you have for the sides of the business area and significant impacts of course. But from a real perspective you could – could – place it like that.

So I will keep myself fairly short today here. And I will stop by that. Thank you, Leif.

Leif Johansson

All right. Let’s go to Slide 7 then, on the truck slide. There you can see we actually got $50 billion sales in the quarter, good progress there with 32% after tax adjusted. Much of what I said earlier on the market, certainly is correct also to say for trucks with improved market conditions. We have – we are increasing the order book and we have an operating margin above 10% on the truck side, which obviously is something that we’ve been striving for.

If you look at what we have in focus here, we are now seeing, with the order intake in the U.S. and now also in Japan, we are in the midst of production ramp-ups there. And in quarter three, let me just remind you there, that when you bring a lot of people in like new ships for example in the U.S takes a couple of weeks there before they are really productive in terms of getting to the same efficiencies that we have the older moment your workforce did.

Strict cost control and we have again benefiting from, but also product introductions ahead of us, which we are quite happy with. We have, for example, the Condor range coming in Japan with the new medium-duty engine, the first application over new medium-duty engine generation.

And also hybrids in France with Renault and also environmentally sound trucks DME Volvo and also MethaneDiesel coming from Volvo. So new product introduction that will give our customers the benefit, for example, burning natural gas or biogas and also be able to operate on efficiently – on a good efficient fuel, efficiency levels.

If you go to Slide 8, there you see the net order intake, and as you can see we have good news there also. And of course, these are real data, so we all read the same newspapers on what might happen in the future, but these are the real data that you can see in our order books as they flow in.

Change Q-on-Q here progressive over the year than a – yearly comparison with 34% up and there you would really see now the strength of North America, as you can see North America and South America now even though South America has grown quite nicely is beginning to be looking more like it should but the North American market is considerably bigger than the South American market, which was not the case in the midst of the crisis there.

But 129% up in North America; Europe as you see almost 30%, South America at 30% and Asia there which is really a consequence of Japan and remain 3% other markets still doing very well.

If you look at Q1 to Q2, we have a normal seasonality, so we would have expecting a slower Q2 order intake. And we still see we think quite reasonable numbers there, stable numbers with Europe and North America in plus territory South America and Asia in some minuses. And you see other markets actually doing quite well there and all of that combines into a curve that is pointing towards, yeah at the right corner there on the slide at the total levels.

If you look at the heavy-duty truck marketing Europe on the next slide, there we are basically saying, let’s leave that as it is that’s EU members plus Switzerland and Norway and we also have noted earlier in the day that even outside of the U.S. into the East – of the EU and to the East of the EU, we also see some strength in the market, but unchanged when it comes to EU members in Switzerland and Norway.

And heavy-duty truck market in North America, which is Slide 10, the same points to be made there. We think that we have about the right in 230, 240. We obviously had a couple of months here that’s been higher than that. Would argue and hope that it doesn’t run away and the type of cycles that we had in ‘05, and ‘06 here, there is no reason to think that of course because there we have a pre-buy effect in ‘05 and ‘06. But it would be good if we could see a more stable development in North America, coming above than historical trend lines, but to do that in a slightly less cyclical way. I see some speculation now and then about the new emission rules in terms of fuel efficiency that could again create, you can say pre-buy effect. We don’t think that would be the case.

The old emission rules and the once that were impacting I would say it’s in’06 were really from a customer point of view costly exercises to get our engines more clean, while we think that’s good nothing like that is going to happen for the future, there we actually energy efficiency driven by in some case regulations and labeling, but those energy efficiencies will be translating into fuel efficiency for our customers and therefore we don’t think we will see much of an abnormal pre-buy effect in the next couple of years more based in on real replacement cycle and economic cycle, as we run through the next couple of quarters here in North America.

With that let me switch over to Construction Equipment. We have Pat Olney, our new leader of Construction Equipment on Slide 11.

Patrick Olney

Thank you, Leif. Let me start then by saying that Volvo Construction Equipment had another strong quarter in Q2 delivering just under SEK 1.9 billion of operating income on 18 billion in revenue for an operating margin of 10.8%.

This was fueled by continued strong growth year-over-year, 32% growth in the top line adjusted for currency. And that growth was really supported by both growth in the markets, worldwide you could say as all the major markets were increased year-over-year, but also the continued development and reinforcement of our market share positioned in China, where we maintained the number one position, which was established in Q1.

We could say the operating margin of 10.8% did suffer from some headwinds as we did have the impact from the Japan crisis effecting us for SEK 300 million negative on the bottom line and also as Mikael mentioned earlier, significant impact due to the strong crowner in the second quarter affected the top line and the bottom line as well.

Looking ahead, we continue to rollout the Tier 4I Stage III B product offering and we are pleased to be leading the industry in that rollout and we have many machines already launched in Q1 out in the field and being customers’ expectations.

If we go ahead to the next slide, we show here our position in China. Number one again in the second quarter within a 11.8%. Market share year-to-date, and on a rolling 12 month basis than achieving together with Volvo branded products and SDLG just under 50,000 units and sales, which is a historic high position for us in the very important Chinese market.

Then as Leif mentioned earlier, the Chinese market we’ve seen a softening in the last couple of months due to the government’s efforts to curve inflation. We expect these effects to be temporary and see that the fundamentals in terms of fixed asset investment and construction demand, which underlie the market are still quite sound looking ahead. So we still have a very good outlook for the Chinese market both in the medium and the long-term.

Finally, I would just like to comment that we after two year Hyades we again held the Volvo Days Event in Eskilstuna, which in which we showcase the full range of our new products and our full offering with over 50 new models on display. We had over 10,000 customers, which is a record level of interest for us and now of course in focus we’ll be need to take that tremendous interest from our customers and convert that during the next quarter and the firm orders.

So by that, I think I conclude the comments on Volvo CE.

Leif Johansson

All right, Pat. Good. Let’s go to Slide 13. There we have Håkan Karlsson, our President, CEO of Buses, Håkan?

Håkan Karlsson

Thank you, Leif. Just like the weak market on the city side in North America and Europe, we had a strong deliveries and improved profitability during the quarter. The global bus market recovering a slow pace, with good demands in South America, Asia and Middle East. The city bus segment in North America suffered from the body of discussions and could be down as much as 20% 2011 compared to 2010.

In Europe, the total market is in the same level as 2010, but we have a slight lower demand on the city bus segment up to today. We had good order intake during the second quarter and in line with last year and we have an order book up 17% compared to last year. Strong deliveries, mainly in North and South America and International, up 36%. And then the result, SEK 275 million, 5% margin and still in a negative currency situation.

During the quarter, we have made some important product launches. In Brazil, we launched for the first time a new front engine bus, which we have developed together with Volvo Trucks in Brazil. Front engine buses is a fairly big segment that we haven’t participating in the past, in the range of 10,000 to 12,000 units yearly. We have got a good launch and the market is very positive to the new vehicles there.

In Europe, we continue to introduce the new city range. We are in with our product intercity 8,900 in serial production and the 7,900 a real city bus vehicle will be launched in a couple of months. And the third one is the global Hybrid rollout because after the success in Europe, we have now introduced our Hybrid concept in South America, and we’ll also launch it in China. And today, we have received almost 350 orders on our Hybrid Buses so far. And the first one outside Europe is in South America with 60 Hybrids, and it has been followed in Mexico then for another 10. So once again a successful introduction and launch of our Hybrid vehicles out there.

To manage the slow recovery in the market, we have to focus then naturally on the order intake in North America and Europe, and continue to improve cost and capital efficiency to improve our margins going forward.

So that was all from Buses.

Leif Johansson

Good. Let’s go to Slide 14 on Volvo Penta and Göran Gummeson, who is the President and CEO, he cannot be with us. So let me do that. We have a good development there, and what is happening here is that we have a very weak marine market and that’s even saw that in the U.S. it’s almost at historically very low levels, and a weak return of the market on the marine side also in Europe.

What is really good news from Volvo Penta is that the break in into the industrial engines, which is to take the groups Powertrain engines and do application engineering for them into different segments of industrial engines is now beginning to pay off very nicely, both in terms of sales and in terms of operating income.

And we actually see strengths in market shares in both marine, which is again a weak market, but industrial also and industrial is actually growing and doing more in line with what you see for example at Construction Equipment on total market point of view.

If we look at what that meant, it translated into good double-digit margins for Volvo Penta and we now see them in focus as we move forward, the real focus during the season here is to make sure in the Mediterranean and Scandinavia that we have a good service level for our European boat customers and continue to increase marine market shares there. We are introducing, as you know, a lot of new technology, spoke about electronics last time, new 400 horsepower D6s and also then the continuing success of IPS.

But also to remember and perhaps over time see as more important for Volvo Penta, a really good momentum now for growth in industrial engines. And we hope that with that growth in industrial engines, Volvo Penta will be more two legged than one legged for the future and that will return good stable operating income and growth presented this quarter.

With that let’s go to Volvo Aero. We have Staffan Zackrisson, our CEO of Volvo Aero and Slide 15.

Staffan Zackrisson

Thank you, Leif. First, about sales. It’s down to SEK 1.6 billion, but adjusted for divestment of Volvo Aero services last year and the dollar impact where underlying growth is 8%. The industry had a tremendous order boom placing aircrafts and especially we have Paris Air Show once very successfully, so plus 200% building a backlog up to 7,300 aircraft.

And a huge success during the air show was the new Airbus 320neo and that aircraft is currently got a 1,000 aircrafts on order or commitments right now. This is driven by the growth of traffic, it’s a 7% this is above the long-term trend that is close to 5%.

Of course fuel prices affects the airline profits, which are expected to be half what was announced by the international organization prior this year, but the orders are up and that’s because of the fuel efficiencies that the airlines wants to get.

If you look on Volvo Aero’s profit, it has improved from quarter one, but still very week. Operating income for Volvo Aero, it’s affected by the dollar mostly and we also have supplier issues on new product introduction. It’s a – both on the quality and the volume side to their ability to deliver.

We have signed an important contract for the Pratt 1,100 engines that will give us bigger revenue over the last – next 50 years, over $40 billion and it’s a nice addition to our portfolio of engine programs. This engine will power the Airbus 320neo. Of course what the engine delivers is better fuel consumption and noise also with the new technology with the geared turbofan.

What’s in focus for us is supply management initiative. We work with our suppliers to get their process stability to improve and also their raw materials situation, it’s a long-term commitment from us, whether inside our shops, productivity improvement program, that is running to get cost out of the system as well, and to meet the challenge of the dollar for us. And thirdly, the execution of this new program that’s just entered the detail signed is of course vital for our future and that ends the report from Volvo Aero.

Leif Johansson

Good, we have financial services on Slide 16, and its technology works Martin Weissburg, our President of Financial Services will speak to that slide, Marty?

Martin Weissburg

Thank you, Leif. With our financial services operation, positive trends continued in the second quarter and with a more reasonable results for the quarter. New financing volume for Volvo Group customers was SEK 12 billion in the quarter and this is the best quarter of new business for financial services since the fourth quarter of 2007.

And it’s approximately a 50% increase in new volume adjusted for currencies when compared to the second quarter of last year. This is of course driven by very strong Group deliveries along with good VFS share or penetration in financing those Group products.

Operating income improved some again with a result of SEK 250 million in Q2. Growth income improved in absolute terms and also on a percentage basis and this is indicative of improved portfolio fundamentals and some reasonable growth in the portfolio. We had significant improvements in credit provision expense, which really drives the results and benefit from a Brazilian syndication, which I’ll speak about shortly.

Some of the highlights in further to what is helping profitability is, in the quarter, all VFS regions were profitable. This is two quarters in a row now. Also as previously mentioned, we syndicated or sold approximately SEK 4 billion of our Brazilian retail credit portfolio and this was for global portfolio balancing purposes. And this syndication had a positive impact on operating income in the period of $45 million.

This syndication or sale is similar to one that we completed in the second quarter of last year, and VFS retains account servicing and customer relationships in all of these cases, and I would add that our Brazilian business continues to perform and grow quite well. Also when highlights portfolio growth in all region – all regions and done so within our risks management and segmentation strategies.

In focus, strong focus and I would say good success in building skilled global financial services teams in our growth markets, Brazil, Russia, China, and others, we’re well established in these markets for many years yet organizational buildup remains very much in focus.

Syndication opportunities as with Brazil in this – in this past quarter, we will continue to be in focus, as we will continue to syndicate small portions of our portfolio on an opportunistic basis. This is in-keeping with our portfolio management practices and is a key element in properly managing best over the business cycle.

So I’d say organization development and syndications are just two of the many topics in focus within business cycle management, as we continue to prudently manage growth in this up cycle, and continue to be well prepared for all parts of the business cycle.

So, Leif, that’s the report from financial services.

Leif Johansson

All right, good. Let’s conclude that on Slide 17 and the one which has Group summary there. You see earnings per share advancing from $1.55 to $2.52, $2.01 in the last quarter in Q1 ‘11, $2.52 this year. And then you see operating cash flow on the slide below there. We have in-focus as we move forward.

We are managing a productivity and ramp up and with that you can say increased productivity both in the U.S. and in Japan, less so in the rest of the Group Australia and some parts of the Group, we are still in – also in a ramp up mode outside of those countries.

We – I’d just say almost constantly have supply chain problems, they can be roll bearings or they can be tires, or they can be certain materials. So far, we’ve been able to manage those quite reasonably well with very little impact in Q2 here.

We expect to be able to be continued to manage that but there all risks there when the supply chain in some parts of the world is as strained for capacity as it is. From our own point, you can say, we are eliminating bottlenecks in many parts of the Group, and what of course, we are trying to do here is to make sure that we can get the combined output of assembly factories, Powertrain facilities and for example gearbox facilities.

And so far that’s been going well too. I think we spoke last time about the need to look at capacity investments towards the end of this year with really trying to estimate where would 13 and 14 or even 15 be in terms of capacity needs and how obstacle about that. If we look now, you can say that perhaps at least in the short-term here a better way to look at that is to eliminate bottlenecks, and then see how the world develops over the next say a year or 18 months.

We’ll have a continued focus on cost and working capital control. We’re happy that we shaved off another day here in terms of CCC. We will not build inventories and therefore we expect to be able to make those adjustments. And of course in the midst of everything here those are not any significant issues, but we don’t want to start a trend here of building inventories.

And finally, it is good to note that we have a very strong sales momentum right now, both in terms of underlying demand in the different markets that we are operating, but also in terms of having successful products to go to those markets with.

And with that let me open up for a Q&A session and answer any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes from Mr. Nico Dil, JPMorgan. Please go ahead.

Nico Dil – JPMorgan

Good afternoon gentlemen. I’d like to ask three questions, please. First one is on the drop through in Construction Equipment. I just try to strip out $850 million in currency, the extra sales of $1.2 billion and $300 million that we’re missed due to Japan and I know the drop through of about 13% year-on-year. Overall, the margin in Construction Equipment has been declining a little bit. Whether you – wonder whether you can give us some more explanation apart from the currency, as well as sort of the Japanese issues that you’ve been facing as underlying drop through sale seems to be a little bit low.

Secondly on the China, sort of wondering what you’re seeing on the financing part in China within Construction Equipment. Wonder whether you could talk here about the financial tightening that the government announced that whether that has been perhaps easing up a little bit already or whether that’s still standing, just an update there. Lastly an update on Aero, how long do you expect the production disruptions and the raw material impact still to last?

Leif Johansson

Let’s see, should we ask Pat on the first two of those or and if Martin have something to chip in there, you’re welcome to do that too, Pat?

Patrick Olney

Okay, thanks Leif. First point on the drop through margin, I assume it was Q2 this year over Q2 last year, you’re trying to estimate I think we – our calculations at least based on backing out the currency impact and the Japan crisis would have had us somewhere over 14% on an apples-to-apples basis, which would have been a record. So a slight difference maybe in calculation there. But I will say we are like all competitors facing pressure on material cost, which we work to pass on into the marketplace, that’s really the challenge that we’re – we are faced with, but so far we’ve been successful in pricing those cost forward.

When it comes to the financing, I’ll start by saying first of all, it’s been a strength for us to have access to cap to financing through Volvo Financial Services in China, and that’s allowed us to continue to find financing solutions for our customers.

I’ll also point out that still quite a bit of the business, in terms of fixed asset investments in the country are financed by either cash or other basis are not actually requiring financing. So the – it’s about two-thirds of the CapEx in the country on projects is actually financed through other means than bank lending. So we don’t see, as much, perhaps exposure to the tightening in that segment. I don’t know, Martin, maybe if you have some other comment on the –

Martin Weissburg

Yeah, I guess, I would add while the market has tightened, we have not and I would say that from the Volvo standpoint, financial services has ample capacity to continue to grow in a very good way, our CE finance and truck and bus finance business in China. And our credit appetite remains robust. It’s a strongly performing portfolio.

Unidentified Company Representative

Good. Aero there Staffan, can you speak to that?

Staffan Zackrisson

Yes. Through our supply management initiative, we worked closely with our suppliers and we expect to get results from that during the third quarter.

Nico Dil – JPMorgan

Okay. Just one follow-up question here. Did I understand you correctly that the 14 – was it 14% or 40% drop through write-down in Volvo Construction Equipment versus Q2 last year?

Unidentified Company Representative

I think actually what Pat was saying was the operating margin if you clean out all the effect –

Nico Dil – JPMorgan

Yeah.

Unidentified Company Representative

Okay. So it was not the drop through rates there.

Nico Dil – JPMorgan

Okay, okay. I understood. Thank you so much.

Unidentified Company Representative

All right.

Operator

Next question comes from Mr. Frederic Stahl of UBS. Please go ahead.

Frederic Stahl – UBS

Hi, gentleman, good afternoon. Could I ask you about the R&D productivity program and your R&D outlook? Could you maybe remind us of your – how you see that the savings, so the productivity increase is developing in terms of time. How you expect these to scale up? And then secondly, if you expect any significant changes in R&D spend post Euro 6 and then do you have the Tier 4 introductions as well, obviously?

Patrick Olney

Okay. I perhaps should ask our incoming CEO to speak a little about the future on R&D.

Leif Johansson

Yeah. When it comes to the R&D. 30 program we are running at full speed ahead and it’s a number of activities that we’re doing looking into tools, processes and other efficient means in order to get the work every sort of the efficiency out of every invested kroner dollar or whatever into the system. This is of course nothing that you do from one day to another and this program is over a number of years. But so far so good. We have this steering committee and is monitoring this. Their KPIs are getting into play, I’m just got to measuring this in a stringent way and we will continue to do so going forward.

When it comes to the R&D, going forward, that’s something that we of course have to judge over time here. But you cannot say that, if you look at over time, we have of course Euro 6 that we’re getting through, but on the other hand there are other things coming in into the portfolio as well that we need to take care of. So I wouldn’t sort of sit and giving any forecast on the R&Ds going forward long-term. But one thing I want to message is clear that we’re going to work very much on the efficiency to make sure that we have a very efficient R&D system in place.

Frederic Stahl – UBS

Great. Could you maybe give us a good estimate of how much one of these engine, regulatory changes cost you, whether it’s Euro 5 or Euro 6?

Leif Johansson

Yeah, I think we could – it’s very difficult, you can say, to isolate it frankly further I guess. If you do what we typically do, which is what – also what you see in our R&D cost is that we – when we make big changes in the Powertrain and the packaging of engines and gearboxes, then we also take the opportunity to make other changes in combination with it. It’s a good opportunity you can say to change. To isolate, we are talking about billions over some period of time. I don’t know that I really have a good casual number isolated Euro 5 or Euro 6, big numbers.

Frederic Stahl – UBS

Great. Now that’s fine. Thank you.

Operator

Next question comes from Ms. Laura Lembke of Morgan Stanley. Please go ahead.

Laura Lembke – Morgan Stanley

Yeah, good afternoon. Just three questions please. And the first one is on capacity utilization. I was just wondering if you could give some indication by region, where you are right now, both for the Trucks and Construction Equipment segment. And then secondly, could you tell us a little bit of where truck pricing in Europe and the U.S. is versus pre-crisis level? I mean this morning you spoke about pricing being relatively positive, but I’m just trying to get a feel of where we actually are right now. And then lastly, could you also give a bit of outlook on your working capital development in the second half? Thank you.

Leif Johansson

Let me start with capacity. I think in general, I think we can say we don’t have much of an issue when it comes to assembly capacity. There is some tightness in some of the supply chains that we spoke about before. I think the issue that might need to be addressed over the next 24 months or 36 months is capacity on heavy duty engines and potentially also to move automated gearboxes.

But, in general, you can say what we would be aiming to try to do is to get those capacities when it comes to Powertrain components in line with regions where they are sold. So for example, investments in North America for North American engines and over time, investments in Asia like we did with the medium duty engine for the Asian markets. And then they always spread that out. But not an issue for capacity in general when it comes to larger assembly factories where they, all the people, more of an issue of both to the next elimination on the Powertrain side.

Laura Lembke – Morgan Stanley

Sorry. I think you misunderstood the question. It was more about capacity utilization levels by region. So if you can tell us a little bit of how high utilization is, for example, in Europe and U.S. and also, I guess for the Construction Equipment division?

Leif Johansson

Yeah, I think in general you can say, if you take heavy duty truck – heavy duty engines, there we are in the range of 80% capacity utilization. So it becomes a matter of looking how to call 12 and 13 to get that right. And you can say installed capacity when it comes to assembly factories is not that meaningful, because it really has to do with people and I don’t think that’s much of an issue and I don’t know that we can give you a casual number on the different factories or when you say about Eskilstuna for example, Pat are we –

Patrick Olney

Eskilstuna, we are probably running in the, yeah, two-thirds, 70% utilization store-room to develop as we did the CS09 program there a couple of years ago. But same comments for me as you made for the truck factories. The issues are not in assembly capacity for CE. Perhaps with the exception of China where we’ve actually had to double shift operations in line with the market, it’s more key components, hydraulic components where we need to make investments to alleviate the bottlenecks going forward.

Leif Johansson

I think on the assembly capacity, you can say, it’s still low utilization rates in – also in – on assembly side, both in North America and Western Europe, higher when you move out there.

Truck pricing is – has been in North America and in Europe, quite reasonable in the sense that we have been able to get across cost increases, driven by either regulatory regimes or from material increases. And I’m not so sure that that I know how to compare that to 2007, 2008 because as you know that we have fairly significant regulatory changes. Prices are obviously higher, but is cost. I think the best, perhaps, way to look at that would be to look at gross margins and try to compare them, where they are actually now, again coming back to be quite good.

In general, on pricing, you can say in the markets where we see a good demand, we have been able to get across both cost increases in terms of raw materials and regulatory costs. That’s in line with what you expect in (inaudible) or what do you want me to answer?

Laura Lembke – Morgan Stanley

Yeah, that’s fine. Thanks, yeah.

Leif Johansson

Good. Then we have the outlook for – yeah. I know. As you know, we don’t give the forecast per say here. But as I expressed earlier on, we are confident in the target of 20 days when it comes to our cash commercial cycle here. I mean, the negative effect, if I put like that in the working capital in Q2, it was really, is like build up on the inventory, which has very natural explanation.

So, I mean, we have some effect there from Japan. The Japanese usual to speak where we had some material incoming. At the same time, we got some problems in other materials from Japan and we couldn’t switch off the inflow of the material that actually didn’t have a disturbance. So you’ve got some raw material and weak issues there.

And then we also have vacation effect currently here as we are shutting down in Europe for four weeks, while we have U.S., for example, going for vacation only for two weeks since the day we have some buffering issues to manage to keep on going in the U.S. while we are on vacation in Sweden and smaller things like that. And so, that is the thing that will of course be straightened out as we move forward here and then we have the so quoted extra payment date in – on the payable sides here. But it’s really worrying impact trade payables and inventory where we will make it happen to get down to the 20 days here and we are confident and that we will do that over time.

Laura Lembke – Morgan Stanley

Okay. Thank you.

Operator

Next question comes from Mr. Yann Benhamou of Exane. Please go ahead.

Yann Benhamou – Exane

Hi, good afternoon. Yann Benhamou from Exane. Three questions please. First, assuming that the current prices for currencies stay where they are, what do you assume quantitatively in terms of ForEx impact in H2 compared to what we have seen in H1? Second question, for Construction Equipment. Do you see a sensitivity of profitability depending on China, in other words, would you consider that China are higher than average profitability for you, for Construction Equipment? And last point, in Brazil they will be new entrants over the coming years plus players having no calculation. So, do you see the current huge margins changing over time on it? Thank you.

Leif Johansson

On the truck side?

Yann Benhamou – Exane

Truck side, yes.

Leif Johansson

All right. Should we start with currencies? And I’ll ask Mikael to comment on that.

Mikael Bratt

Yeah. As I said earlier today here, to give guidance when it comes to FX impact is, it’s a very challenging task and nothing we intend to do here. But what we have said is that we have given you some guidance previously, what kind of flows we normally have in the different quarters here. And when we look at the second quarter here, we have really an impact coming from the dollar here, as we have seen the biggest movements there.

And, I mean, everything else equal I will say. You shouldn’t see sequentially that much of an impact between the quarter here, but I would say, it all depends on what’s happening here and that’s, very difficult to give any guidance on that. But when it comes to hedging impact, we only hedge out for flows there. And we are not, I would say, taking advantage of what you might, could see as favorable currency levels at – on a particular movement. So we are following the natural flow of the currencies here. And what does stand for flows mean? I would say, it means practically around 50% of the flows you see in the quarter is hedged over the time period there.

Yann Benhamou – Exane

Okay. Profitability, in China Sea?

Leif Johansson

Hey. I guess, I’d start by saying don’t quote specific profitability for specific markets and sea. But I think you can say that given the size of the China business for us, it’s – we wouldn’t be doing the result. We were doing overall, if we didn’t have a profitable business in China. So we can say that it’s a profitable business for us. Well, from that standpoint you could say there is some exposure to China, but beside to my market comments from earlier, again when it comes to the softening in the market, even with the softening that we foresee, we still expect a very strong market in China, up 10% to 15% year-over-year. So don’t feel extreme exposure from that standpoint to the market.

Leif Johansson

All right. Thank you and let me get the question over Brazil and the truck market and the configuration of the truck market with different competitors there over to Mikael. Mikael is our good expert on Brazil.

Mikael Bratt

So of course, Brazil here is a steaming market, attracts a lot of attention from players that are not currently in Brazil here. And I would say that there are certainly some movements for new entrances here. And I think you have seen some announcements from some other players investing more in Brazil here. But I would say, I mean, they are of course operating under the same circumstance as our sales here, and with the challenges there. The only thing I can conclude is that we have a very good position there, we have been around for a very long time in Brazil, very strong and good performing data network and we have good products now, where we’re actually taking market share in our segment. So I think we are well-positioned to meet the new competition in Brazil.

Yann Benhamou – Exane

Okay. Maybe a last question, if I may.

Leif Johansson

Overall, the external theme, you see announcements every now and then of different players and industry having set up factories and define products. Over time, it is just as important or sometimes more important to this distribution networks, that came to the 24X7 service on a number of vehicles specifically over a large country like Brazil. The place quickly get up market shares are limited on the distribution side.

Yann Benhamou – Exane

Okay. Thank you. Maybe a last question. When do you expect the ramp up in the U.S. to be completed?

Leif Johansson

Say again, when do we expect the ramp up –

Yann Benhamou – Exane

– in the U.S. for trucks to be completed?

Leif Johansson

I think the way we see it right now and with the order intake we have right now that we will be coming into Q4 reasonably well placed.

Yann Benhamou – Exane

Okay. Thank you.

Operator

Next question comes from Mr. (inaudible). Please go ahead.

Leif Johansson

Operator, you have quite a lot of disturbance on your line there. So we have difficulties hearing you.

Unidentified Analyst

Can you hear me?

Leif Johansson

Yes. Yes, we can.

Unidentified Analyst

Good. I was wondering if you could update a little bit on your penetration of own engines and gearboxes in North America, and really whether this is making a difference to your business out there at the moment. Second thing is, I was just wondering if you could give us a little more explicit guidance on capital expenditure going forward. I mean should we expect it to be a fairly stable figure or should we expect it to increase in line with sales?

And then thirdly, some comments obviously in the presentations about industrial engine growth. Can you just sort of tell us a little bit more about that business about where – who the end customers typically are and the geography of them?

Leif Johansson

I think on the engine – penetrations of own engines and gearboxes in the U.S., which is now coming up into the 80% when it comes to engines and 35%, 40% on the gearbox side. That clearly are – is good news. It means that we will be coming into a spare parts stream of revenue that we have not had before and as we go through the cycles, you know, that is always very good. So we are doing well with that and happy with that. And when I said those numbers, now those are the Volvo brand on the Mac side, as you know, we have 100% own engines. And your second question was on?

Unidentified Analyst

CapEx.

Leif Johansson

CapEx, right. You want to speak to that, Mikael?

Mikael Bratt

I can take that. The guidance we have given you when it comes to CapEx here is about SEK 10 billion for 2011 here. And that is increase compared to previous year. As you know, we pulled quite a lot in order to reduce the CapEx during ‘09 and ‘10 year-end. There is a of course some pent-up demand and that needs to be done. So you should expect around SEK 10 billion for 2011 here.

Unidentified Analyst

And then going forward, one might be –

Leif Johansson

(Inaudible).

Mikael Bratt

No, I wouldn’t say. I mean that is not a rule of thumb you should use here. I think it depends on a lot of different things where we are in the product cycles and other things also. So I think we – let’s take one year at a time here in terms of guidance here. But it is not that dramatic fluctuations over time, I would say.

Leif Johansson

Let me talk a little about industrial engines. And by the way, I think we have Dennis Slagle on the line too. Is that correct, Denny?

Dennis Slagle

Yes, I’m here.

Leif Johansson

Yeah, if you want to add something more on the U.S. side, feel free to do that. On the industrial engines side, the large segments on industrial engines would be everything that has to do with pumping. For example, pumping water or pumping different fluids in chemical industry, et cetera. There is a big segment in power generation and power generation is growing in many places because of inefficient grid and you can say smartness of grids. But you also see a lot of power generation being used for safety reasons, for example, in hospitals or computer halls.

And then over time, what is quite evident is that there a number of people in segments likes cranes or different parts of mining equipment, et cetera, who now feel that with a much more advanced engine technology that they need to have to be able to meet regulatory machines are looking for two things. And one is a good engine, and the other one is actually the ability to supply spare parts all over world in a global logistics system.

I think the segment here where we have found Penta to be quite efficient is also is actually to be able to deliver both application engineering into segments like that, but also in terms of being able to supply spare parts and support for those products regardless of where they are. Good. Dennis, anything you wanted to add on the penetration of own engines or gearboxes there?

Dennis Slagle

Just, first of all your figures are correct Leif, but the one thing I do want to add is the tremendous success of the I-Shift, we call it mDrive for Mack. That has helped us because of course, we only put that behind our engines. With CSA requiring driver, requirements, et cetera, this makes a marginal driver into a very good driver and it’s really starting to get popular and frankly our competition is not that strong in that area. So we look forward to seeing – using the I-Shift and then drive those as a vehicle to go even deeper in penetration.

Leif Johansson

Good. And Dennis Slagle, that is our Head of North American Trucks. Good. Let’s go to next question.

Operator

Next question comes from Mr. Sebastian Gutale, Société Générale. Please go ahead.

Sebastian Gutale – Société Générale

Hi, good afternoon. I’ve got two questions on Construction Equipment. My first question would be, since the start of the year, we have seen some Chinese players in this industry using aggressive fitting techniques to markets with zero down payments. And I’d like to know what was your strategy in December in your mind as you used the same technique to be able to increase your market share?

The second question is about the SEK 1.2 billion revenues lost due to Japan at Construction Equipment? Would you expect to recover these revenues in Q3? Should we see less seasonality than usual due to this catch-up effect?

Leif Johansson

I think on the first question, you’re asking whether we, on the finance side, are doing zero down payment and full financing, et cetera. And I think the answer to that is clearly no. We are trying to keep up the discipline that we learned how to do in our case because there basically all is done. I’m not so sure that I hear frankly a lot about zero money down payments even from our industry. I’m looking around the table here to see whether anyone related to that.

Sebastian Gutale – Société Générale

Hardly can confirm this. But I think typically we see at least go for at least around 20% down and then financing typically over a three-year period. So we secure that there is always good equity in the machine, if you like. That’s pretty much what we – that’s right, Pat. And I guess as we collectively do not use credit risk as a way to build market share. So we –

Leif Johansson

Now we’ve heard of some competitors having more aggressive sales promotions and perhaps discounting and that’s something based on our positioning with the Volvo brand. In the market, we certainly don’t resolve to as a way to promote our product and our brand.

Leif Johansson

And your second question, see if you can repeat that? I didn’t catch completely what you asked there?

Sebastian Gutale – Société Générale

And the question, you’ve lost $1.2 billion SEK revenues due to the Japanese disaster. And I was wondering if you would expect to recover these revenues in Q3 or Q4 and –

Leif Johansson

I think what we have said earlier in the day is that with what we know today, we are – we don’t expect to have any more negative, significantly negative effects of the disaster in Japan. That is both true for Construction Equipment and trucks. But I also don’t think that we think that we can recover lost sales. If you look at what we lost in Q2, that most likely is what we have lost. Customers, who are in the midst of buying products like that typically would perhaps would have gone and made that. So I don’t think we can – you cannot add that into quarter three.

Sebastian Gutale – Société Générale

Okay. That’s very clear. Thank you.

Leif Johansson

Very good. Thank you very much. That concludes the conference call for Volvo second quarter 2011. It was my 57th call. And as always, it has been a pleasure to be with you. Next time, you will have Olof at the helm and I wish him all the best and good luck. Thanks, Olof, and have a good summer.

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