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Executives

Olof Persson – President and CEO

Christer Johansson – IR

Analysts

Fredric Stahl – UBS

Nico Dil – JPMorgan

Kenneth Toll Johansson – Carnegie

Michael Tyndall – Barclays Capital

Yann Benhamou – Exane

Sébastien Gruter – Societe Generale

Laura Lembke – Morgan Stanley

AB Volvo (OTCPK:VOLVY) Q4 2011 Earnings Call February 3, 2012 8:30 AM ET

Operator

Ladies and gentlemen, welcome to the Volvo year-end report 2011 conference call. Today I’m pleased to present, Olof Persson, President and CEO of Volvo Group. 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. Speaker, please begin.

Olof Persson

Thank you very much, and good morning and good afternoon to all of you, and welcome to this conference call on the Volvo Group fourth quarter and full-year 2011 report. I’m sitting here with Anders Osberg, our new CFO; (inaudible) Public Affairs and Public Relations, and then Christy Johansson, Investor Relations.

There is a presentation available on the Web and I hope you all have access to it. I would like you to follow me to page number two, where you can see a group overview and the word record is there mentioned and we can say that the word record we can put in front of a lot of the items we do present, both on a quarterly basis and on a yearly basis, when we talk about sales, when we talk about the operating income and when we talk about operating margin. However, and I will come back to it, there are also some issues that we will address, that we will continue to address and I will come back to that a little bit later in the presentation.

What I would like to do is to go through the Buses, Penta, Aero, and Financial Services on this slide, giving some updates – you can see the numbers – and then coming back to trucks and CE a little bit more in detail.

Starting with bus, I think bus, if you conclude the fourth quarter and also the full year, it has been a difficult market in, particularly, Western Europe and North America, when we talk about city buses, but it has been compensated by good movement in the developing economies and in the BRIC countries. Their margin of 4.4% is of course nothing we are completely satisfied with it, but I must say that the bus management team and the whole bus organization has done a good job in improving the profitability and I think it’s only fair here to mention that for the first time ever Volvo bus has been hitting the SEK 1 billion absolute profit for the year of 2011.

Penta has seen a very tough and sluggish market on the marine engine side and has basically been able to offset that by its second leg, which is now based industrial engine, both the Versatile and the Genset side, and by doing so has been more resistance to ups and downs. However seasonable this quarter it’s a weak quarter for Penta and we can also see that in the numbers with 4.8% operating margin.

Volvo Aero has come back from very low levels and is now showing 8.1% operating margin, and I think the Volvo Aero organization is now progressing with their own efficiency – internal efficiency that we have been reporting on before, but also – and of course that’s always true when it comes to Aero, we do have a headwind on the currency and in particular the dollar. But, all in all, I would say good development on the Aero side.

When it comes to Financial Services, we can see that we have put on SEK 12.6 billion in new financing and I’m really pleased to note that Volvo Financial Services has grown with the business in a very controlled and good way. We are keeping the penetration rates around 25% as an average and we’re doing so with good control and good system support, making sure that we’re growing the business in a good way. We also see that now then in the operating income, where we see the SEK 262 million.

So, by that I would like to quickly go through page three, where you can see that we have grown from SEK 72 billion to SEK 85 billion in the quarter. That’s a 20% growth excluding currency, and also the conclusion is that we now are zooming in on and have been for a while sort of 50% – around 50% in the North American and Western Europe markets and 50% markets in the rest of the world. This quarter, I think, we are 53%, 47% in advantage of North America and Western Europe.

On page number four we can see that we had a good trend and we are then now coming into the SEK 300 billion-plus turnover for the full year, which actually is a full SEK 46 billion increase during the year with an operating margin on the full year of SEK 27 billion and SEK 7 billion in the quarter. Year-over-year, if you look at the leverage, we do have a leverage, which is 20% and if you look at it quarter-over-quarter and quarter sequential, we can see that the leverage is thinning out and that was the remark I did in the beginning that I’m a little bit concerned over and that we need to continue to address around our leverage.

Follow me then to slide number five, and I think also here good news, we are having an operating cash flow in the fourth quarter of SEK 10.7 billion, almost SEK 11 billion, and a full year of SEK 14.1 billion. Cash flow down somewhat compared to Q4 in 2010. The major explanation for that is the changes in payables. At Q4 last year, or sorry, in 2010, we were in a build-up phase and increased the production rates. In Q4 this last year, in 2011, we moved actually to a slower production rate in the European system, in particular.

I’m very pleased to report that the cash conversion cycle, the CCC days has continued to stay on very good levels, 21 days , and that means, of course, combined that we have a return on capital that has now moved up to 29%. It’s good, it’s not record, but I think the 29% constitute different in Volvo than what we saw five, six, seven, eight years ago when we had higher numbers than the 29%.

So, all-in-all, I would say that this high capital efficiency has made it possible for us to grow SEK 4 billion to SEK 6 billion during the year and basically still be able to generate SEK 10.7 billion, or almost SEK 11 billion in cash flow in the quarter, or actually if you look at it for the full year, the SEK 14 billion.

If we then move to page six, this high capital efficiency and also, of course, our operating income has meant that we have been able to improve our net debt situation. So we’re now down to 25% net debt over equity. And if you take away the pension liabilities we have – we’re actually looking at a number of 20%. Given all this – the developments during 2011, the Board proposed to the AGM a dividend of SEK 3.00 per share, which means a direct return about 3.3%, then also means that SEK 6 billion is distributed to the shareholders, but we have SEK 12 billion of net profit then re-invested in the group for future investments and activities that we have developed.

On page seven you can see the Truck in the direct development and I would like to spend a few minutes on this one. As you can see, we have had a stable growth, 21% in the quarter, and if you look at the full year, the full SEK 33 billion in growth, and we are now coming up to SEK 201 billion yearly turnover.

If you look at the different markets, I will say Europe is very much driven by the northern part of Europe and also Eastern Europe that we have had good development in our sales to Russia, for instance, whereas the Southern Europe is still very slow and at low levels. North America, 46% up, driven by replacement needs. We do have a good economy and a business case for our customers to change over to the new technologies, fuel efficiency and so forth.

South America has slowed down, as we have discussed before, but I’m glad to see that we, on the back of gaining market share can show a 19% increase. And also in Asia, I would like to comment, it’s a good growth of 21%, but we do see a mixed picture there. One is the Japan, which had a slower pickup in the fourth quarter, as we – or if we compare to what we expected, but on the other hand, India has shown a good trend and we have good development in our Eicher joint venture in India.

So, if we then move to page number eight on the operating income, I think that the full year SEK 4.9 billion – sorry, the quarter SEK 4.9 billion and full year SEK 18 billion. It’s a good improvement. And if we look at 8.6% operating margin, is also on a level historically which is very good. One point I would like to make here is that year-over-year we have a 17% leverage, which is good, I must say on these levels, but if you look Q3, Q4, you see a little bit of a different picture. And there are a number of explanations to that and I would like to point out a few.

One is that in the component business, we started the adoption to the new European rates, already in back end of the fourth quarter. That means that we lowered the component business in order to make sure that we have the right volumes going into the final assembly, which we then started to adjust in the first quarter this year.

Secondly, of course, you have a mix issue, when we see Europe growing less than North America. That’s also impacting. And finally, I would like to mention that we have an issue with ramp-up of suppliers in North America, much less than we had in the third quarter, but still it’s a negative impact.

Nevertheless, we take this with you. And as I’ve talked to you before, in the new organization and the new focus we have, leverage will be high up on the agenda and we will address this as we go forward.

If you then follow me into page number nine, you can see that that we have had a good year in Construction Equipment, SEK 65 billion on the full year, 88,000 machines, and we’ve actually grown the business with SEK 11 billion for the full year. Also in the quarter, we see that we have a 15% growth, excluding currency, and we have growth in all markets apart from South America, which is actually moving sideways. The North American market is very good to see. That is coming back. It’s re-fleeting of the rental fleets that we see, as it’s a little bit the same kind of phenomenon we see on the truck side. It’s a sort of re-fleeting activity we see.

Asia, I’m actually very pleased to see the 11% growth in Asia, given the slowdown we have seen in China and it shows that a) we have other markets in China, in Southeast, then in Asia other than China. Southeast Asia, for instance, has gone very well. And, of course, the fact that we’re gaining market share and keep our number one position in China means that we grow there. So that’s good news.

Then moving on to page number 10, talking about the profitability in VCE and there, of course, just looking at the graphs you can see a different picture than we have seen before, where we actually on the face of it a negative trend. I just want to, first of all, clarify that if we have backed the currency, we would have been on the same level of profitability in Q4 this year as last year, so that again means that we have fewer leverage, and the comments coming back – actually I have the same comments here as I have on the Truck side.

Now, the explanations on the lack of leverage here is also a mix issue. China is going down, North America is going up, so that is one explanation. The second explanation, which I think it’s a investment decision that we have done that is about the R&D. We are investing heavily in the capacity. We are investing in the SDLG brand and the new products, but we’re also investing in the Volvo brand, both the new technology and also in our – let’s call it BRIC products. I have mentioned before the 55 new products or model updates that we do have in the plans, in order to making sure that we brought under Volvo brand into different and other market segments.

So these are the major explanations for the lack of leverage in Volvo CE, Trucks, I would like to emphasize my comment – my general comment about the focus of leverage goes also for CE.

If we then move into page number 11, you can see there on the order intake that is slowing moderately and it’s actually following very much our anticipation of the market development throughout the markets we report here. In Europe, we highlighted in Q3 that we saw a slowdown, we took the actions needed. We did slow down the component business or the component production. We did all the planning for a lower production volume in the European system. We did that, we are executing and actually see that now, and we can see then – and I will come back to that in the – in the total Europe forecast that order intake is now stabilizing on a lower level, but it’s stabilizing.

North America the same thing. We’re talking about up 22%, and I’ve talked to you before, it’s the replacement. South America, we highlighted already in Q3 the fact that we saw a slowdown and I will come back to a little bit what that meant also for our full year forecast.

Asia, down 3%, again the mix between positive signals from India and slower than expected Japan effect. And also I would like to highlight at the end the other markets. It’s very good to see that we now have booked 5,000 trucks in other markets and that is primarily Australia and Sub-Sahara, Africa, and as you can see it’s plus 39%. So, all-in-all, a minus 7% order intake Q4-over-Q4.

If you look at the orders and deliveries book to bill, mathematically it is 0.84. I would like to draw your attention to the orders, the 58,000 there. Those orders are coming in on the back of our reduced production rate. So we are actually – do produce in line with the demand. And then you can see that we have the deliveries of 69,000. This means, of course, that you will have a reduction of inventory. And I think that is good. That means that we have two things. One is that we have aligned our production according to the demand and we also made sure that we are not sitting with excess inventory and that we have worked on actually getting those trucks out of the yard to the customers during the quarter.

Now, coming into the outlook for heavy-duty trucks, you can see that we have kept all our absolute numbers. 220,000 for Europe 29, 250,000 for North America, 105,000 for Brazil and 30,000 for Japan. This is unchanged from our Q3. The percentages have changed a little bit, because we now have the actual data. And if we start with Europe 29, I think as we have said before that when we add everything together, the order intake that we see right now, the activity levels that we see on the fleets, the spare parts sales that we see holding up, and the macroeconomic uncertainty, if we add all these factors together and plus some, we feel that we have the data in order to call Europe 29 to 220,000.

In North America, again, we’re keeping the 250,000. We have done the same analysis and what we can see from these types of activities, plus the profitability reports coming in now from our customers, we do see that – we believe that we have enough data to call North America under 250,000. Brazil is 105,000 and that is unchanged. The percentage there moved and that is because the 2011 market came in somewhat lower than expected, which I consider being good news. That meant that the pre-buy effect on the Euro III was less than we anticipated. That also means that we – as being – have switched over to the Euro V and we are early out and taking orders on it, is well positioned there.

We also have a good inventory situation, where we now sort of have enough trucks, especially on the medium due to the VM side, to support first quarter deliveries. And we are also keeping Japan at 30,000. Again, slower than expected Q4 and somewhat slower start of this year. But, again, we see activities, we see the post-tsunami and earthquake activities coming, so we’re calling the markets still being at 30,000, going up from 25,000 this year. So, all in all, no changes on the truck side compared to our Q3 communication.

If we then move to 13, the only change we did on the Construction Equipment market was that we – or is that we have taken another look at China. If you remember we had 0% to 10% increase in China. After adding all the data and discussions we have with our people in China, we have decided to be a little bit more conservative and talk now about a flat market in 2012. We do have – we think that or we believe that we will see a slower than previous year spring season. The spring season last year was very, very high. On the other hand, we see a stronger autumn season than last year, because the autumn season was lower than normal. And if we add this up, we believe that we would have a flat year-over-year development, which I would like to remind you is a quite substantial market of 400,000 units.

Would also like to add there, on the Chinese market for construction equipment that we have seen, I don’t think that has been perhaps always noticed, but we have a different development between the excavatory market and the reloader market. The excavatory market has dropped quite substantially, year-over-year basis, whereas we actually have seen that the reloader market has held up quite well. And as we know, with our SDLG partner, they’re very strong in the reloader market in China, and thereby make sure and also been able to keep good numbers and good deliveries there.

Then moving on to page 14 and coming back to the reorganization status after 120 days, coming from the November Capital Markets Day I promised you to – on a quarterly basis give you an update where we stand, and making sure that we have a good communication, so you understand how we are filling up the framework around these three big areas, which I talked to you at that point in time, processes and structures, customer offering, and utilizing the full potential.

And if we start with the processes and structures, you can see that the new structure now is operational. We have compiled or created 25 new senior management teams. They are in place. They’re operational. They do take decisions and are up and operational. We have also appointed 109 new managers that are filling those positions. What is also very important is that we have new governance principles in place. We are now working on them. And we also have, of course, processes, ownerships, and governance defined, which is also very important in order to work in a functional organization like the new one we have.

New finances steering model on the implementation, of course, extremely important. And then you have new Head of Volvo Buses, and then you have Head of Volvo Penta. The reason why I gave you this update is because after 120 days we want to give you the sense and the flair of that this is a quite substantial change we’re doing and that we are moving fast and we are making sure that the internal setup is going as quick as possible, so we get filled up with no delays and that we then are moving into processes and making sure that we develop new ways and meeting the targets we are setting up.

We are not standing still on the customer offering. We actually have and I told you that on the Capital Markets Day, when it comes to the brand segmentation how we are going to position our brands in the future, what segments we should be in, how we’re going to develop the brands, how they are going to work in between each other, and there is a huge and very, very valuable brand asset that we do have is initiated and the work will be ongoing during this year.

I also would like to reinstate and highlight to you the Asian product focus, which we are continuing to have and we’re looking at trucks, buses and construction equipment, and here is the whole theme about finding ways and means of making sure that we have products for the Asian markets in different segments. So, if we take trucks, for instance, we have (inaudible) joint venture, the DND joint venture, which we’re looking at both, what kind of products should we have and also the joint venture itself.

On the buses side, we are working on, both in India and in China, or building on on the successes we have there. And when it comes to construction equipment, you are by now well aware about our dual-brand strategy and how we work with that throughout the regions.

When it comes to utilizing the full potential, you should bear in mind that when we talk about the trucks organization per se, we’re probably talking about organization around 80,000 people. You don’t do a change like this overnight from a Monday to Friday. So what we have initiated now is the detail mapping of the new organization, looking at and also getting commitment from the new managements on what sales and cost efficiency opportunities we do have. To me it’s very important. And when you do this, of course, you look at top-down targets, but the most important thing is that when the new organization come into place, the new management must commit to and also live up to, in the future, the different targets that we have.

And I would like to reemphasize over and over again, the change we are doing is primarily in order to make sure that we grow organically, that we sell more products by smartly utilizing our brands. But, of course, if we find ways of being more cost efficient we will do that. And then I’m talking about procurements, engineering efficiency, double working and so on and so forth.

So, concluding on the page number 15, a strong full year. Again, you can put the word record on there and I think everyone in the Volvo organization has pulled behind to present those numbers that we see here on page 15, and you cannot be other than satisfied to see the development we have had in almost all of our items, both on the profit and loss, but also on the balance sheet, but again, giving the bearing that we are happy, but we are not satisfied and there are areas that we need to continue to work on, and I can assure you that we will do that, and I’m coming back to the leverage discussions I had before.

With that we close both the fourth quarter and 2011 and start to look into 2012.

Just talking about the future, why not sort of go in directly to March 28 this year, and on page 16 we just want to highlight and inform you that we do have a – what I believe will be a very interesting Investor Day in Pithampur in India, where we’re going to have plan tours, new engine plants, truck assembly and a new paint shop. We are going to have presentation then from Eicher Motors and Volvo Group Trucks in Asia.

And by that, I thank you very much for listening in and I think operator that’s enough, and open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We have a question from Mr. Fredric Stahl from UBS. Please go ahead.

Fredric Stahl – UBS

Hi, again, gentlemen. Three questions, please. I think you’re looking for small growth in terms of volumes if you look at your guidance and assume fixed market shares. Could you give us an idea what you are expecting in terms of services and what type of growth rate you are seeing in the service business right now, I’m thinking trucks and construction equipment there? That’s question number one.

And then I was wondering if you could give us an idea of where Nissan Diesel is now in terms of profitability, if it’s positive or negative? You are coming into the period when you should be reaping a lot of the synergies you’ve guided for, your predecessor, Olof, guided for when he bought Nissan Diesel. So an update there would be nice.

And then finally, if you could give us an idea of how much production staff you had in Europe prior to the changes you made in the last couple of weeks? Thank you.

Olof Persson

Did you say production staff on the last question? You were breaking up there a little.

Fredric Stahl – UBS

Yeah, production staff, yeah.

Olof Persson

Okay, let’s start with the service side. I think it’s fair to say that what we have seen without giving – because I don’t think we gave the service side or split out the service. It’s a stable development, both on the volume side and also on the pricing side, and I would say that goes for both trucks and for VCE. So that gives me the signal that we do have – both machines that are moving and truck fleets that are moving.

Fredric Stahl – UBS

Is that a stable growth rate or is it – or sales flat?

Olof Persson

Do you have any more information about that, Christer?

Christer Johansson

Fredric, I would say that in Europe on trucks and construction equipment, we see single-digit growth actually, in the range of five-or-so-percent. If you take the U.S., we see actually double-digit growth in the spare parts and service business.

Fredric Stahl – UBS

(inaudible). Thank you.

Olof Persson

When it comes to the Nissan Diesel, I’m looking at Christer here, but I don’t think we give that kind of guidance.

Christer Johansson

We don’t break down the profitability by markets, but it’s fair to say that it has been quite challenging for UD Trucks now, considering the very sluggish demand that you’ve seen in Japan, and you saw that their delivery in the quarter was actually down by some 16%. So it is a tough domestic market in Japan, and then you have the strong Japanese Yen actually hurting a bit the export business for UD Trucks out of Japan.

Olof Persson

And then coming to your final question about production staff, I’m not sure really I’ve got the question. Was it again for like how many we were or how many people are reduced?

Fredric Stahl – UBS

Yeah, I think that – no, no, I just want to know how many you were before you made the changes.

Olof Persson

Oh, that one we have to look into and come back to you. I don’t think we should – I don’t have that number. I’ve a lot of numbers in my head, Fredric, but that one I cannot pull out of the number transferring machine.

Fredric Stahl – UBS

If you want to tell us how many people you took out then that’s welcome.

Christer Johansson

I think it’s hard to say, Fredric, that in December we were slightly over-staffed that we took down volumes in the component plants. And then in January and February we will be slightly over-staffed on the blue collar side, until all the temporaries has left, and then in March we will have a very good balance again. But, it’s fairly small impact, I would say. We have actually timed it quite well as far as we can see it now.

Fredric Stahl – UBS

All right. Okay, great. Thank you. Bye.

Christer Johansson

Thank you.

Operator

Our next question comes from Mr. Nico Dil from JPMorgan. Please go ahead.

Nico Dil – JPMorgan

Good afternoon, gentlemen. Like to ask three questions, please. First of all on the cash flow days, the cash flow conversion days, you’re currently sitting at about 21. Is there any further potential for improvement? So since you’ve reached this level now for a couple of quarters, are we going to see a further improvement target?

The second question is around Volvo Construction Equipment in Europe. I’m trying to understand a little bit the optimism there in the outlook. Is it the rental fleet who are supposed to buy here or is it the construction equipment companies themselves which are a bit more positive in terms of what they want to buy going forward?

And then the last question is really around the reorganization that you’ve put forward. Olof, I’m really trying to compare sort of what you’ve done in Construction Equipment versus what you are now trying to do in trucks and what you have established? Now, as far as I understand from your previous comments, you’ve now allocated the managers in-charge of the business areas. Have you also highlighted or indicated how you can move from this matrix organization to a more functional organization going forward and then what sort of savings you could potentially make out of that?

Olof Persson

Okay. I think if we start on the cash flow, the 21 days, I think I’m looking around the table here, but I think that is a very good number. I’m going to say that shows the cash efficiency, as you can see, has gone down substantially. And we also – I mean, see in Asia, for instance, that we have growth opportunities. We are investing in production facilities and that is of course something that needs to come into play here. So, I think that the 21 days is a very good level and it’s – we have been working very hard to get there and we’re going to continue to work to make sure that we have a high capital and cash efficiency. Obviously, in Europe, I think it’s a little bit of both here.

We do see some of the rentals, but also some of the construction coming in and you have to remember that Russia is included in Europe as well and that’s one play into the Volvo Group. But we have been out talking to the organization and checked out with the customers on the (inaudible) trends, and these are the numbers that we come up with.

And, when it comes to the organization and the going into the functional organization, it’s a lot to say about that, but to talk to your actual question at the end, we are now drilling through mapping out all the potentials that we can see in the different areas, and then particularly focusing how we can grow even further, but also as I said, if we find something on the cost efficiency side, we will of course address that as well.

And when it comes to moving from the matrix to the functional organization, one thing which is quite obvious is, for instance, that we do not do any internal invoicing anymore. So, there are only sort of cash and sales we’re measuring is to the end customer and internally we then keep high control and good focus on the cost side within the different functions. So that’s one way of moving away from the matrix and the business units and business areas into the functional organization.

And so that releases a lot of – I would say, power to start to look at, instead of dealing with internal invoicing that we now are dealing on actually and focusing on the customers and making sure that we get when it comes, and it’s also simplifying the whole transaction base within our company itself.

Nico Dil – JPMorgan

Could you give us a quick flavor of how much Russia is in Europe?

Olof Persson

Well, Nico, I don’t have the numbers on an absolute level here, but I can look into it. If you look at the order intake we’ve seen here now in the last three months, if you look at it year-over-year, Russia is actually up here in the 60%, 70% range if you look in Construction Equipment. I don’t have the absolute number, but on the year-over-year change.

Nico Dil – JPMorgan

Thank you.

Operator

Our next question comes from Mr. Kenneth Toll from Carnegie. Please go ahead.

Kenneth Toll Johansson – Carnegie

Yes, hi. I was interested in a little bit of pricing trends. There is a weak construction equipment market in China. What do you see pricing there and also pricing for trucks in Europe and North America?

Olof Persson

Well, I think in – if you start with what we’re seeing in China, it is a very competitive market, but I think we have and established ourselves very well in being competitive in the segment we are in and that is the premium segment if you talk about the Volvo side and when it comes from the SDLG side, the competitiveness that we do have is, of course, the fact that we do have the base of all the Chinese market there.

So I’d say, of course, it’s competitive. All markets we are in are competitive, but we have shown that we are able to, with our cost structure and our localization in China, for instance, on the excavator side in Volvo, being very competitive, still making good money in China. And our plan is definitely to continue with that.

When it comes to EU, I would say we are talking about flat. And I would definitely – and I think that’s – we will see that the fleet is coming up in the mix there and in North America the pricing is flat and with a little bit of a positive asterisk to it, so you can say it flat to improving.

Kenneth Toll Johansson – Carnegie

Okay. Thank you very much.

Operator

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

Michael Tyndall – Barclays Capital

Hi, there. It’s Michael Tyndall from Barclays Capital. Thanks for taking my questions. I’ve really got two questions. One is around the refocus part of your current plan. I’m just wondering whether or not the decision to sell Volvo Aero was part of that and then if you could talk about the logic behind that, is it strategic fit or is there some sort of return on capital benchmark or market position? And I guess what I’m trying to get at here is I’m wondering whether or not there are other elements of your business that you are looking at, at the moment and saying, these actually won’t come up to scratch, we will need to think about whether or not we want to stay in them long-term.

And then, the second question is just around China construction equipment, sorry to come back to this, but I guess the concern is what if the market is worse than you expect. I’m wondering what sort of flexibility you have to accommodate that and perhaps I know you can’t give regional profitability, but if you could give us some feel for, at what level of decline in the market, you would start to be particularly concerned?

Olof Persson

Okay, let’s talk about the Volvo Aero and the process that we have initiated. And I think we’ve made it very clear in the press release that we made that it is an issue about focus. It is an issue about see if we can find a home and an owner that can continue to develop Volvo Aero into the future, into the airline business, taking care of all the huge assets and investment that has been done in Volvo Aero. That means that we have a very logical connection with all the other business areas and the truck business.

We have the tightly interlinked bus on the engine side, on the chassis side. We have the Penta side, which is basically on the engine side, where we do have a lot of commonality. We’re going to continue to drive that as well and then we have the VCE, of course, on the engine side and as a complement also on different other areas in terms of distribution and what have you. So, with that, I think we are in a very much aligned group, focusing on commercial vehicles, construction equipment and engine manufacturing.

Then, when it comes to the China and the sort of development, of course, we have a flexibility in China and we have shown that before and if need be, we will show it. The labor cost in China giving the total percentage of the products is low. We have in China – we should remember that, we have actually a rather low fixed cost. If you look at the Shanghai plant, it is a final assembly plant with a very low breakeven, and we have great flexibility and we showed that during the ups and the downs in the Chinese market before.

I’ll not give you a certain benchmark on the market and so on and so forth is starting to have a major impact or whatever. But of course, we have said it before that the mix changes that we do have in the CE is something that we need to address and make sure that we work on, of course, improving the profitability where we have good profitability, but perhaps more focus on really getting up to profitability in areas where we feel it’s more to go there. And in order to make sure we’re getting the leverage out there.

Michael Tyndall – Barclays Capital

Thanks very much. It’s very helpful.

Operator

Our next question comes from Mr. Benhamou Yann from Exane.

Yann Benhamou – Exane

Hello, this is Yann Benhamou from Exane. My first question is relating – related to the truck business, you have quoted a certain number of reasons behind the erosion of profitability. Could you rank those reasons by order of magnitude, especially on the mix side, please?

Second question, just to better understand the sensitivity to the mix of Construction Equipment, could you help us assessing what is kind of a margin gap between North America and China; you can also rank different profitability? And finally, could you give us your view about the sort of next EPA regulation in the U.S. to come for trucks and what kind of opportunity you have in terms of cost structure, because it looks to me that you would have relatively the same technological solution? Thank you.

Olof Persson

Okay. When we look at the mix issues here, I think we are very careful in not – we have concluded that we do have differences in the different regions and as we have moved up in profitability in China, for instance, and that is something we have communicated earlier. But I think in order to get a consistent communication here, Christer, could you talk a little bit about the – that issue?

Christer Johansson

If we take construction equipment, it’s true that in China, the spare parts business is very limited and there, we are making good margins on selling new equipment and that’s where you’ve seen a slowdown, especially on the excavator side, and then we’ve seen the U.S. market picking up now and that is with lower margins for us at this dollar rate and that’s why we are moving ahead with the localization and building up production in Shippensburg for excavators, loaders, and haulers, but that would come online here in the next two years or so.

When it comes to ranking, the lack of operating leverage in the truck business and the reasons for that, I don’t think we will point – do that ranking. But it’s like we said, it’s a mix issue with the U.S. growing at lower margins than what we have in Europe, its absorption at the end of last year and so on. So we don’t rank it.

Yann Benhamou – Exane

Okay. Would you say that for Construction Equipment, North America is the lowest margin in the group?

Christer Johansson

Not in the groups.

Yann Benhamou – Exane

I think within the Construction Equipment, sorry.

Christer Johansson

It’s lower than the average for the rest of the world in Volvo Construction Equipment at these dollar levels.

Yann Benhamou – Exane

Okay. And then, we have the EPA.

Olof Persson

Yeah, on the EPA, could you please repeat that question?

Yann Benhamou – Exane

It looks to me that there is an upcoming EPA regulation in the U.S., which will use relatively the same technological solution that in Europe for Euro VI. So do you expect any kind of an additional leverage in terms of costs related to this?

Olof Persson

I think the next regulation coming up in the U.S. is actually the CO2 regulation where we are talking about how you can optimize the vehicles, cab design, low-friction tires, et cetera, et cetera. So – but that will be a gradual introduction from 2013-2014 over a four or five-year period. So, we actually don’t expect any significant pre-buy or anything in connection to this. It’s – as it looks now, it will be a fairly smooth introduction actually.

Yann Benhamou – Exane

Okay. Thank you.

Operator

Our next question comes from Mr. Sébastien Gruter from Societe Generale.

Sébastien Gruter – Societe Generale

Hi, good afternoon. It’s Sébastien Gruter from Societe Generale. Three questions, if I may. My first question relates to the SEK 400 million losses in the group functions and if I had the FX impact in that line, the losses was almost SEK 750 million, a way above your usual numbers. So, I just would like to know what is going on in that line.

My second question is about selling expenses which were up 16% quarter-on-quarter. Why such an increase and what is the outlook for this year? And my final question is about Latin America and the truck business. I just like to know in your Q4 order intake, how many trucks were Euro V versus Euro III? Thank you.

Olof Persson

Okay, on the other line there, I think it’s – Christer, you have an answer and also a normalization number there, I think?

Christer Johansson

Yes, I think you need to be careful. What you did is you added back the year-over-year change, which was SEK 366 million, but that’s a year-over-year change. So, if you look into the actual number, the SEK 400 million negative in the quarter, it’s – you can say, the run rate usually on that line is around SEK 200 million to SEK 300 million, and I think we are more running around minus SEK 300 million as we have put in some operations there like Volvo Rents, et cetera, that is currently loss-making as it is in a build-up phase. So, it should be normalized around, I’d say, SEK 250 million to SEK 300 million.

When it comes to currency, we actually had a positive impact there of SEK 37 million coming from unrealized hedging contracts and the distribution of that, you have actually on page 29 in the report. There, you can see how those SEK 37 million are accounted for.

Olof Persson

On the selling accounts side, I think you have to put the increases in cost in relation to the year-over-year growth. I mean we have been adding SEK 48 billion in end sales and of course, we do investments in our sales network, we do investments in our geographical reach and we need of course to invest in order to get those kind of sales number coming.

Having said that, I mean the efficiency of the selling and administration is of course also something that we’re now looking into in the new structure to make sure that we don’t have any inefficiency in the selling and admin expenses, and that’s part of the mapping that we are actually doing, but that we are investing in our dealer network, that we are investing in our growth that natural, but then you should always make sure that you do that on an efficient level and that’s what we’re looking into.

Then, on the split between Euro III and Euro V in Latin America or in Brazil, I’m not sure, you’re shaking your head a little bit, Christer.

Christer Johansson

I don’t have the actual numbers, but you can say we – there’s a fairly large junk of Euro V in there as we started to sell Euro V trucks already at the Bertone Fair back at the end of October. So, we’ve been taking Euro V orders, November and December. So, without having the actual number, I would say we have a decent order book of Euro V now when production starts up here last week of January and going forward.

Sébastien Gruter – Societe Generale

Okay. And just a follow-up on the selling expenses, I mean, we should expect SEK 6.5 billion, SEK 7 billion as a run rate, at least in the short term until you managed to achieve some savings in that line.

Christer Johansson

I think we’re better off not giving any – I don’t think we give any guidance on this normally. But some of the – the number I have been very clear on as well that some of the findings that we will do in this mapping, we can address really quickly, some of them are more structure and will take some more time and it’s going to be mix of it. But I don’t think I’m looking for it. We’re not giving any guidance on that going forward.

Sébastien Gruter – Societe Generale

Okay, and many thanks.

Christer Johansson

Thank you.

Operator

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

Laura Lembke – Morgan Stanley

Yeah, good afternoon, gentlemen. And I have also three questions, please. And the first one is on pricing in Brazil. I’m just wondering if you could tell us how pricing for the industry as a whole has developed over the last 12 to 18 months and if there’s been any impact from the new competition that you’ve seen, especially in the heavy segment.

And then, secondly, it’s on your R&D capitalization, if I look into your Q4 capitalization ratio that actually jumped to now 34% compared to like last year’s only 20% and also lower rate usually in the quarters, which kind of give you almost like a 1% benefit to your EBIT margins. I’m just wondering if this is kind of a bookkeeping in Q4 or if there’s anything behind this that is driving this and whether we should therefore maybe plan for this going forward. So basically, what will be your R&D capitalization ratio going forward and then maybe also your R&D as a percent of sales overall? Thank you very much.

Laura Lembke – Morgan Stanley

Okay. I think, Christer, you’re updated on the pricing in Brazil, so these are the questions to you.

Christer Johansson

You can’t say that basic, it’s difficult to know what competition has done, but so far, we are actually quite pleased with the pricing on Euro V. We’ve been able to recover the cost increase that you have with the new SCR engines. So, at least initially now, we’ve had a good development and on the orders we have taken so far.

When it comes to R&D capitalization, we have a policy where we start capitalizing the R&D projects as we come closer to production of that specific product and if you have a five-year R&D project for a new truck, we typically capitalize only 1.5 year and that we start when we take the production decision and now we are coming closer and closer to Euro VI, that’s why you see that we’ll start to capitalize more and more of the R&D cost of the Euro-VI project that we have coming out for the 2014 legislation. So, it’s – you will continue to see a fairly high run rate of capitalization also now 2012.

Laura Lembke – Morgan Stanley

Okay, that’s very helpful. And could you maybe also give some indication on CapEx going forward?

Christer Johansson

We have given the guidance on property, plant and equipment for the group being in the range of SEK 10 billion.

Laura Lembke – Morgan Stanley

Okay. Thank you very much, it’s helpful.

Operator

Our next question comes from Fredric Stahl from UBS. Please go ahead.

Fredric Stahl – UBS

Yeah, hi, and I just wanted to follow up on the sale, maybe if you could give us some – give us an idea of how you’re thinking around your guidance with a minus 5%. I mean, I know some of your competitors are also reasonably relaxed about the outlook there. So, I’m just curious to hear how you think about the market?

Olof Persson

You’re talking about the 105,000, Brazil?

Fredric Stahl – UBS

Yeah, exactly, exactly.

Olof Persson

I think that what we’re seeing on and what we’re really calling the market on is basically looking at a switch-over first quarter and giving the activity levels in Brazil as a country, also adding on that some positive signs in terms of interest rates and other things, gives us the forecast or the conclusion that we will see a lower-than-normal first quarter and then a gradually improved situation over the rest of the year, leading up to those 105,000. So, that’s basically where we are coming from.

Olof Persson

Okay. And thank you very much. I think it’s time and I would like to thank you all very much for participating in this telephone conference and I wish – would like to wish you all a nice and good weekend. Thank you very much.

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