Volvo's (VOLVY) CEO Martin Lundstedt on Q4 2015 Results - Earnings Call Transcript

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Volvo AB ADR B (OTCPK:VOLVY) Q4 2015 Earnings Conference Call February 5, 2016 3:00 AM ET

Executives

Lena Olsson - Executive Assistant IR

Martin Lundstedt - President and CEO

Jan Gurander - CFO

Analysts

Bjorn Enarson - Danske Bank

Hampus Engellau - Handelsbanken

Christer Magnergard - DNB Bank

Anders Trapp - SEB Enskilda

Erik Winter - Citi

Klas Bergelind - Citigroup

Erik Golrang - Nordea Equities

Graham Phillips - Jefferies

Fei Teng - Credit Suisse

Lena Olsson

So good morning, everyone, and welcome to this press conference covering the Fourth Quarter of 2015. On stage today we will have our president and CEO Martin Lundstedt and our CFO Jan Gurander. And as you all know, this is a webcasted event so during the Q and A session please use microphones. Martin, why don't you start?

Martin Lundstedt

Thank you, Lena, thanks a lot. So, first of all, good morning, ladies and gentlemen, to this presentation also from my side. Fourth quarter, as we see a good quarter with improved underlying margins despite flat volumes for the truck business, and as you know declining volumes for our construction equipment. Of course during this press conference also in addition to cover the quarter four and 2015 full year, you will also have the opportunity to ask questions if you like also regarding the changes to the executive board of Volvo and the new organization structure that will come into effect as from March 1 this year.

So if we get started then with the fourth quarter and some of the comments -- see if this is working, it's not, there. As I started to say we had continued improved profitability on flat volumes in the truck business and on declining volumes then in our construction equipment business. Underlying operating margin at 5.7% then if you take away the positive effect in quarter four of the arbitration case, and that is also if you compare without the effect of the arbitration case 7.9% operating margin for the truck business, also showing continuous improvement. Operating cash flow of 14.7 billion and thereby also strengthen the financial position and a positive net cash position. The Board is proposing to the AGM a dividend level of SEK3 and also that you will hear more about from Jan, we are now planning to finalize the structural cost reduction program as we go into 2016. But that you will hear more of from Jan.

Then if we get started with trucks Europe and what we see. As you know we have had a recovery in Europe during 2015, increased freight volumes, improved earnings for our customers and thereby also taking the opportunity to renew the fleet and we have a continuous replacement need given the good years at the end of I mean, 2005, 2006, 2008 -- 2007, 2008 and so on. Market shares for Volvo ended at 15.7% and Renault trucks at 8.1%. What we have seen during the course of the year that we actually started 2015 pretty slow with a low order book and we have gradually improved during the course of the year for the two brands and what we see now is that also the order book for the beginning of 2016 is better than previous year.

Net order intake improved by 20% whereof 24% for Volvo and 15% for Renault trucks and as a consequence of the continuous recovery in Europe our current estimate of the total market for 2016 is a further improvement by 4% up to 280,000. We can also see, by the way, that used trucks volumes are developing positively. As one example we see plus 12% in Europe North and that is also an indicator supporting this view. North America coming to that, we had as you know a very strong last year when it comes to deliveries of 302,000 units. Market share for Volvo given its main focus on on-road segments continued to develop slightly positive to 12.2% whereas the Mack brand then given its strong position in vocational and in oil and gas, and pretty weak presence in long-haulage actually declined to 7.4%.

Going into 2016 we see actually that the continuous recovery in the construction sector in the U.S. is a positive in relative terms positive for the Mack brand. The net order intake decreased by 58% in quarter four but I think we need to go through the different factors why that was a bigger drop than what we believe when it comes to the total market outlook for North America for 2016.

First of all, we had the market correction when it comes to the long-haulage segment after a pretty long period of very good volumes. Secondly, the dealer destocking to get balance in the structure that we see industry-wide and our estimate is that this will last during at least quarter one and quarter two to get the right balance for different segments and regions. And thirdly, we had an exaggerated; I mean difference between year-on-year quarter four also. So our current estimate is that the market will drop from 302,000 to approximately 260,000 with if anything a little bit of downward pressure actually. We have already decided and we are underway to take down the production levels and we are doing that more than, I mean the market forecast in order also to correct the balance between dealer stocks and production output. So we are on the level of approximately 30% adjustment downwards.

Another positive development, of course, as you can see here is the increased captive components of the power train. We are now on very high levels when it comes to engines. You see high penetration for our I-Shift 82%, Highway mDRIVE for Mack also on a very good level. And as I said, as you remember, the on-road segment is relatively small for Mack and traditionally it has been a resistance for this type of solutions into vocational. But we see now how the markets actually are experience the very good performance of the AMT or semiautomatic gear boxes. And with the introduction into vocational for mDRIVE, 6% on deliveries but when we look into the order book now going forward we have a penetration rate of 19% and it's increasing rapidly so that is showing that the market is very positive in feedback on that as well.

South America the total market as you know continued to decline further by 55%. In Brazil our market share dropped slightly in Brazil and the main explanation for that was actually the mix between, and some of you know these expressions, the semi-pesado and pesado, so to speak the semi-heavy and the heavy segments where we have a stronger position in the heavy and that decreased more than the semi, semi-heavy. When you look into the different segments we maintained positions in the two segments but that was so to speak a product mix effect in the market or a segment effect in the market. The net order intake for South America continued to decrease by 36% and our estimate for the time being now is that the market will continue to go down to a level of 35,000 from last year's 42,000. That means that we are continuing to do adjustments in our Latin America structure and in Curitiba.

For Asia, the slowing economy in China in medium and heavy due to market was down in China with 24%. We also saw the surrounding markets of course given the freight volumes, trade and different effects also coming into full effect. Our total view now on China is that we will go sideways basically for 2016 so approximately the same level as we have seen in 2015. Japan remains however on healthy levels and we expect that also to move sideways on a good level of 90,000 for heavy trucks. We have declined our market share in Japan from 18.8% to 18.3% and main reason is actually that we have done a changeover in our production system and thereby also decreased or slowing down a little bit deliveries. We are coming through that change now and moving into the market with full focus.

On a positive note also in Asia and also India we see that mature markets such as Korea and Australia are showing very good results for Volvo brand but also for all brands. Korea we have a very strong position has developed really well and also Australia. We actually had record market shares of, I think it was 26.1% for all the three brands, showing also that you can have a very successful multi-brand strategy where you have clear brand positioning for the three brands, Volvo for the cab [reunion] premium segment, for the Mack convention segment and also then for UD when it comes to the Japanese region haulage distribution segment, so I think that has been very successful.

India also our current market forecast is that the recovery also linked to the economy will continue. And our view now is a level of 350,000 for 2016 and of course giving good opportunities for both Volvo and even more for Eicher. Coming in then to Volvo construction equipment, as you all know, continued to meet the substantial market headwinds mainly then in emerging markets such as Brazil, Russia and China resulting in a decrease of deliveries of 26% in quarter four. And just as a small detail but might be an important detail, minus 23% without product exits that we have conducted during the year. China continued to face very weak demand with the total market down by 48% up to November. What has been positive as the total demand in Europe excluding Russia then that is on low level showed a positive development of 3%. And the net order intake during quarter four was down year-on-year with 18% and if you exclude the product exits it was down with 13%.

The current focus of course is to improve the market and product mix and thereby earnings and get better resilience into the business and less dependence on the BRIC markets. And I think we've had a good year when it comes to the heavy machinery. We have moved market share from 6.3% to 8.1% and that's quite a lot so a 1.8 percentage point. As one example in Western Europe, Volvo Construction had a strong development on heavy machines that was up 14%. So I mean the profitability focus we're working on, on product lines and market earnings gives now a more resilient structure. We are also continuing to do the portfolio pruning and look to where we might -- will continue also to exit some of the products. To further strengthen presence in core segments we are actually lining up a new set of products at the Bauma fair in Munich in April whereof one of the big news of course will be the new artic-hauler A60 60 tonner that will then take the next step as the biggest today is the A40, 40 tonner.

And so the market outlook for next year remain, as you all know, bearish for China. Our current estimate is minus 10% to minus 20% whereas the rest of Asia, North America 0% to minus 10% and Europe pretty flat. Buses had a mixed picture when it comes to market developments. We had good demand in North America. Saw a steady recovery in Europe, and a continuous weak demand in Brazil. During quarter four sales increased in all regions for us except South America and also what was positive, the sales increase in all product ranges. Also service sales increased plus 7% mainly driven by Europe and North America. The quarter was very strong for Volvo buses with deliveries up with 9% and net order intake with 24%. And now important to read very closely this and follow that this positive trend will continue.

Also on the product side we launched the new 9800 coach in Mexico, very good feedback so far. We have also been doing the preparation for introduction of the hybrid buses in India. And we have a very big interest from India given their environmental agenda and we will be shipping the first five hybrids to the city of Mumbai during the first quarter. For Volvo Penta industrial engine segment showed mixed picture, declining volumes in emerging markets and flat volumes in mature markets, whereas the marine segment was flat. On a positive note Penta is strengthening its position in all segments. For the whole year Penta increased units sold with 17% and the net order intake however decreased with 8% in quarter four. During the quarter also on the product side a new D16 marine application was launched to further strengthen a very strong product range on the marine segment.

So with that I give actually the word to you, Jan, to go through the numbers and the financial analysis.

Jan Gurander

So, good morning. It's time to summarize the fourth quarter for 2015 and also a few words on the full year for 2015 in financial figures then. And if you look upon the sales figures we go from SEK77.5 billion in sales up to SEK79.6 billion. Worth to mention here is that the improvement comes basically from a currency effect, it's 3% up in Swedish Kroner if we take out the currency effect it's down with 1%. And of course that relates to what Martin has described actually that we do have more or less flat volumes on the truck side but though -- and then we had decreasing volumes down 26% on the sea side. When we talk about the different regions we see that with the strong development that we have seen in Europe but also we see now order intake coming down for North America we see the kind of slowing momentum in North America. But last year in terms of deliveries and so on helped us a lot actually and you can see that we have 3.1 billion more in sales in North America in the fourth quarter.

South America then more or less exactly compensating, the downturn exactly compensating on the downside you can say the uptick that we had in North America. And then Asia being fairly stable and other markets, it's actually so that some markets that actually have a downturn compared to one year ago, it's mainly in Africa where some markets its actually quite much slower than what we had in 2014 in the fourth quarter. If you then look into the profitability and earnings, as always we have one-timers and we have restructuring costs and we try to do this, communicate it in an as transparent and clear way as possible. This is then, as you remember last year, we had the two big one-timers in the fourth quarter, one was the provision we put up for the EU litigation or potential litigation and then we had the China credit risk of 660 million. So the reported was a negative of almost 1.5 billion but if we exclude these kind of one-timers, it was 3 billion in positive.

This year in the fourth quarter we had the arbitration case for the [full year] and which was 800 million. If we take away that one, we're 4.6 billion in profit. And you can see here, this is another quarter where you can see more or less all of our business areas are helping with improvements, with the exception of sea, but I will come back to sea a little bit later on. I think given the market circumstances and also if we actually exclude the one-timers and so on, the work that they're doing there and the profitability on a decent level given the circumstances. We go there from a 3.9% EBIT margin there on the 3 billion up to 5.7% on the 4.6 billion.

Looking then into the same exercise but actually to see where the different kind of, you can say improvements come from. When we go from the 3 billion to the 4.6 billion we see that we have then of course Europe and North America helping us quite a bit from the market side with the increased sales. Also markets now where we have good earnings in our operations as well. Of course from the market side on the negative side it goes without saying Brazil is actually hitting us quite a bit compared to what it was in 2014. And of course all in all the lower volumes that we see on a Group level, as I said before more or less flat on the truck side, but actually the lower sales and deliveries that we see on the sea side. Apart from that we see that we get help from our savings programs, when we measure them in local currency, we have lower selling expenses. R&D is more or less flat if you take away the currency there, we do have savings compared to one year ago. And then we have some other, in the other which is a little bit unusually high, we had the 158 from the China credit risk. Also another thing that's there is the lower earnings that we see in the fourth quarter 2015 compared to '14 from our joint venture in China the CV, and of course the CV is affected by the downturn of approximately 25% in the market in China.

Turning into trucks, here we have going from 54 billion to 55 billion in sales. Once again currency there it's at plus SEK2 billion; if we exclude the currency effects it's a negative of 2 billion. The operating income goes from 3.2 billion up to 4.4 billion and it is on a rolling 12 months basis 16.2 billion. Here we have once again excluded these one-timers that I mentioned before, the ones that are affecting the truck segment then. And then we have the operating margin on trucks going up to 6.0 -- from 6% up to 7.9% and we were at 7.94% actually but how we twist it and tweak it within it, go to the 8% actually but it's very close to 8%. Here then going from 6% to 7.9%, last year it was a negative of 540 million. With the EU provision that we put up we come to 3.2 billion and this year then we had the arbitration case, it's 4.4 billion in so to say running operations. We had then in the latter part of this year of 2015 we had a higher capitalization and amortization which helped the result quite a bit in the fourth quarter.

Looking into the whole year of 2016 we think that capitalization, amortization for the whole year will be fairly much in balance as it looks right now. But in the beginning of the year we will capitalize a little bit more than what we amortize and that will turn for the latter part. Lower selling expenses and of course Europe, North America on the positive side and the currency of course helping us with the almost 700 million. We do have a negative product mix and this is maybe more of a financial thing, it's so that the relative share of our profitability is -- or the relative sales that we have is actually lower on the Volvo side than on the other brands so from that point of view it's a negative product mix. The other brands are selling relatively more in the fourth quarter 2015 than what it was in 2014 and then of course Brazil affecting the truck business negatively quite a bit.

On the construction side here as I said before down 26% in terms of deliveries, sales is only down 10% or 11%. If we take away the currency, sales is down with 16%. So we can see here that the -- of course helped by currency but also the fact that we moved the product mix a lot going from the smaller machines to the bigger machines that's why sales is not coming down so much as the unit sales are doing. So once again the strategy or tactics that we are doing right now see definitely gives an effect on the top line but also to help to offset the difficult markets that we're into right now. You can see that last year minus 815 million this year minus 191 million. In all these figures every quarter now we have the China credit risk provisions included so they are not excluded anywhere, and that's also why that was such a big negative on the fourth quarter last year with the minus -- the credit risk provision of 660 million that we put up at that point in time.

And then of course the operating margin for both quarters, both '14 and '15 is on the negative side. But then looking into a little bit you can say the underlying performance if one excludes the China credit risk provisions last year then we were at the negative of SEK150 million and this year we are actually on a minus 33 million. So all in all given the fact that we lose this 25%-ish in unit sales we are more or less on the same level, actually a little bit of an improvement. Also sea is actually delivering for the whole of last year in an extremely difficult market environment where China, Brazil, Russia and a lot of other important markets are down, still making a 2 billion profit for the whole year, which I think that's quite an achievement for the guys working at sea. Apart from their working with the product, mix you know that we are working also with our product portfolio and we see positive effects coming out of the fact that we are working with that.

And as Martin said the fact is that we are phasing out some or have phased out some products gives also a positive effect. And we are of course working through the whole kind of cost structure in sea as well when it comes to operating expenses and all the other stuff and that gives a positive or helps sea right now in this difficult environment. Of course on the negative side apart from volumes we of course get the very low capacity utilization in some of our factories for the time being, and that's hurting us quite a bit, and then earnings in China is of course on a level, it definitely doesn't help us if I put it that way.

Turning into other areas, buses and Penta, buses has done actually increase in sales with almost 25%. If you exclude the currencies, it's a positive of 17%. And it is a combination of fairly, some markets being fairly good but also that we gained position here, so buses are definitely gaining position in many markets for the time being. And we can also see now that we are on the positive trend in terms of earnings as well for Volvo buses. For the whole year last year it was almost 900 million in profit and it looks as though it is a solid improvement that we see now coming through in this business area where we have been struggling quite a bit actually.

The, where we see, we see actually good market and product mix in buses for the time being. We have a strong sales situation in the northern parts of Europe. We see hybrids selling well where we also have a good business; UK is one of the markets where we have a positive coming out of that. And also then that we see good development on the fully built coaches which also increases the sales value in North America, so we are at almost, I think we have 3.7% EBIT margin for the whole year.

Penta is basically now a little bit above 1 billion in earnings also had a fairly good quarter or good quarter in terms of sales up almost 10% but being about 1.1 billion or 1 billion in sales. 11.7% in EBIT margin for the whole year. We checked backwards here in the morning and, a quick check backwards we didn't find any year that was better in terms of EBIT margin for Penta. I might be wrong but it's at least the last 10, 15 years we didn't find anything like that. So Penta is really continuing to delivering extremely strong actually.

Customer finance also an area, we customer finance broke the 2 billion threshold, and if we look upon purely our customer finance activities this is also a record. Our customer finance activities have never been above 2 billion. You will find one year that it was about 2 billion before but then it was also real estate and pressure involved in pure customer finance, I think it's quite a good achievement for these guys. And we have this where we want to be approximately on our return on equity 13% to 14% on that one. So still a very, very good performance there. Of course the market where we are, Brazil is the market that we have a very, very close eye on.

Then we come to the cash flow and the cash flow for the quarter was close to 15 billion. And the cash flow comes actually through in I would say in all aspects in this quarter and I think this trend we have seen now for, I think we have to go almost three years back actually that cash flow is improving. It comes, of course, from the fact that we are improving our profitability in the Company. Secondly, it comes from the fact that we have discipline in terms of our CapEx expenditures. We are now for quite some quarters actually we amortize more than what we have in CapEx. And the Company is well invested there is no need, there is nothing that for the time being is suffering from or anything like that, and of course thirdly, also we see that we are improving also on the working capital. And the working capital effect was fairly huge in the fourth quarter, basically with improvements in all areas, accounts receivables, payables and also on the inventory side.

The structural cost program measured in Swedish crowns we are at 4.6 billion. If we measure it in local currencies we are at 6.8 billion. We have one year left. If we look upon the last two years, 2014 and 2015, we did 3.5 billion per year. This means that there will come another 3 billion, 3.5 billion next year which means that we will reach the 10 billion. The, what call it activities are more or less all of them in place when we come to year-end. We have a few things still left to go especially on the sales side I would say some smallish still on the production side. And the main thing that we said that will be finalized and transferred in the second quarter is the outsourcing of IT. And with this one, this is the last time you will see this slide, because now going forward we will continue to focus the company on continuous improvements and also of course to implement the new brand organizations that we announced last week.

So, a few comments on the full year, basically here if we had a few one-timers in the fourth quarter I can tell you the one-timers in the whole of 2014 and the whole of 2015 there are quite a lot of them and that's -- you see this small note down here that you can read when you have the time. But basically to measure the underlying performance we go from a little bit less than 12 billion in 2014 up to the 20 billion in 2015, excluding these one-timers and it takes us from 4.2% in EBIT margin up to 6.5% in EBIT margin. And of course there is a quite sizeable FX effect from the currencies, a little bit more than 5 billion and of course that has helped us last year. But I think the -- if you look upon it structurally -- last year structurally we have approximately you can say ballpark figure, is 1% in internal improvements more or less every quarter if you look upon the whole year. And then we have the other percent basically coming from currencies last year, so there is an underlying improvement within the group but also some tailwinds from currencies.

With that welcome back, Martin.

Martin Lundstedt

Thank you, Jan. I think you can say also just to summarize what we have said, foundation laid for further going into 2016 and beyond. You have seen it earnings improvements, improved cash flow and thereby also strengthened financial position. And also very important step for us now, the new organization given even more focus on customer segments and driving the service business, increased focus on profit and loss for the different brands standing on its own commercial and profitability merits. And still leverage, the best of two worlds, I mean bring the scale where it matters and where it matters. So I think this is the next step with the foundation that we have laid now and move into that.

So I think with that, Lena, the presentation as such is over and we start with the question and answers.

Question-and-Answer Session

Lena Olsson

Thank you very much, Martin. Who would like to begin?

Bjorn Enarson

Thank you, Bjorn Enarson, Danske. I'll start with the positives then, North America and Brazil. Can you give some color on the ongoing ramp-down in production and how we should look upon that, I mean it's quite sizeable of course coming from a very high level. And how difficult or complicated it is to give some help on when looking into 2016 earnings? And also the cost reduction or the lower production that we have seen in Brazil and the workforce that has been lower during November, December, are you initiating more measures also in productions in terms of manning, etc. in Brazil? Or what kind of extra measures are you planning there?

Martin Lundstedt

If we start with North America then this is where we had high deliveries more or less the whole 2015. We are now ramping down and of course before you're coming down you take some stop weeks and stop days, etc. so that is a fine-tuning effect that we have now during quarter one. But as we have said we are more or less taking down the production level on the pace going forward with 30%. And as we have said the correction, or the market our estimate is 15%, so we're taking it down more just to be sure that we actually have a good balance between the stock -- dealer stocks levels and our production rate. And we have a good also flexibility for doing adjustments both upwards or downwards from that level. When it comes to Brazil as you said, we already started to take stop days in order to really be in balance between output and our production levels. It will be less in quarter one due to the fact that now we are taking down manning accordingly. And we are of course following this if that is the right level or if we need to do further adjustments, and that goes of course for production but it goes for the whole organization also when it comes to other parts of the value chain.

Bjorn Enarson

A short follow-up, the ramping down has historically been quite costly for Volvo. Is there anything that you see has changed or anything that is more prepared that you will have more of a smooth ramp-down?

Martin Lundstedt

As we said our estimate now is that we have been pretty clear on that that we want to be sure that we are taking down production, if I may say so, a little bit more aggressive to be sure that we're coming into balance, because we have an upward flexibility in the system, so there is where we're standing right now.

Hampus Engellau

Hampus Engellau at Handelsbanken, I'm coming back to North America. Just to clarify you're cutting production more than suggested by your market outlook. Is there also an element of reducing inventory? And when do you need to switch that if you're correct in your market outlook?

Martin Lundstedt

As we have said, our current estimate is that we need quarter one and quarter two when we look at both the Volvo and Mack brand in order to correct the inventory. Of course there is always a mix what you have in inventory how does it look in different regions, but that is our current estimate. Then of course if we are correct we will have an upward pressure. But as I said here, we have a good flexibility in our two production flows in North America, so that is approximately the timing.

Hampus Engellau

Moving over to Europe, you're growing 20% in orders. If I compare with Scania and Daimler, it's more than twice. How much of this is comparison and how much is there an element of market share gains? And could you maybe talk a little bit about Renault and Volvo?

Martin Lundstedt

First of all, of course, if we start with an average figure of 20%, you should remember that I think Volvo Group, both Volvo and Renault came in a little bit weaker than the other brands into 2015. And we saw that also the market share development that really declined during the first quarters. And gradually we have stabilized that and also improved in some market areas in Europe. So our feeling now is that we are going -- we all, for both brands going in with a stronger order book and also that we are going in with a market share that is more solid than it was last year. And what we have seen of course also for the Renault brand is that the southern markets are also recovering because that has been one element for the Renault brand that -- the relative weakness of southern Europe in relation to northern Europe. So there is an element of that. And in addition for Renault, it was still at the end of the switching over to the new program during the end of 2014 for some of the specifications. So for both brands it's, I think, those effects.

Hampus Engellau

Okay, one last question from me, the organizational change in trucks, could you maybe add some more comments to the 50 minutes presentation already on that?

Martin Lundstedt

I think as we said, there are a number of, for us, pretty clear targets we want to achieve. Again, during the last three, four years with good reasons, it has been a consolidation, looking at the cost structure, whether we have the resources, how we are doing with the brand positioning for different brands in different regions, etc. It has been a good and focused work. But we see now, in order to drive organic growth, to drive service sales, it starts with the customers. We know that we have discussed it many times before. And what is it all about? You need to have a brand organization really taking care of that tailor-made solution in a good way for the different brands. Tailor made could be a more standardized offering, depending on what brand it is, or it could be a really tailor-made solution including service packages.

Elements to drive this is being close, agility, decision-making power out in the different brands and regions. Use the fact that in many of the regions have a one-to-one system, as I call it, or end to end. We have a very good supply chain in all major regions that we should use better to the continuous improvement process to really drive operational excellence in the flow. So from an asset, people and business and brand positioning perspective, this is the logic step to take. And then of course it is important also, I think, to make sure that every brand and every business area is standing on its own commercial and profitability merits going forward. And in addition, it's more fun and why not? I think it's a good synergy. And then of course, as we have said, the backbone is also important to keep in mind. Where does it matter when it comes to scale?

As you all know, scale is a very overrated word. But there are scales to find where we should be very consistent. We have done a good job when it comes to the modular toolkits of standardized interfaces and still having ability for performance steps in between. We have scale or can put more tickets when it comes to technology sharing etc. So really find that balance and to work on it. That is then main idea, so to speak. And really, as Jan was into, leaving big structure programs, big banks and continuous improvement, continuous introductions. That is what our customers want to see.

Christer Magnergard

Christer Magnergard from DNB. Just a follow-up question from Hampus there. You mention that all brands should stand on their own. If I read between the lines, it seems like at least one isn't doing that today. In that case, where do you see the largest potential to improve profitability or improve or drive organic growth going forward or that brand?

Martin Lundstedt

You don't even need to read between the lines. As you remember on the Capital Market Day, we actually disclosed at least the relative position of the different brands and regions and I think it was pretty clear. And again, I think we have -- for example, I assume that you're all thinking about UD. We have a very strong value chain for that brand. We know that we are actually also looking on a structure where we can have a very good development. So when we are doing that work and we empower, as I said, the flow thinking, the business thinking, we have very strong view on our ability to improve the position there.

Christer Magnergard

And then moving onto construction equipment, if you could talk a bit about capacity utilization you see going forwards? The problems we have in the market will probably continue here for the next two quarters, and also what your expectations are for the credit provisions you have in China, or have had, if they will continue?

Martin Lundstedt

When it comes to, if you start with the capacity utilization of course there is one thing, what you have in the fixed cost and the structure, etc. I think we have done some measures on that part. But to some extent, you have what you have, so to speak, and you need to have a global presence. What we have done on that area is more fine tuned there with the product exits, what is really the core, and continue to see what effects that will have. Then of course we are doing continuous adjustments when it comes to manning in production but also when it comes to the whole structure of course.

I think, as you almost hint to, if you really look into it, and also the whole sector, with the decline of 26%, big dependence on some of the markets, we see really now the effects coming through when it comes to the focus on heavy machinery, really scrutinizing the product portfolio. Make sure where we are concentrating our efforts, also a number of opportunities when it comes to the operational excellence in itself. It's not only about the capacity utilization but how you utilize the capacity you utilize. Meaning everything about quality lead times, delivery position, etc., and I think they are doing a great job now, very focused and consistent work in that matter. So we are not being all over the place, so to speak.

Jan Gurander

When it comes to credit risk, I think we would like to know as well how much it will be, at the end of the day. And if we knew it, we would put up the provision immediately to say now it's done. So I think we have, in a little bit similar way as you have the difficulties to predict. I think when we stated with the 660 million in Q4 2014 then we maybe hoped that the market, we had taken the big downturn in the market that it would stabilize and so on. But then you saw last year that the market continued to decline.

And of course, when you have that decline in the market, our end customers utilize the equipment much less. By that, they don't have the cash flow, our dealers they don't have the cash flow either and so on. So that's why it continued, of course, during 2015. I think one can definitely not rule out that we will have further credit provisions in China going forward. But the size and magnitude, I don't even want to speculate on it actually. So I think you can pick a number.

Martin Lundstedt

But from a more anecdotal point of view maybe I cannot, should not say but we would discuss about the bridge for the total Group and we had 660 million as a one-timer. But we didn't have the 158 million as a one timer. I think that is, we said. Let's stop there. These are part of a going business. Okay, we had an over-optimistic view a couple of years ago and now we have that coming up. It's better to know that because it's part of the learning process going forward for our business model.

Christer Magnergard

Then a final question just on the balance sheets, now you're no net debt and at the same time you have [indiscernible], but you have also said that the big investments are done, there will be no big bangs]and the free cash flow is very strong. Where are you comfortable? What kind of gearing level are you comfortable with and how should we look at it on the balance sheet going forward?

Jan Gurander

First of all, I think it has been a necessity actually to strengthen the balance sheet, as we have done, actually. We are in a highly cyclical business. We have seen downturns before. We now have that. It's a risk area. From that point of view, I think you need to have a solid balance sheet. We should not either forget the fact that we are running our financial services as well, which has assets of, what is it, approximately 140 billion as well.

So from that point of view, you need to have a strong balance sheet. Our one area that we don't like, but it's the seasonality that we have on our cash flows as well, that we have a little bit of a tendency to basically not generate any cash flow the first two quarters, what you saw last year, but usually it's the first three quarters. And then all the cash flow comes at the end. And from that point of view, we need to manage also the volatility in our, and that's the working capital basically that's fluctuating so much.

So I think from that point of view, that's, and also then connecting back also to I think the balance proposal from the Board as well to have SEK3 per share as a dividend. I think that's where we are today. But of course, if we continue to see stability in our earnings, you are all asking for how we manage our, can you manage the downturn in North America. You have forced that before. If we can prove that and we can continue to improve our earnings, of course a day will come that we can take a look and maybe be a little bit clearer also on the strength of the balance sheet.

Martin Lundstedt

And you know it's costly to be short of cash. No, but I think it's, if you really look at shareholder value long-term, really to have a healthy balance sheet for that, really driving the business. If you see the solutions and not at least customer financing, that is a very important element for driving long-term organic growth, for example.

Anders Trapp

Hi, Anders Trapp from SEB. Hi, I have a couple of questions. But firstly, first question is really listening to what you're saying about no big bangs going forward, evolution rather than revolution I guess you're saying also. Is that enough considering that we are probably going to see down volumes also in 2016 looking at the guidance that you have? And maybe some further downside risks to that? So with the capacity adjustments that you are now talking about, or having implemented or about to implement, is that enough to safeguard the profitability in 2016?

Jan Gurander

Shall I start or?

Martin Lundstedt

No, but I think -- and when you're talking about continuous improvement, I think that is a mindset when we come to how we're actually improving the business step by step. Then of course when it comes to the current situation in different marketplaces, you need to use the tools that you have. And that is regardless of a structural cost program, or if you're working more on a continuous improvement basis by driving efficiency, driving quality development, etc. So we will not take out the tool of doing the necessary adjustments in our value chains of course.

And but at the same time, when we look at where do we have opportunities going forward really to drive efficiency for real, all the different elements, we believe more connect the flows, work through the different value chains. And we have, as I said, a number of elements that make the group strong. We have strong regional value chains that we can utilize better not at least to cope with the different regional volatilities that you're after. I think we can utilize that even better if we do that.

Jan Gurander

Exactly. So, one other thing. What we have identified is also that currently when we work along the value chain or the process to deliver trucks and service trucks and so on, I think in the organization that we have had, it's a functional organization. If you have a strong functional organization -- and it has had its merits, so I'm not complaining about that. That made my life easier to take our SEK10 billion if I put it that way. But you see that you lose a little bit of efficiency along the value chain. And that's also why we now changed the organization. And when you then look upon certain parameters along that value chain and KPIs, we see that we are not where we would like to be. And I think we have a fairly good understanding what it means to be world class on these parameters.

And now we need to find -- and Martin mentioned one example before, that we have had disturbances in [indiscernible] for the last six months, basically. And we have talked about disturbances before as well. They are partly connected to the changeover programs because they are structurally quite big. Now we want to actually take out the benefits but we have restructured it and then come back and actually make the operational efficiency much better. And that is quite a big potential that we have.

Martin Lundstedt

But of course, Anders, you know it as well, if there are real structural things going forward, you will do it.

Anders Trapp

I was really after if you're happy or content with that basic structure that you have now which I guess you are. And then gradual improvements from that. Also 5 billion in help from currency on EBIT last year. Much less this year, I guess. But could you give any kind of indication if it's even worth putting into the model?

Jan Gurander

When it comes to currencies, we will -- '16 compared with '15 we will not have a help of the currency as it looks right now. It will be on the negative side. It's a little bit difficult to exactly judge that. We have said before, take the flows from last year and then apply the rates. The flows will change quite a bit, most probably with the region shifts that you see as well. So I think it becomes a little bit of a guessing game for us as well actually. But it will be on the negative side. We also see some of these raw-material-related currencies from emerging markets become weaker compared to what they were in 2015. That will hurt us a little bit as well. And we have said that we will not say more than it will be, as it looks right now, on the negative side.

Anders Trapp

And finally also, with the huge shifts in demand that we have seen last year and also huge currency swings as well, are there any big regions that are actually loss making now? I'm thinking of South America of course.

Martin Lundstedt

We don't comment on -- but I would say that South America is better than what you believe actually because with the production that we have in Brazil, and export to other markets in Latin America, having done a dollar denominated price on the trucks, we are actually not that bad in Latin America. So Brazil is not very good. But no, I think as a whole that also we talked about in [Ghent], the performance in all our brands have improved over the year maybe with one exception. And that's also why we maybe take a little bit different measures there. And that's Japan that is struggling most actually.

Erik Winter

Hi, Erik Winter, Citi. On U.S. there are some inconclusive numbers from some of the competitors and some more increasing speculation on softness. Do you see any tendencies in your order books? That's one. And the other is related to Europe. I think truck deliveries were up 19% last year and you're forecasting flat 2016. Why is that?

Martin Lundstedt

If you look at the order book at the start of the year, I think that is following pretty much what we have said. And of course there are some markets that are a little bit more uncertain than -- at least than North America, even as we said, a number of factors coinciding so to speak. So I think that is the region where we have to be closest on the ball so to speak and follow where we are. And again that's the reason why we are correcting also the levels a little bit more to be sure that we are rather on the conservative side. When it comes to Europe, we are not forecasting flat. For the market, we are forecasting an increase of 4%. And I think also it's fair to say that 270, 280 is a pretty good level now. I mean when it was 320, 340 all of us know that it was an over-swing also on speculation. So I think it's a good market. And as we said, we feel that we are coming in -- we know that we are coming in from an order book perspective stronger and we feel that we have a good momentum in the market.

Lena Olsson

All right. Let's move over to those of you participating over the phone. Operator, please go ahead.

Operator

Thank you. We have a question from the line of Klas Bergelind from Citigroup. Please go ahead your line is now open.

Klas Bergelind

Yes, hi Martin, hi Jan, it's Klas from Citi. Just come back to construction, we knew that the southern hemisphere couldn't offset the winter season up north and we knew that transaction flows would fade. But what happened here to the previous market share gains on the larger machines? I guess if I look at that typical margin you deliver at recent volumes, those market share gains boosted margins by 200 basis points. When we look at the fourth quarter, it looks like even weaker numbers there, if you consider that.

Jan Gurander

I think that we gained market share, something like approximately 2%, a little bit less than 2% in the heavy machines. Then you should remember, the market shares are fairly low, it's below 10% that we talk about. So relatively we gained quite a lot of market share actually. And as I said, we are quite pleased with that [traction] and the deliveries. I think our profitability and the margin in construction equipment would have been significantly lower if we didn't have that development. Then I don't know exactly how we calculate your 200 basis points since I don't have your spreadsheet. So I don't think I can help you there.

Klas Bergelind

What I meant, Jan, was exactly to what you said here, that without those market share gains, you're delivering a margin that is mid-single digit negative. So my question becomes into the first quarter, if we don't have any spring season in China, if BRIC is still a big problem, what sequential uptick should we think about, you typically get a 200 to 400 basis points uptick quarter on quarter here. Is that possible? Or will the first quarter also be a tricky quarter?

Jan Gurander

I don't think, usually we don't guide anything on quarters. But you know the seasonally weakest quarter we have is the fourth quarter. And then you know that you should -- the stronger in the spring season is the second quarter. Then to speculate whether there will be spring season at all in China, this year it was a very low spring season, last year, that's another thing. I think it's very difficult actually to speculate. The fourth quarter is usually the weakest quarter, if I put it that way.

Klas Bergelind

Okay. Yes, then the question on North America and the flexibility. I'm sorry to come back to this. But let's say that you deliver a 10% margin in '15, truck volumes down 16% this year. The aftermarket is a big portion of revenues, should still grow, if we listen to Packard 3% to 5%, so what happens to the margin there? Is it dropping to 7%, 5%? Or do we go below that?

Jan Gurander

I think you missed one thing there; it's the effects of the 10 billion program.

Klas Bergelind

True, absolutely. But that is obviously in most people's models here. I'm just trying to understand roughly what can happen to the margins?

Jan Gurander

Once again, the only guidance we give on this basically where we see the total markets. And then to speculate whether that market expectations that we have right now, if they are the right ones or not -- it sounds like you have the right different parameters into the models, you can tweak around those.

Klas Bergelind

Thank you, Jan. My very final question is on the production levels as we go through the first half in North America. I understand that you will probably under-produce significantly in the beginning of the year, Jan and Feb, but when you look at the second quarter, will that be more in line with demand or will you also under-produce the second quarter?

Jan Gurander

First of all, you could say I think it's a correct assumption as you said. The downtick means that we're gradually taking out manning, of course and that is mainly during quarter one. So from that perspective, it's correct that we will have a more balanced production in relation to the manning as well in quarter two. And we have been forced to take more of, so to say, stop days and stop weeks during quarter one. So our plan is to be correctly manned to the level that we have decided now in quarter two.

Klas Bergelind

Great, thank you so much.

Operator

Our next question comes from the line of Erik Golrang with Nordea. Please go ahead your line is now open.

Erik Golrang

Thank you. I have two questions. The first one on the order intake on trucks in North America, it seems that your share of orders is on a quite steep decline, or has been over the last few quarters. If you can say something about that and the development into 2016.

And then the second question for construction equipment, a bit more medium to long-term. What kind of planning assumptions do you make for market demand there over the next couple of years? I guess you want to bring up margins but what do you assume as an underlying market development here? Do you think you will get any support over the next couple of years from higher market demand in construction equipment? Thank you.

Martin Lundstedt

Okay, so if we start with the order intake in North America. As we said, there are three different factors coming into play here. And we have at least our own view that we pretty early came to the conclusion that we have to do something with stock and inventory on dealer level. And of course, when you start that discussion in the value chain, it also the net order intake that is, coming into our factory level here.

So for that reason, you see a big overshoot. Then if it's 58 or 54 or comparison figures, I think the main thing for us is to find the right balance going forward in our books, of course, to safeguard that we are continuing on a good note with our market share development but also that we have a good balance between production stocks and retail deliveries. So I think that is what we said. We have three factors; we need to make sure that we continue to understand well what is what in those three factors.

Erik Golrang

Could you say something about your specific cancellation level over the last two or three quarters?

Martin Lundstedt

No. I cannot say. But that has not been the biggest issue actually for us, the cancellation because again, when we look at the retail deliveries, as we said, the fact we find there is mainly then the correction on the on road. And again, there you also see the difference between, and of course, correction, and also already during 2015, the correction when it comes to energy sector. So again, that is the difference you need to understand that we have an assumption of some maybe 14%, 15% decline here. If that should be the case as our estimates is 260,000, is the fifth best year ever in the US, or in North America. So we have some sort of view on the total market as such.

Jan Gurander

When it comes to the cancellations, it was mainly the first and second quarter, a little bit into the third quarter where we saw the cancellations because they were the overshoot that we had in the fourth quarter 2014 of the order intake.

Martin Lundstedt

Which is also part of the explanation, by the way.

Jan Gurander

Yes, so from that onwards I think we have seen limited amounts of cancellations on order intake. That's not a big issue today. It was for the first half.

Martin Lundstedt

The funny thing, there you have also what we talk about continuous improvement in the value chain. Typical behavior when you have a shortage of deliveries that you start to have a speculation curve. And that was part of the in quarter 4 2014 when it comes to the order intake.

Erik Golrang

Okay, thank you, and on construction equipment demand longer term?

Jan Gurander

To say when it will come back, etc. is very difficult, of course. There are some factors that mean also that what we have seen in some of the countries, like China, of course, will not come back to that level. It has been an investment-driven economy and then partly on that note also in construction a speculation-driven economy, as you know. And as China now is moving along into a more consumption-based economy, slowly, that of course will long-term affect what is the right level for such a market. And therefore I think what we are doing now, and then of course when it comes to other markets, you can say the highway build.

And we have a pretty healthy view on housing in the US. Still commodities are down the drain but at the end of the day, we will have a need of that. I think that the important part of us is the find the right level of resilience both when it comes to market mix, that we have the healthy product mix, where should we be really good? Where are we good? And how should we continue to drive those segments? And also to have a good flexibility among different regions to cope with that and again also what we see is about automation level, the solution level that there is still a big pocket to develop when it comes to share of orders for different types of equipment. So I think that is a very interesting focus.

Operator

Thank you. Our next question comes from the line of Graham Phillips from Jefferies. Please go ahead. Your line is now open.

Graham Phillips

Yes, good morning. Two questions please. One for Jan, one for Martin, first of all just, Jan, on the R&D capitalization, the 704 million and the lower sales and marketing costs, obviously that benefited the margin in the fourth quarter for trucks, I think if you adjust for that it was probably the lowest margin for the year in trucks. So how should we think going forward? I know you've said that R&D capitalization will be moving as well in to 2016. But what do we think, again, reflecting back to the way you used to talk about the regional profitability in traffic lights. I guess Europe will be a green. North America perhaps goes to orange or red. South America is red. Just again trying to get a bit of feel for 2016 truck margins?

Jan Gurander

I think on, if you look upon the gross margins, of course they will be affected in the different regions by of course the market developments, as you correctly said. And of course we will do everything we can to offset, of course, a downturn in North America that we adjust to. And it's the same in Latin America. And then how much you can adjust to the lower volumes or if there will be a negative effect that's very difficult to say. Just due to the fact that you lose volume usually means that you lose gross margins. So it will have a negative effect. So there will be certain mix effects of course coming there apart from that, you will see that the -- you can say the underlying improvements that we have done and we are still doing in the efficiency program, that will continue to gradually kick in, in 2016. And that affects all business areas.

But I would say mainly the truck business areas and maybe sea as well within the Group. So you will have that as a countering effect to maybe some regions going down. But on the other hand, Europe is coming up. But you should not forget that there are still efficiencies coming in. It doesn't stop for that. We have implemented quite a lot during '15 that will have a full year effect in '16. And there are a few activities still that we are implementing now in the beginning of '16 as well. And then you have the move into what we call continuous improvement or working with the operational efficiency.

Graham Phillips

How much of the R&D capitalization benefit is the truck division of the 704 million?

Jan Gurander

It was the majority of that one. I don't have the exact figure. But I think it was 80%, 90% of that.

Graham Phillips

And then just a question for Martin if I could, if we take your announcement last month about increasing the size of the Board and the focus on brands, how should we read I mean it's quite a large board now, 13 members, and again, how should we -- is that going to be unwieldy? And how should we read the fact that construction equipment is only one member of that board? They've obviously been diluted as far as presence on the Board. There's a lot more focus around trucks at the board level. Shall we think of construction equipment not being -- whether you'd had a look at the business now, what is your perception and view of that going forward?

Martin Lundstedt

No, I think it was pretty clear what we announced the new executive board level structure that Volvo construction equipment and Martin Weissburg is taking a seat in the Executive Board. That is the second largest business if we compare the business areas. And as we have said, the importance of that and the focus we are putting on that is obvious. Then you can always argue about the 12 or 13. I think we have senior executives that are driving their businesses. All of the 10 should actually qualify for [Stockholm] large cap. Just to have a good view on it. And therefore, the important part of this is really to make clear what are the mandate frameworks and where do we have the meeting points where it matters. In product board, in service board, in quality board. And then off you go and do your business actually. I mean don't complicate it more than necessary.

Graham Phillips

And you mentioned metrics, one of the measures will be new metrics, what new metrics are you introducing for the brands?

Martin Lundstedt

Typically clear responsibility of operating income, cash flow delivery position, quality development, organic growth, service portfolio development, part sales, etc. Everything that has with customer satisfaction and business to do

Operator

Thank you. The next question comes from the line of Fei Teng from Credit Suisse. Please go ahead, your line is now open.

Fei Teng

First one on the product mix in trucks. You said it was weak in Q4. I'm just wondering, was there a particular region driving this? And what can we expect going into next year given that orders on Volvo look slightly better than the other brands?

Jan Gurander

The product mix is, as I said, it's more of a mathematical effect than anything else due to the fact that the relative shares of Volvo that usually have a stronger [Multiple Speakers] gross margins are actually lower compared to the other ones. And of course that comes from, as Martin has said, the fact that Latin America is coming down. So it's a pure mathematical effect.

Martin Lundstedt

And since you have more or less the [indiscernible] brand structure in Latin America that is how it is.

Fei Teng

Second question, on R&D, it looks like cash R&D went up quite materially from Q4 versus Q3. Can you give a bit more color on what's driving that and what can we expect for 2016?

Martin Lundstedt

Was it cash flow or?

Jan Gurander

No, cash R&D.

Martin Lundstedt

Cash R&D. No, cash R&D, the cash R&D was actually -- when it comes to R&D, when we let 2014, you can say, the major part of the adjustments were actually done in R&D. So the fact that we year-over-year now, when we come into end of '15, should not become -- should not be worse, actually I'm a little bit disappointed, now that I can agree with but should be on the same level actually when we leave the year. So we have said that more or less on the -- when you talk about cash R&D, that we are on the levels that we would like to see going forward right now. [Multiple speakers]

Fei Teng

-- or for full year?

Martin Lundstedt

I was talking about full year then.

Jan Gurander

Yes, because quarter-on-quarter you will have also some….

Martin Lundstedt

It's usually a bit lower when you come to the summer time and so on and then it's usually a little bit higher at the end of the year. So that's fairly -- but if you take the whole year, it should be on a stable level for the Group as a whole.

Jan Gurander

And if it's at least slightly difficult to run a ship like this on a quarterly basis, I can tell that on an R&D level it's even tougher actually. But I think on the, I mean it's more about, I mean what is our target on the cap level for cash R&D going forward on a yearly basis that is important. And I think we are starting to see a level where we can be expected around what is it now, 5% or something.

Fei Teng

My final question on the subject of the new corporate structure and the increased accountability that you talked about. Can you just give some details on what basis management compensation will be structured for each of the divisional heads? Will it be determined by divisional targets for the truck overall or for the Group overall?

Jan Gurander

What we have said basically is that we will run that on a pretty pragmatic level. We will have business review meetings on a quarterly basis with the different -- we will roll that so we don't have all the brands at the same time and then we will actually have a policy when it comes to the I mean brands or business area specific areas. And then of course it's like running a normal business review on all different factors. And that is actually the input to the decision for us where it makes sense when it comes to different types of commonality or scale may that be production or a network development or competence development or things that -- but I think what we have said is that we are running the different operations on their own commercial profitability merits and then we're actually finding where do we need to meet when it comes to product portfolio or production or whatever it is.

Lena Olsson

All right, we have reached the end. So thank you so much, Jan and Martin, and thank you all for listening. And welcome back in April.

Jan Gurander

Thanks.

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