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Executives

Christer Johansson - Head, IR

Olof Persson - President & CEO

Anders Osberg - EVP, Finance & Business Support & CFO

Analysts

Nick [inaudible] –CNC

Fredric Stahl – UBS

Alex White – JP Morgan

Laura Lampkin – Morgan Stanley

[Inaudible] – Deutsche Bank

Peter Reilly - Deutsche Bank

Andres Book

AB Volvo (OTCPK:VOLVY) Q3 2012 Earnings Call October 24, 2012 8:30 AM ET

Operator

Ladies and gentlemen, welcome to the Volvo report on the first nine months, 2012. Today I'm pleased to present Olof Persson, CEO. (Operator Instructions)

Olof, please begin.

Olof Persson

Thank you very much and welcome all to this Volvo Group third quarter conference call. There is some presentations on the web and I will guide you through by telling the page number I am talking to. So please follow me to page number two. And I think that the heading of this slide pretty much summarized the three dimensions that we have seen in this quarter.

The slowing demand, the one of the under absorption, and as we have communicated earlier, we did see a one upcoming on the UD trucks and the restructuring of the UD trucks. And we also had warranty, an increase in the warranty provision. It totaled the one to a billion. The slide shows also that we are now running on a 318 billion, 12 months revenue. And if you do exclude the one in Q3, we have a 25 billion, 12 months rolling operating income.

Now please move to slide three where we as usual, I would come back to trucks and see E just a few words on the buses and our financial services. I think buses is continuing to struggle on a very, very difficult market around the globe. We do see a continuation of a combination of low demand and high capacity on the European market and in particular the city bus market. A lower than normal activity on the American market and Brazilian and South American market, particularly Brazil who is still suffering from the switch over between Euro III and Euro V on the bus side.

In Asia, we do see still a good level of buses. And as we have communicated, we have decided to end the European bus market our production to concentrate that into our facility in Poland. And that is a decision in principle. And our decisions with union are ongoing with that one.

When it comes to Penta, I would say that the volumes and the market situation is still very tough. You do have a market that is perhaps at the best bottoming out in the U.S. It's still very tough in Europe. And also on the industrial Indian side, we have seen tough market conditions around the globe during the quarter. But still I must say that posting our 8.5% profit in a business environment like this is something that shows that Penta is working very hard on its' cost control and flexibility.

Last time we're going to see (Arrow) coming in the quarter with a good result of 14.3%, 1.6 billion. And we of course wish them all the best in its future now with the end of GK and family.

A few words on the financial services, in general a good quarter, 11 billion new financing leading up to a 27% penetration, which is within the frame. I think it's healthy between the 25% and 30%. We do see that the [inaudible] and losses are low. The stability and the quality of our customer financing has proven healthy during the quarter. We are also now having a good profitability with 383 million in the quarter. And of course, now looking at the return on equity under 12 month rolling, almost 11%. And moving upwards towards EFS long term target between 12% and 15%.

Moving into page number four just quickly, I think the trends if you look on our regional distribution is basically the same as we have seen in the previous quarters where Western Europe is down with 12%. Eastern Europe is basically flat. North America up and then your South American Asia trailing downwards. Confirming the picture now, we can see that the upturn in North America is not offsetting the downturns in the other markets, which means that we do have a decline quarter-over-quarter with 6% in our revenues.

Also interesting to note that our split regional wise now is 52% in North America and Western Europe. And we do have still of course many major activities and operations. Asia is still around the 22%, South America, 10%. And also Eastern Europe around 7%.

I will come back with the more detail on truck and C. But before that, I would like to hand over to Anders who then will go through the cash flow and the balance sheet a little bit.

Anders Osberg

Very good, thank you.

Let me start a little bit about the cash flow then on the left hand chart on page number five. As you can see there, we are recording a negative cash flow for the quarter of a little bit more than 7 billion. And of course, the main reason for this is in the headline. It's the production cutbacks that are affecting our payables negatively. Even though quarter three is not seasonally a very good quarter, of course, this is the major impact that we see really from the payables here.

Then on the right hand chart, we see on the investment schedule that we have a quite ambitious one. And the split up as we see here is really from the bottom on the leasing side primarily then Volvo Rents. A very important distribution channel for us where we have invested in new fleets. And this is more or less coming to a peak now in this quarter. And now we have renewed fleet in this activity and this distribution channel.

Then of course on the tangible side, we have invested in primarily in growth markets like in Asia and Russia on our factories and the new tooling side. Whereas on the intangible side, we see an increased capitalization of R&D like on the Euro VI and the [inaudible] technique.

Flipping then to page number six on the capital efficiency side, you see on the left hand side our CCC days and the affecting elements there. And keeping a very close watch down on the inventory. Now our inventory is flat in absolute terms. But we are showing then a slight uptrend in relation to sales. And of course, this is something that we are addressing and that we really keep a very close eye on. And again on the CCC days, uptrend into 28 from a historical point of view is still a very good number. But there again, we have to keep a very close watch on this.

Finally then on the right hand graph, we see on our ROC, down from the peaking 28%. But still yielding a very good 23% on our investments.

Olof Persson

Okay, thank you, Anders. And then moving onto page seven. And I would like then to spend a little bit more time in discussing with you the trucks and then also the Volvo CE.

On page seven, you can see the trend lines in sales and the bridges. And basically what you can see here is of course the same region distribution as we had for the group in total with the ups and the downs in the different markets. And then looking at the operating income, then showing a 2.8 billion or 6.2 if you exclude the one of course. Basically trailing on a decent level in profitability in the underlying business.

But of course, the quarter three, and I would like you to follow me into page number eight. And there looking at the trends in Q3. And we can clearly see that we did have a declining demand in the different markets. And what happened during the quarter was actually that September, which is normally a growth month where we start to see the orders coming in in order for them to fill up the production for the order didn’t come in. I would say that this uncertainty that we have set in Europe spreading from the southern part of Europe via France and then also went into the rest of Europe. We also saw the uncertainty in North America coming through as well. And I would say that Russia, Eastern Europe, and Brazil, you could add those Russian Eastern Europe to this line as well. We saw a decline in demand and a lot of uncertainty. But in Brazil and Russia and Eastern Europe, we saw basically good signs. And in the case of Brazil, we have seen I would say confirmed good trends coming into the order intake.

This has led also that the inventory levels, which Anders also talked about, has been our absolute focus here. Because when you see those kind of development, our reaction is very much to keep a close eye on the inventories to make sure that we don’t go into this kind of uncertain situation with too high of a production rate. And we took a number of actions as you can see on the right hand side in the quarter three to proactively and conscious decisions to react quickly in order to making sure that we are adapting the production level.

And as always, it starts with our component manufacturing engines and transmissions. And we are taking that down in the quarter with 10% to 20%. We are also then followed up with low production rates for Volvo in Brazil, tough weeks in U.S. And then we also took the decision in quarter three to be implemented during quarter four with a further reduction in the rental trucks production systems by 20%. This kind of breaking that we have done means also that we have downed the absorption cost, the breaking cost in the system. And that amount in the quarter as under-absorption cost of 600 million.

Now looking into Q4, we have of course a number of actions and also focuses that we have. First of all, I would like to stress that we do have further readiness to adjust production if needed and if the order intake does not support the production levels that we have. We also say that we will be I will say more active in our market activities in order to find and be really of course on a selective basis. See if we can get markets, get business into our production system by being slightly more aggressive in certain markets and certain segments around the globe. And focus will very much be for the fourth quarter to insure that we are adapting our production capacity together with adjusting our inventory levels in order to be really fit for fight going into our assumed market that are then forecasting for 2013. So that will be very much in focus going forward.

Moving then into page number nine, we are looking at the order intake and the numbers are there for you to review. You can – I think I would like to highlight that we are having the same book-to-bill as in Q2, 90%. That you can see also the South American, that is particularly Brazil, now have a book-to-bill of 116%. And you also see that we do have an increase there of 19%.

You could also note for instance that Mack, which we discussed in the second quarter had a high negative number because of the high order intake in Q1. Now it's coming back with a sequential better order intake to 41%. And then moving then to the book-to-bill rate, substantially higher than we saw in the second quarter. However of course, the book-to-bill rate if you look at the right hand side is something that we follow extremely careful. And I think that the trend you see on the right hand side of the chart shows now how fast we are and how fast we have become in order to really adjust our orders, sorry, our deliveries with the order intake that we are getting.

One important part in relation to this slide is of course our market shares. How are we doing on the markets? And if we take on the European markets, we are continuing to have a historically high market share level. We have dropped a little bit if you look at the rolling 12. On the other hand, in U.S. on a 12-month moving, we have increased our market share. And the same goes in Brazil where we also had somewhat increased our market shares. So we are keeping our market position on the important market that we're talking about. And that is also very much important to me.

If we then would sort of look at the first small indications of October, I would like to say that if we look at Europe, we see a cautious stabilization in the order intake. But that it is very early, but it is a cautious stabilization. If we look at U.S., we start to see a small signs of improvements. And I would say in Brazil, we definitely see clear signs of improvements in terms of the order intakes. So that is basically the reading we can do from the first call it three weeks in October.

If we then move to page number ten and look at first our 2012 forecast, it's unchanged throughout all the different regions. We do 230 to 5090 and 30,000 in Europe, North America, Brazil, and Japan respectively. And basically this is where we believe the market giving them the regulation pace we see and the activity levels that we do see.

And then if you look at the 2013 forecast, we basically say that we do see a sideways movement into 2013. And let me go through on the North American both in 2012 and also the forecast. We are continuing to see in North America a reasonable to good level on the dealer's side in terms of activity level. We do see the freight volumes keeping up. The spare parts volume are keeping up. The profitability of our end customer is holding. But there is an uncertainty, both in terms of the presidential election coming up, but also the party discussions that are ongoing in the U.S. at this point and time.

In Europe, we do see a sideways movement. And it is very much driven by the major economic uncertainties that we definitely do have. Whereas we see in Brazil a slight uptake going from 90 to 95 on the back of this [inaudible] financing and other stimulus activities that we have seen coming here at the back end of this year. And Japan, we don't believe is moving sideways.

If you'll now follow me into page number 11, talking about CE. And here again, I would like to stress that what we see here is very much a scenario where CE as we also pointed out in the Q2 report where we have a market situation where the markets have slowing down. And weaken in a number of areas. If you look at the side spreads, you can see that we are following basically the same trend as we have done previously over the years with the exception I would say with Asia at minus 25%. We have been able to thanks to our strong position in China holding up and holding against the market drop there throughout the year.

Now we have two impacts I would say. One is of course China continues to be on the low side. And then also the drop in mining in Southeast Asia, which is of course also an important part or a part of our business, which then is in that region.

Due to the fact that we have put on the brakes very hard in order to make sure we get the pipelines right, and when I talk inventory, it's the complete pipeline. Not only our own inventory and production [inaudible] but also the whole way out to our dealers to make sure that we are having a balanced pipeline going into 2013.

And if you go on to page number 12, we expand a little bit more of that when we look at the trends in Q3. And as I said before, we do have a weakening construction market. And actually a rapid flow down in mining. Now if you look at mining and the importance of mining and as you know, we are in the so-called light mining segment and not into heavy mining. Approximately 14% of what we see is units or in mining. We believe and we see that the industry as such as quite high inventory levels. That in combination with a lower demand means of course that we do have a price pressure. We have seen that price pressure coming throughout in the different markets. And we do also then see that we have an order book reduction.

I think that if you look at the actions implemented in Q3, we can see that we started to break quite early. And if you remember from page number 11, the decline of sales, it's 9%. But if you look at number of produced units quarter-over-quarter, it's actually 35% lower. And of course if you break that hard, which I absolutely think is the right thing to do looking at the pipeline and looking at the inventory situation, I think that we also see that now by doing this for five consecutive months also that we do a positive cash flow for the first nine months in Volvo C despite the lower. And again, it's a conscious decision of stepping on the brakes. It is something that we do in order to prepare ourselves for next year and making sure that we come into 2013 in a good shape.

But also here if you look at actions in Q4 and going forward, we of course are looking very much on having the readiness to adjust production if needed. And again here in construction equipment, we will have selected market activities in order to make sure that if we have good opportunities, we think it is strategically right to do so. Then of course we can also support a production system by going after some business.

So we have been looking at this construction in what I would call a second way. We had a first wave in CE when we sort of reshaped operation and started to focus and grow it in China and elsewhere. Now CE is in the second three-year period in terms of strategy. We're looking at right sizing and looking at all kinds of costs in order to become more efficient.

When we look at the markets, also here we have a – if you take the midpoints in our study for 2013, we are basically looking at the flat movement in China. Basically minus five to plus five. In Asia excluding China, a little bit on the negative side, midpoint or minus five. I would call that due to the mining. In North America, a midpoint zero. Europe, midpoint somewhere south of 10% due to the lowering in the market we have seen. This year in South America basically, midpoint zero.

We did do some updates for the 2012 forecast. We had before in Europe, plus or minus zero. Now we say zero to minus ten. And in China, the slowing down has continued. And we now look at minus 15 to 25, we're looking at minus 25 to minus 35. And then it will go into more of a flat market next year.

If we then look at page number 14, our second to last slide summary, slow truck orders in September. September is normally a very important month to build up for the autumn production. It didn’t happen. We took the actions. Flat inventories in Q3 in absolute terms in relation to sales, we saw an upward trend in inventories. Very much in focus going forward. We will have an impact production of the September fallback also in Q4. We will have under absorption also in Q4 due to the braking that we have done. But we truly believe that those are the right decisions to make. We are not gambling on uncertainty. We are reacting on this thing as we are getting. We are now positioning our self for the remaining of the year to have the right pipeline, to have the right production capacity, and have the right cost structure in order to attack the markets that we do see coming in 2013. And as I just said, we have the markets basically moving sideways. That is our forecast and our best estimate at this point and time.

Finally, I just want to give you an update also on activities we're doing on the strategy. And this will be a recurring slide coming back in each and every quarter as I promised at the capital market stay. We have this time to report on the launch of the new FH, which is of course known. But also then the two right side thing and changes that we're doing in our size of marketing organization.

The right side [inaudible] are the UD trucks. And then UD marketing organization for trucks in Europe, Middle East, and Africa. The UD trucks right sizing activity, it's completed in so much show that we know that it's now 950 employees including temporary. That will leave us by January 1st of 2013. And that is actually 10% of the total workforce in Japan that we are now right sizing.

When it comes to the [inaudible] marketing organization for trucks in Europe, Middle East, and Africa, we have given you a guidance for a restructuring cost of 900 million. That will come starting in Q4. We are in the midst of negotiations and discussions. So I would not comment more upon it today. But we will of course come back to the market when we have more to tell about this. But we thought it would be good for you to have that as a guidance that we do see restructuring costs coming also on this one.

So I would like to just stress that the activities that we are doing in the third quarter and the way we adopt our production capacity in order to position our self-going into next year has no impact on the speed, the ability, and the determination in order to go on and execute on the 2020 targets that we presented at the capital market stay.

And just as a final note, I can also tell you that we are going in now to start our frames discussions when it comes to ISIT costs, when it comes to R&D, when it comes to segment marketing activities for 2013 in order to align ourselves to meet the 2015 targets long-term. So that process is set up and will be up and running.

And by that, I would like to conclude my presentation. And leave the floor open or the telephone line open

Question-and-Answer Session

Operator

(Operator instructions). The first question comes from Mr. Nick [inaudible] –CNC, please go ahead sir.

Nick [inaudible] –CNC

Hi. It’s really nice if production you have [inaudible]Milan to the United States. You said you have reduced the component production for engines and transmissions. Will that affect Milan production and will be imported from Sweden, or will be keeping the same production [inaudible] in Milan?

Olof Persson – President & CEO

We will – our distribution channels – not the distribution channels - the way we support our production system in terms of [inaudible] and transmission, that is set, we will not change that. So the volumes that is coming in, going into the American market will be produced in Hagerstown as before. Then of course that volume will be reflecting the volume that we see on the American Market. But the way we support and supply our internal system will not change.

Nick [inaudible] –CNC

Thank you.

Operator

Our next question comes from Mr. Fredric Stahl – UBS, please go ahead sir.

Fredric Stahl – UBS

Hi, good afternoon it’s Fredric here from UBS. Three questions please.

First of all, what do you estimate the payback will be on the $900 million SEK restructuring you’re taking in Q4?

The second question would be on – well if you could explain – it was awhile since we had this kind of destocking you are going through now, so if you could explain the moving parts behind – the mechanics behind the relatively small reduction in book value of inventory versus the destocking you’ve done and the hit to P&L you got. If you could just give some collar on that, that would be great.

And then finally on the bus business, I guess this is more or less a strategic question, but given that you are now going through a relatively large change across the group, isn’t it also time to review buses, the future buses within the group, is it really nice that you want to keep in the long run. Thanks.

Olof Persson – President & CEO

Okay I’ll take number one and number three, and then I think Christer can give a little bit of light on the second question.

Fredric, when it comes to the payback of the $900 million SEK I would like to come back to that once we have the discussions and negotiations that are ongoing right now, finalizing and that we can – and we will communicate. So I would like to come back to you on that one once we are finished with that, and being able to communicate more exactly.

When it comes to the bus, I’ve been very clear that I do see a large synergies in the buses on the engine side, on the [inaudible], on the electronic systems side, and also on the new technology side, just to mention hybrids for instance. Now, that doesn’t mean that we can have a bus business that is running on a sub average profitability, and we need to, and we have taken for instance the restructuring steps now in decision and principal regarding (Citybells) production in Europe, and we will continue to try to drive that profitability up.

Christer Johansson – Head, IR

Fredric, it’s Christer, can you repeat the second question you had?

Fredric Stahl – UBS

Yes, I just wanted to understand the book value of the inventory has only changed very little between the quarters here. But you have destocked and you’ve taken a big hit in the P&L as a result of that. I was just wondering what the – what’s behind this, how does the mechanics work here behind the numbers?

Christer Johansson – Head, IR

Well you can say the inventory, when we looked at increasing inventory we were referring it to in relation to sales, because it can – when sales is declining and you’re sitting on an inventory, it can very quickly become a problem. So, you are right in absolute terms the inventory was more or less flat, but [inaudible] in relation to sales. It’s increasing and that’s what’s concerning.

Fredric Stahl – UBS

I was more interested in how the under absorption, you know how the mechanics behind that calculation works, but we can take that after the call.

Christer Johansson – Head, IR

The under absorption is more related to the production. I mean, when we talk about the increasing inventories, we actually look at what you have outstanding and the deal at work as well. So you have – if for instance when we saw the pipeline inventory increasing in construction equipment, it was not only our inventory it was the whole deal network that started to become too much inventory, and then that’s what we’re looking at.

Fredric Stahl – UBS

Okay, well let’s follow – I’ll follow-up afterwards.

Christer Johansson – Head, IR

Okay.

Fredric Stahl – UBS

Thanks.

Olof Persson – President & CEO

Thank you.

Operator

Our next question comes from Mr. Alex White – JP Morgan, please go ahead sir.

Alex White – JP Morgan

Good afternoon everybody its Alex White at JP Morgan. I wonder, could you talk – I have three questions please.

Firstly, could you talk a little bit more about construction equipment within Asia? I was wondering if you could give us some sort of indication of the Q3 volume development in China relative to the rest of Asia?

Secondly on buses, can you give us an indication of what it will take to get back to a break-even level, and when you think this might be achievable?

And lastly, some idea around what we should expect from a cash flow perspective in Q4?

Thanks.

Olof Persson – President & CEO

Okay, when it comes to construction equipment in China, it is of course a – I think we have a 25% decrease in Asia, and a big part of that is of course in China following the market. And what we have seen before, as I said, in the quarters up to this one, we have been able to hold that up rather well with our market share. I would like to add to that, that despite this, it is a very important market still even with this drop, and it’s also good to see that we continue to be number one in China with STLG and the Volvo brand together. So we are holding our fortress – not fortress, we are holding our position in China on that one.

When it comes to buses, there are, and we are looking at a lot of different activities in order to increase the bus profitability, but I think also at the end of the day there has to be a jive between what we are doing in terms of getting profitability and markets as well there. But definitely there are a lot of things that we can do ourselves, and that we are addressing, and we are in discussions with that, so.

And when it comes to the cash flow, Anders perhaps I can leave that question to you?

Anders Osberg – EVP, Finance & Business Support & CFO

Yes, on Q4 of course it’s very hard to give an estimate or a forecast here. It’s a matter of really the inventory reduction that we’re working quite heavily on of course. And we are expecting, and we are forcing ourselves to really reduce the inventory, and make an impact on the cash flow for Q4. Also we have other things like payment patterns for company like STLG that we are quite dependent on of course. And then the major question of course is the development on payables in a scenario where there are pull brakes and so on in the production system. And of course that is the major thing that we need to watch very closely. So, in essence it’s very hard to give a fair estimate, you know. Seasonally Q4 is a good, the best quarter for us, and so it was the last of the year before that. And of course our aim and our focus here will be to produce a very good cash flow for Q4.

Alex White – JP Morgan

Could the dividend be at risk?

Olof Persson – President & CEO

The dividend is not for us, that is for the board to decide.

Operator

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

Laura Lampkin – Morgan Stanley

Hello?

Olof Persson – President & CEO

Yes, hello.

Laura Lampkin – Morgan Stanley

Okay, fine. This is Laura from Morgan Stanley, sorry. I actually just have two questions left – the first one is on your production cuts, just coming back to this – I mean, based on the market outlook that you have given us, both for the end of this year and also into 2013 – I mean, can you confirm that it is the right way to look at it and to say, unless you see a further [inaudible] in markets, we won’t see any further affects from that, say cost under absorption of post Q4. Is there anything else to come that we will see in Q1 2013? And then the question – the second question is regarding the outlook of the [inaudible] – I mean, you’re expecting truck and construction markets to remain largely flat next year, but then on the other hand you’ve made some kind of positive comments in, that for example, that October was shaping up a little bit better than expected, but I’m just really trying to reconcile the two statements - I mean, would it be fair to say that your 2013 guidance mainly reflects the lack of visibility that you have today, but maybe there isn’t, you know, some scope that markets that could actually develop a little better, is that the right way to look at it? Thank you.

Olof Persson – President & CEO

Thank you, well, when it comes to the end of production cuts, and the aligning, both in terms of production and the pipeline inventory. We, of course, in doing that in order to get into shape, based on the forecast and the market estimation and stuff that we’re doing, so, we’re trying to keep consistent [inaudible] the one hand we see in market and with due forecast of market of this size, and therefore, we are shaping ourselves into that market development. And by doing so, we also then, of course, are looking at in the 2013 where we should be balanced. Now, you can have, and we do [inaudible] in the forecast as well, for instance in the U.S., even though we’re talking about the flat market, we’ve said that we don’t start to do that to have there in terms of the presidential election, and a devoted discussion that we are forecasting at a slower Q1 – and those kind of affects you can have, Laura, in this – but as a whole, and as the market of course, that is our aim then to make sure that we are in line and that we are balanced if you look at it for a full year.

When it comes to the forecast, we have tried to mid-point ourselves, thinking that all this kind of different input that we are getting with pluses and minuses, risks and opportunities, and tried to put ourselves in a situation where we mid-point ourselves into the forecast, or putting forward here, and that’s exactly what we have done. For instance, in Europe, we have now [inaudible], not on a micro-economic level, but you also have the Euro Five, the Euro Six, and so then how would that play out during the year next year – it’s very difficult to say. So, of course it’s a combination of the visibility, as usual, but then on the other hand, we are also then utilizing all that data crunching that we are normally doing in order to put that forecast together, and this is the best information that we can do. And then, of course, you have opportunities and risks too, so that’s a little bit that we do. I don’t know if you want to add anything, Christer?

Christer Johansson

No.

Laura Lampkin – Morgan Stanley

Okay, fine, thank you very much.

Olof Persson – President & CEO

Thank you.

Operator

Our next question comes from Mr. [Inaudible] from Deutsche Bank, please go ahead, sir.

[Inaudible] – Deutsche Bank

Yes, thank you. A question on the [inaudible] reserves that you talked about previous and you mentioned in your reports. The adjustment that you make, is that reflecting a certain specific issue that you have had, or are you also hiring the warranty per vehicle going forward? And the second question is a little bit of the selected market activities that you are mentioning, if you could give some further color on that it would be appreciated in what you’re really intended to do. Thanks.

Olof Persson – President & CEO

Okay, when it comes to the [inaudible] prevision and the increase, we are talking about the legacy [inaudible] data, that is what we are having, and what we see – when we take the – I think, Chris, I’m looking at you, but I’ve heard under 8 billion, we want them to see it with an 8 billion cycle warranty reserve. And we don’t look at the activities, but we do have on the first half of the year, and the first nine months of activity, and we do see now that we – in order to fulfill our warranty commitments and other things that we have, that we have under other provisions, and I guess that is what we need to add that to it, and that is the one of time that we are doing there. So, and then on the…

[Inaudible] – Deutsche Bank

So, you’re not changing the amount of reserve per vehicle going forward, or is this adjustments for activities in the past only?

Olof Persson – President & CEO

This is more the legacy issue that is related to quality issues that we had some time ago, and then that we are adjusting for for now. So, it should not impact going forward as the quality on the product coming off of the lines today are at the right level.

[Inaudible] – Deutsche Bank

That is very clear. Thank you, and then second one?

Olof Persson – President & CEO

Yes, when it comes down to issues – I mean, when we say, selective marketing activities, that is when we see that we have from a [inaudible] point of view, or that we have a tactic point of view that we can actually by being more aggressive than what we were being before, and I’m not only talking [inaudible], there’s a lot to offer that is important to remember everything from financing to customer support agreements, and what have you, and then we have said that we would be more willing to do that, but I want to stress that we are, and I truly believe that this is the right strategy – very careful about the press and discipline, because it’s easy to get into the trap and do something now that would be difficult to recoup at the end, but on the other hand, I also think that there is always a way also to make sure that we protect market share, and by that, also getting individual units out which will then have a good basis for our fleets in a different markets. It’s not going to be a sort of a general thing, it’s going to be surgically, and it’s going to be tactical, it’s going to be strategically, and we are going to work on the whole pallet of offering that have to the customer.

[Inaudible] – Deutsche Bank

Thank you.

Operator

Our next question comes from Mr. Peter Reilly from Deutsche Bank, please go ahead, sir.

Peter Reilly – Deutsche Bank

Well, good afternoon, I’ve got two questions, please. Firstly, the thing that really struck me in your numbers today – [inaudible] sales down 15% and the margin is down two percentage points, [inaudible] sales down 8%, and that the margin half. Now, I know that you’ve had some issues on absorption, which is my next question, but could you talk a bit about the structural difference – I mean, is [inaudible] better managed, does it have [inaudible] more flexible core space, does it have a shorter inventory pipeline, because it’s quite a stark difference between the two businesses. And my second question is, can you explain in more detail by what you mean by under absorption – now you have this big number of a billion in the sack, is that because you’re running production currently bellow sales, or are you running production more slowly than it was a year ago, and also, I would like to know what’s the cost level like in the trucks in inventory, because I’m assuming that you have been running your production more slowly – the trucks that you ended up with under the course have got high unit course, and that we have a head wind in Q4 even if production make normal just because you’re delivering and invoicing high cost trucks that you’re majoring in the course of the quarter. So, if you could help us understand what that billion in the sack actually is that would be very helpful.

Olof Persson – President & CEO

Okay, let me – I mean, when it comes to [inaudible] and comparing that to see what attract, there are, of course, structural and [inaudible] differences that are different – I mean, if you look at the process of marine business, for instance, you haven’t had marine business down of for quite some time, we almost are talking a couple of years, or rather low in that also mean you haven’t had time impact to really adjust the cost structure, and the flexibility in the system on the marine side. When you look at the industrial engine side, that is basically engines coming out from our engine system, and it is a selling on of engines from our engine factories into OAMs, and others who are dealing them with versatile products or power generation, which is, of course, an easier to product, and also to manage the cost structure, and making sure that you get that out. So, there are definitely structure, but I wouldn’t take away the fact that I have done a very good job, in order to manage the down turn in a good way, but I wouldn’t compare them, it is a – if you look at VC, if you look at trucks, it is a much more complex business, and as I said, one of the key things is that I have been on a very sluggish market now for almost two years, and on the marine side in particular, where they have their own manufacturing, and have been able to done to too.

Anders Osberg - EVP, Finance & Business Support & CFO

Yes. Peter, it comes back to the standard cost system and how that is set up. When you’re producing, you have surcharges added to each and every product you produce and then it goes into inventory. Surcharges for fixed cost, whether it’s depreciation or other type of fixed costs that you have in manufacturing. When you produce less, you will add less of the surcharges and the cost will go into the inventory and surcharges and the variances will actually be impacting the P&L immediately in the month that you have a difference.

So if you upset the normal set of 100 and you’re producing 90, you will get the variance of 10 in the quarter that is inferred.

Peter Reilly - Deutsche Bank

I understand the theory. I’m interested in the practice. What does a billion mean? What are you comparing to because it’s a very big number and when given these numbers, it’s quite nice to know what they mean.

Anders Osberg - EVP, Finance & Business Support & CFO

You can say the actual cost you can say are the cost of the blue collars and white collars, et cetera that we have in the manufacturing operation and then in the standard cost systems, you add a certain portion of those costs to each and every product that is then produced into inventory and then later on sold. But in this quarter, we were producing very few units, so the variance has become – became very high and that, you get immediately into the P&L.

Peter Reilly - Deutsche Bank

Surely you don’t get it until they actually deliver the trucks, and I’m assuming you allocate your direct [inaudible] every month?

Anders Osberg - EVP, Finance & Business Support & CFO

No, you get the gross profit when you sell the truck. But the variance you get in the month you have it so to say.

Peter Reilly - Deutsche Bank

Okay, so the billion is compared to normalized product run rate, not necessarily what you’re selling or what you sold last year, but I mean, a normalized rate?

Anders Osberg - EVP, Finance & Business Support & CFO

Yes, [inaudible] you have a normalized production and let’s say the two [inaudible] we have a normalized production of the 25,000 trucks. And if we were to produce that number of trucks, the variance would be zero. But if we are under producing, we are – you say we get the variance or we have to adjust the standard cost down to 20,000 and then the unit will burden each and every unit produced with a higher surcharge.

Peter Reilly - Deutsche Bank

And can you just – my last question on this, can you tell us how production ran versus sales? What’s the percentage of sales you’re running in the third quarter?

Anders Osberg - EVP, Finance & Business Support & CFO

That number, I don’t have on top of my head right now, Peter because really what’s happening, we’ve started to break the component manufacturing, engines and gearboxes [inaudible] and then you have the lead time until you see the assembly operations breaking and so put those production – I don’t have it right here, Peter. We would have to look into that to understand more about where the number comes from as it comes down to more of the sensitivity.

Peter Reilly - Deutsche Bank

Okay, it’s been helpful .

Anders Osberg - EVP, Finance & Business Support & CFO

I think [inaudible], you get the negative variance in the month that it has incurred. You could say the alternative would be to continue to produce and put that cost into inventory if you want. But then you have an inventory problem.

Peter Reilly - Deutsche Bank

Thank you for your answer.

Operator

Our next question comes from Mr. Andres Book from [inaudible]. Please go ahead sir.

Andres Book – [Inaudible].

Thank you. This is my last thought for the day. I have one question. A lot of companies have reported weak September sales, but something big happened for you in September as well, you announced your FH and New Truck. When I talked to people in industry, they’re very excited about this new truck. Do you think that has had any impact in your sales perhaps, on your orders perhaps, customers decided to wait a few months to evaluate the new truck?

And secondly, I believe the order book is open for this new truck. How have the orders developed? Thank you.

Olof Persson - President & CEO

I think that in general you just said it. I fully agree with you, that the excitement in the industry is very high for this new truck. I think also that the excitement of the classic or, let’s put it, the icon FH that we’re now setting is also very high and we see a lot of interest in that. So I wouldn’t say that we see that and we know how to handle this kind of switchovers between products. We have done it before and we know how to handle it in terms of managing the customers and expectations, and their renewal that the customers need. So I would say that we haven’t seen any of that yet and when it comes to the perception and then also the situation for a new FH, I am not – I don’t think we are normally giving that kind of information at this point in time, but I can say that the interest and the perception has been very good in terms of interest risen by the new FH.

So the conclusion is, I don’t think the September numbers and what we see going forward here has been impacted by this new truck and when it comes to [inaudible], it’s great interest and a lot of positive comments but we do not comment upon the ordering take on it. We can say also that it’s really in the second half of next year that we will have the volumes ramping up. We are starting some more production in March and gradually ramping up. It’s really as we come into the second half of next year, so that’s why we would say – I would say that orders will start to come in more into next year for the new version.

Andres Book – [Inaudible].

Okay, thank you.

Operator

(Operator instructions).

Olof Persson - President & CEO

Okay, so there are no more questions and then I would just like to thank you for participating in this conference call. I wish you a good day.

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