Volvo's (VOLVY) CEO Martin Lundstedt on Q1 2016 Results - Earnings Call Transcript

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Volvo AB ADR B (OTCPK:VOLVY) Q1 2016 Earnings Conference Call April 22, 2016 3:00 AM ET

Executives

Kina Wileke – Head-Media Relations

Martin Lundstedt – President and Chief Executive Officer

Jan Gurander – Deputy Chief Executive Officer and Chief Financial Officer

Analysts

Erik Golrang – Nordea

Hampus Engellau – Handelsbanken

Bjorn Enarson – Danske

Anders Trapp – SEB

Agnieszka Viela – Carnegie

Olof Cederholm – ABG

Klas Bergelind – Citigroup

Alasdair Leslie – Societe Generale

Graham Phillips – Jefferies

Kina Wileke

Good morning, everyone, and welcome to this Press Conference Covering the First Quarter of 2016. Today on stage, we will have our President and CEO, Martin Lundstedt; and our Deputy CEO and CFO, Jan Gurander. We will start with presentations followed by the questions and answers from you in the audience, and since this is a webcasted event, we do appreciate if you use microphones.

So, enjoy. And Martin, please go ahead.

Martin Lundstedt

Thank you, Kina. So, ladies and gentlemen, good morning also from my side to this reporting and press conference for the quarter one reporting for the Volvo Group. Just a couple then of highlights to start with, the highlights released at the operating margin for the group, it was maintained despite, as a matter of fact, a lot of volatility in the markets. We were seeing North America coming down from high levels, and organization did a good job to adjusting capacity ahead of that good anticipation. And also that we continue to see both of Volvo Construction Equipment and the Volvo Trucks also continuous headwind in mainly emerging markets.

Profitability was maintained; thanks to the lower cost base that is continuing to kick off according to the plan and also that we have the good adaptation, as we said, of the volumes mainly done in North America. On the negative side, we also had extra costs related to quality campaigns. We also continued to launch new products and features. You saw that also a little bit ahead here on the films in a number of important segments, in the off road segments for the trucks as one example, new engines ahead of 2007 greenhouse emission levels in North America as well as a number of very important product launches also for the Volvo Construction Equipment sector at the Bauma fair.

And during the quarter, we have also, as we already announced, introduced a new brand-based organization with full profit and loss responsibility for the truck side. This implementation is well received in the organization and is now executed step by step with starting effect as on 1st of March. Volume development for trucks, volumes was down approximately 5% and then the major effect of that of course was a decline in North America whereas Europe continued to grow. Focus is to continue to be very close to the market demands in North America and in Latin America when it comes to the lower side as well as continue to follow the positive trend in Europe with adjustments upwards.

For the Volvo Construction Equipment side, the volume was pretty flat but differences between the brands. And mainly then the improvement in SDLG was related to the emission legislations that is coming into effect as from April 1 from Tier 2 to Tier 3 whereas for Volvo the volume drop was related to the slow markets. So this quarter also sales or services of spare parts all disclosed separately. This is also for the Group an important part, as you know, of our business. And in combination with our products they create tailor-made customer solutions, greatly contributing to the profitability of our customers through increased availability, improved reliability and lower costs to create a full solution so to speak. The service penetration is still an important business opportunity for the Volvo Group moving forward.

Sales or services of spare parts, excluding financial services, accounted of 23% of net sales for the Group. Service sales for trucks was almost flat when adjusted for currency, whereas buses and Penta showed good progress and Volvo Construction Equipment declined due to the lower shipped volumes in recent years as well as lower utilization rate of equipment in certain markets.

When we move into trucks then as a summary of the truck side, it has been different situations on the markets as you know between different continents, good demand in Europe, and the year has started well with regards to market shares, for example, for Volvo Trucks. There is a correction in the U.S. both for stock levels and for mainly the on-road segment when it comes to the activity levels. And we have launched news in the Volvo Truck product offering, and I will give you a number of examples here. One example is that we are focusing a lot on the construction segment. As you saw in the film here, we have a very robust offering with Volvo FMX, and we are introducing a number of new features to further improve the productivity.

One example is the new I-Shift, functions with crawler gears, that means that you have even better maneuverability traction that you can use in off-road segments, but also in important segments, such as heavy haulage, for example, where you can start from 325 tons. It’s fantastic. And that is hard engineering work and that means also actually that you can replace more of the automatic gearboxes with the captive gearboxes in some of the heavy segments. So, this is a very important step for us.

In addition to that, we are also, as I mentioned in the start, introducing new engines in North America for the 2017 greenhouse gas emission levels. We are introducing on – at the premium and a turbo compound, a 30-liter engine that will give for similar operations up to 6% of fuel savings and also for the mainstream 13 and 11 liter engines we are introducing new features also contributing to a fuel improvement of 2.5% approximately. So, this is a very important step.

In addition to this, we are also introducing features when it comes to the onboard connectivity. One example is IC where we actually are recording different roads for that specific application or truck and thereby continue to optimize fuels, acceleration, retardation, et cetera, and the interface between driver and the vehicle. So, those are some important steps that we have been taking during the quarter. Another one is that we have been participating in the European Union truck platooning challenge that was initiated by the Dutch Presidency. This is a very important part showing that we can do a lot of things already today when it comes to automated functionalities.

What you are doing in this type of platoon is really that you have a Wi-Fi connected road train, you can say, with three trucks, and that is giving fuel improvements up to 7%. And this is also showing that we can do a lot of things in order to continue to make a contribution to the CO2 improvements that is necessary for the transport sector.

This is also an important showcase that connectivity will be more and more used, both interaction between vehicles but also using that for off-board analysis. And the Volvo Group, as you know, is world-leading when it comes to the number of connected vehicles, but also the application of that connectivity. We have more than 500,000 connected vehicles, and construction equipment for the time being and that is, of course, growing rapidly now.

We will demonstrate also full autonomous driving in the mining sector in May. So, this part of the business is moving rapidly as we speak. Market environment, in North America, the market declined from very high levels down to a forecasted level for 2016 of approximately 250,000 units, and that is 10,000 less than we forecasted at our quarter four reporting. Main reason is, as I said before, the on-road segment slowing down as well as the continuous stock adjustments at dealers. We predict that stock adjustments shall be over during the summer and return to normal levels.

Other segments, such as construction, continue on levels from previous year and showing also that very signal economic activity level in North America. In Europe, the market continues to rise, and the new forecast for the full year is expected to be 290,000, we had 280,000 in the quarter four reporting. And as a result of – you can say stability as we feel in the European economy and that means that also our customers feel that they are bringing on the replacement need that we have been talking about for a while now for the big volumes that were shipped in 2006 to 2008 mainly.

We also see that, of course, the low oil price among other things are affecting – or in a positive way affecting also the profitability levels, even if a major part of that is transferred to the end customers or the transport buyers. In Latin America, it is Brazil that continues to be on a very low level, and even declining further. We are taking down forecast now from 35,000 to 30,000, and we will continue to adjust, and I’ll come back to that.

Maybe one important figure here is that Brazil in quarter one stood actually for 2.4% of the shipped volumes when it comes to trucks. So also putting it into relation where we are standing right now. So, here it is really about managing the downturn in a good way when it comes to the industrial system and also when it comes to the supplier network and our dealers and customers.

Asia, China is expected to flatten out on a level of 750,000 units. So, we have this downturn, and now we feel stabilization. I think what is important to say about China is that I was actually in China a couple of weeks ago and met with the Chinese leadership and you feel a very strong movement in the new five-year plan or more sustainable, innovative and solutions around the transport sector that is promising. Of course, that will mean short-term stabilization, so to speak, short-term paying for long-term gain. But when it comes to the direction, we are very positive about that development because that will require solutions that we can provide into the Chinese market.

This has also been the focus for our joint venture, Dongfeng Commercial Vehicles, to in a good way take down the volumes and adapt to these volume estimates that we have for the time being, and the job that has been proceeding well. India is continuing to grow based on the macroeconomic development as well as numerous initiatives of the Modi government also to make it more easy to do business and to drive logistics further on. We have a strong footprint, as you know, both for the Volvo brand in the high-end very small sector still, but also in the JV with Eicher Motors, Volvo Eicher Commercial Vehicles. There we have a very strong position in light and medium duty and there we are step by step increasing our presence also in the heavy-duty segment.

Japan continues on a good level and we forecast that will be stable in relation to last year. Of course the earthquake, the recent earthquakes, we have not seen the effect yet. Fortunately, I can report that our installations have not been damaged when it comes to the industrial footprint. We have had minor damages on the commercial network. And most important of all, we didn’t have any injuries on our colleagues in Japan, but the activity levels are still to be seen here.

When it comes to market shares, it has been in general a good development. If I start to comment in North America and start a little bit on the negative note, you see that we have had a pretty big drop in the Volvo truck market share. And the main reason for that of course is that we have been very much focusing on taking down stock levels. We have been conservative. We have an overrepresentation in the on-road segment that is increasing much more and clause 8 on-road segment that is decreasing more than other clause 8 segments as well as we had also quality campaign disturbances in March where we now have contained the majority of that also in the market, but that was a disturbance in March. For Mack, a positive development mainly related then to the strength of the vocational segment where Mack trucks have a strong position and in many segments are market leader also.

In Europe, the market share for Volvo trucks was stable at a good level of around 17.5%. The Renault trucks actually increased slightly and what is important to say here it’s not only that we have – starting to see positive effect of the market mix growing in South and Eastern Europe, but also that we are seeing that we are gaining market shares in core markets for Renault, such as Spain and France, and that we feel is also result that we have now introduced the full range of Renault trucks and it’s very well received also by our customers.

In Brazil, Volvo increased the market share to 20.2%. Even if it’s a small market, it shows that we have a strong position. And progress for all brands has also been seen in South Africa and Australia from already strong positions. In Japan, we lost market shares for UD and that was mainly related to the aftermath of the changeover that we’ve had in the product and production system, but now we have come back to a normal situation for our value chain in Japan and that will show effect. In India, Eicher has also continued to gain market share.

Orders and deliveries, orders were 12% on a global scale and deliveries with 5%. In North America, the main focus for us, as I said, has been to manage the downturn from the high levels of last year and get a good balance into the value chain between order stocks and deliveries. Organization has done a good job here and production output has been taken down considerably, approximately 30%, and that was the forecast also, as you remember, we said in the quarter four reporting.

Orders were down 54% compared to the same quarter last year and deliveries came down to 33% in total. So here again we are managing this very closely and the main priority is that we are actually not being too bold when it comes to the market development. Of course, we are ready if it’s necessary to adjust production when stock levels are adjusted, but here we have been pretty clear about what is the main priority.

On a very positive note, orders in Europe rose by 23% with a continued positive trend for Volvo Trucks. Many markets showed even stronger order intake, in particular in Southern and Eastern Europe. And production in Europe has been in several steps now been adjusted upwards both for Volvo and it will also count for Renault here and deliveries rose by 16%. In the light-duty segment also we had a certain pre-buy effect ahead of the Euro 6 introduction.

Orders in South America declined by 9% and that is a consequence of the political and economical turmoil. Here is really to manage now the low levels that we have not only for Volvo Group, but also for our supplier and dealer networks. But as a matter of fact, we are still continuing to have a result that is around 0 for Brazil in particular and we are having a positive result for Latin America. Now that I think is a very strong message from the Volvo Latin America organization. Well done there.

In Asia orders decreased by 15% with the same pattern for all brands, reflecting the softer demand in Southeast Asia to some extent but also in Middle East of course with the political turmoil there. If we then leave trucks and move into Construction Equipment in the quarter, we have continued to focus to reinforce Volvo Construction Equipment in key segments, key markets, where we have seen a good traction over the last quarters. And I think that improvement continued in a good pace despite harsh market conditions that also continued.

There is a continued uncertainty in emerging markets, even though China, thanks to pre-buy of Tier 2, showed a positive trend. But it is still too early to talk about a turn upwards again for China. On a positive note, there was market growth in Europe. We launched new important products at Bauma, very big interest on that, and also a number of new services for productivity gains as well as that we saw in the market – in the quarter also a continuous market share growth in large machines that has been one of the key areas for us.

Then at Bauma we introduced biggest articulated hauler ever, a masterpiece, out from [indiscernible] I mean that is really showing Swedish engineering as its best. And we got the first three orders actually from South Africa, even if the market is depressed, during Bauma. This will, of course, further enhance productivity for certain applications and it will also gradually move the area of rigid dump trucks but with much better traction capacity of course. So productivity and efficiency is the name of game for this fantastic machine here.

In conjunction also with Bauma also the biggest ever excavator for Volvo construction equipment, 95-tonner EC950E excavator. The biggest machine ever for Volvo. Productivity and efficiency gains of course for customers in the mining segments and reinforce the focus of the offering in our segments, so two very important news for us here.

Market development for Volvo construction equipment. Europe, as I said, showed a positive development of approximately 6%. And our current forecast now is that the growth will be between 0% and 10% here. In the previous forecast it was hovering around 0%, minus 5% to plus 5%.

In the US the market was pretty stable but a change in market mix mainly from the heavy machineries into compact equipment. And the forecast for the full year is maintained at minus 10% to 0%.

Continuous decline in a number of major markets, such as in Latin America and Middle East. And in China, after a slow start, the market gained momentum then for the coming changes in legislation and we saw that mainly of the Chinese brands, including our own SDLG there.

Forecast has moved from – up – to minus 15% to minus 5% instead of minus 20% to minus 10%. So I think that is what we'll see and continues to be, yes, harsh conditions and market headwinds so to speak.

The net order intake was 11% below for the first quarter with a decline for Volvo which was partially offset then by the increase of SDLG due to the pre-buy in China. And the year-over-year comparison is influenced by the unusually large order intake for Volvo also the last quarter ahead of the product exits that we did on Volvo-branded backhoe loaders, motor graders and milling machines. Excluding these product exit, order intake was down 4% below – all was down 4% in comparison to last year.

In Europe order intake was 5% below the same quarter last year, but excluding the impact of product exits it was 9% above. So I think this is important to understand, the effects of that. That has been a very clear focus that we are continuing to concentrate on profitable segments and segments where we can have a very strong leading position for Volvo construction equipment.

The main effect here – in Europe was higher sales in France, Germany and Scandinavia as well as market share gains also. That is important information as well.

Order intake in North America 7% below and in South America a similar pattern as for trucks basically. We have a very low economic activity, so here it's about really managing our value chain in a good way so we can be prepared for the upturn. But that will take a couple of quarters more at least.

So in Asia deliveries were 2% above the last year and, as I said before, mainly driven then by the pre-buy in China and related to SDLG.

Buses. It was a positive market development in North America, Europe, and recovery in Asia, India also moving well here, whereas Latin America gone down and continued to be sluggish. Bus deliveries increased with 28% mainly driven by North America and Asia in this quarter, but orders were up 13% where we saw the biggest impact from Europe.

Volvo buses received also the first fully commercial order – we have, as you know, already electric bus systems in Gothenburg operating and also in Stockholm, but we received a full order for 11 electric hybrid buses and two electric bus charging stations, so much more of a system thinking, to Namur in Belgium. And this is a very important breakthrough. The interest around this urban solution is big around and across Europe mainly for the time being.

But also I have to say in other markets we have discussions with a number of major cities also in, for example, Asia and Latin America.

Other major orders in the quarter were big orders to Egypt, 200 units. We had big orders also to Mexico and Ecuador.

And on Volvo Penta, the marine leisure market remains pretty stable and marine commercial continues on low levels, but positive signs in certain sub-segments, for example, wind farming vessels. Industrial power generation shows a positive annual growth rate. And that order intake was 11% lower than last year driven by the lower demand for marine leisure engines in North America. In the quarter deliveries showed a year-over-year increase of 1%. And also, and Jan will come back to it, we are very happy to see that the – also when it comes to the earnings we have a very positive trend here.

In February, Volvo Penta launched an upgraded glass cockpit system which is also very important. What is that really that is that we have the feeling of being the captain, of being the driver of the boat, of more a core like feeling where you have an integrated instrument cluster. We also launched the latest navigational technology from Garmin, Volvo Penta's electronic vessel control system, to provide a single interface for the driver. And this is of course one of the clear strategies and to continue to broaden that offer that we are integrating propulsion, efficiency, stabilization, maneuvering.

We also have bought 80% of Humphree that are providing then solutions for trim and stabilization systems. So that will further enhance the offering in that direction.

So with that, ladies and gentlemen, I will leave the word to dear friend and CFO and Deputy CEO Jan Gurander for the financial update. Thank you.

Jan Gurander

Thank you, Martin, and good morning to all of you. So for the CEO – CFO this Company fairly undramatic quarter I would say. Looking to the sales situation, I think the sales figures fairly much reflect or very much reflect what Martin has described, with the markets coming down in North America and South America compared to one year ago and of course the stronger markets that we see in Europe.

What we see here that we have a negative development on sales of approximately 4%. If we take away the currency effect, it's approximately negative of 2%. I think this is a theme that you will see all through the report, that the topline is influenced year over year by the currencies, basically you can see that the Swedish krona is getting stronger towards most of the currencies. So that comes through as a theme both in terms of equipment sales and also in terms of service sales as well.

So this one is actually, if we had not taken away, cut the bars at the end, we would actually have more or less a stable situation in business areas, very, very small fluctuations compared to one year ago. If we compare it, we were at SEK4.6 billion last year and this year SEK4.5 billion. And then of course we have taken out the effect of the divestment that we did last year and the effect of the IT divestment that we did in the first quarter this year. Furthermore, last year we had the restructuring charges and as you know, from this year we don't have any restructuring charges anymore.

Also here you can see that the currency effect has affected us during the quarter with approximately SEK400 million negatively compared to one year ago. And as we see the currencies today and, as you know, with the flows that we had last year and when we look upon the transaction exposure, we estimate for the time being that we will have a negative currency effect of somewhere between SEK2 billion and SEK2.5 billion for the whole year.

For the Volvo Group then what is affecting our results year over year? And we have, on the positive side, as you see, the cost programs continued to come through. We have, if we add together the selling and admin expenses, approximately SEK0.5 billion year-over-year, and this is exactly in line with the SEK10 billion program that we are finalizing during the course of this year.

We can also see that we have a positive effect from the R&D, mainly coming out of the capitalization and amortization. And furthermore of course the good markets that we see in Europe, with the gross margins that we get there, has affected the results on the positive side as well.

When we talk on the negative side, we had lower volumes as a whole in the Group and of course especially in North America. And unfortunately, we do also have the safety campaigns that Martin mentioned before and they are affecting the results. It comes through both in the gross income as a negative and also in partly actually the selling expenses as well when it comes to commercial goodwill.

Then of course, due to the fact that we take down America, we lose out the gross margins in North America. But what we have managed to do is that is to ramp down the production in a very efficient way and adjusted our cost base in a good way. And I can say that we are at a decent profitability in North America despite the cuts that we have seen there.

The cash flow is actually also affected of the fact that we are braking down, that we're standing on the brakes in production. I think we mentioned this in connection with the Q3 report that Q1 is seasonally a weak quarter. Last year we had an unusual good quarter in terms of cash flow and working capital and that was due to the fact that we actually ramped up production in North America. And when you ramp up production in North America, we got a very good situation on the working capital.

And as you know, when it comes to the working capital situation there, we have the payment terms to our suppliers. They are what they are. And then we have the receivables. We get paid basically the first day when we ship out through the floor planning and so on. So it's the best situation we have in terms of capital which is good when the market goes up or when we ramp up production, but it hits us at a negative when we ramp down. And that is the reason why we see that the trade payables is unusually weak in this quarter compared to a normal first quarter. So I think that's – otherwise when it comes to the investment and so on they are on the level that we want to see them.

The truck side, when it comes to sales, we have, as Martin showed, 5% negative on the delivery trucks and of course here you can see the magnitude of the drop of those, of delivery trucks. They are 33% down. And that is, as I said before, what affects us on the cash flow so much. Europe is up 16%.

Vehicle in terms of net sales when we then currency adjust is a negative of 5%. And we are stable on service sales for the year. And as a whole it's 7% down not currency adjusted and a couple of percent less negative if we currency adjust.

For trucks then it is a positive. Of course, as we said before, Europe on the positive side in terms of volumes and margins. And on the negative side we have the North America and the lower volumes there. We can see here that the lower S&A expenses that you saw on the first page is very much related, of course, to trucks and then the R&D capitalization as well. And the safety campaigns are related to the trucks operations. And the currency is SEK340 million.

I will say that despite the fact that we then had lower sales this quarter we are improving the margin from 7.3% to 7.8% for the quarter.

Construction equipment, delivered machines up 2%. And here we can see that on the Volvo side, the Volvo-branded side, it's a negative of approximately 6%. And then we have the pre-buy effect of SDLG in China in connection with the new emission legislations that kicked in on April 1. Then we have more or less 0% in terms of sales when it comes to the equipment and services are flat or slightly negative.

The result is more or less stable quarter over quarter despite the fact that we are losing out on sales. And we have then – you can say the programs that we are running to work with the costs is coming through actually supporting the result.

And then we have on the negative side it's a combination of the brand and product mix, very much related to the SDLG sales which, as you know, has lower margins compared to the Volvo machines. We do also within the GPE segment have a shift as well, a little bit from the real big machine quarter over quarter to slightly smaller machines as well. And that is what comes through in the product mix. And the currency is also here hitting us with approximately SEK50 million.

We have hit in the first quarter approximately SEK150 million on the China credit risk as well. We had incidentally the exact same figure in the first quarter last year. It was also SEK149 million and that's why it doesn't show up as a deviation quarter over quarter.

Buses, basically good development when it comes to sales both on the vehicles, on the buses and also on the service side. We here see that we have an unproportionate big hit from the currency, SEK140 million. And that is a situation that hits of course the results very much. Without that one, we would have seen a continued good development in the result and we are convinced that the trend will continue in a positive way going forward for the next coming quarters as well. It is this currency hit that affects the result in buses.

Penta, not much to say. Good development in terms of both the equipment sales or engine sales and also on the service side a strong development. And the result is actually improving from 13% in EBIT margin up to 15.6%.

Customer financing also stable, good development continuing to both grow. I think this is best quarter in terms of new financing ever that we – first quarter that we have ever had. And then we see the result going up from SEK474 million to SEK493 million. A very good development for the time being in terms of the quality in the credit portfolio in North America and Europe and despite the fact that the, you can say, Brazilian portfolio is of course – we are working without that one all the time but really no catastrophe and managed in a good way so far.

Yes, that was – time for you again, Martin.

Martin Lundstedt

Thank you, Jan. I think we can stand here and just a summary. We started on the same note. Stable operating margin and I think given the fact continuous uncertainty in many of the emerging markets, we are taking down so to speak the forecast for the North American market from high levels. Continuous good cost traction, good adjustment and flexibility measures taken in the Group.

Despite currency headwinds we are also actually working in the right way in different markets. And so when it comes to the operating margin and the development we see the underlying improvement in all business areas continue. Product introductions, as we said, are very important for us and continue to be on the core segments.

And just a couple of comments on the new organization also. As I said, we have good traction now in our organization. And just to remind ourselves why we are doing it, we have a good base to build on when it comes to our product assets and networks and brands, a clear accountability when it comes to all the different brands and business areas. They stand on their own commercial and profitability merits, being able to pursue the centralization, brand ownership, agility, and continues to work with improvements in all areas. And we see lots of potential of course when it comes to operational excellence, quality, delivery times and delivery precisions, but also the service potential ?the business potential that we have in the service business. So that is also on track in a good way.

So I think that is a summary of the quarter, and by that also we open up for Q and A.

Kina Wileke

Thank you very much, Martin and Jan. We have several. Who will start?

Question-and-Answer Session

Q - Erik Golrang

Thank you. Erik Golrang, Nordea. I have three questions. The first one, since you now separate the aftermarket business immediately raises the question, can you say something about the differences in profitability here? And perhaps also, to what extent that the aftermarket business shares cost in new equipment so that demand changes from the other could also impact profitability for the other, if that's a factor?

Then the second question on the new structure on the truck side with separate brand responsibilities, anything about the potential impact on cost, or what kind of efficiencies we can get out of that?

And then thirdly, given the working capital changes in Q1, any thoughts on the full-year impact from working capital, assuming that demand sits where we are today? Thank you.

Martin Lundstedt

Yes, I think it's very good question around services. First of all, of course this is a very important focus area for us, and the most important factor, of course, is the customers more and more require that we're coming with complete solutions and that they are tailor-made for different segments. But it's also saying both to the capital market and our owners and also to our organization that this is something that we want to follow, focus, talk about. And the more we talk about it and discuss it also internally in the Group and with our customers, we think it's fair also to have a discussion with the capital markets, so to speak. That I – then I was not really sure about the follow-up question on how we share costs, etc?

Erik Golrang

Yes, to what extent is profitability between the two, if you could separate it, dependent on what happens with the other? Of course, in the end, you need equipment volumes for aftermarket earnings. But in the short term, if you see a big volume drop in equipment, would that impact the aftermarket profit at all or?

Martin Lundstedt

No, the structure is the following, that we have very clear separation of the P&L impact for the two businesses. And the simple reason is that if you look at the value chain, albeit you have two completely different value chains of it. And then it comes together, of course, in the dealer sites, but from P&L perspective we can separate it out.

And then I just comment on the question on if the margins are higher or lower. They are higher. And then when it comes to the brand organization, as I said, the cost, I mean, here we have been of course very clear. We have created a strong cost – I mean a strong foundation with the efficiency program. This is very important that we're all maintaining. And therefore we have a good – together with the brand business leaders a good control over that transformation, of course.

The whole idea of this is even more focus on the value chain, better connections between the brands all the way through the industrial system, the service opportunity, but also the regional footprint that we can reinforce, because we have very strong regional footprints with end-to-end systems. So – but here we have a transformation that is following plan absolutely. And we will not get lost when it comes to our efficiency program.

And then I think it was capital – well, I leave it to you.

Jan Gurander

Well, yes, my favorite topic. The working capital basically, you have first of all, one – you can say one type, one effect when you stand on the brakes, so to say, that's what we're doing now in the first quarter. But then of course, depending on the production level, the higher the production level, the more you have as payables and the lower – so that you have to have a view on as well, actually.

So that is more or less just an automatic effect that you have, a mathematical effect that you have, not very much you can do about unless you change the payment terms, so to say.

Then when it comes to what we can work with, and now in the first quarter, you saw that we have an increase also in receivables, and also in the inventory. That is a little bit unusual thing in the first quarter when you come into the what you call the spring season, it's usually you ramp up a little bit your inventory for the second quarter. So that's a little bit of a seasonal thing. And that will usually come back in the second quarter.

Generally speaking also when it comes to managing, for example, the situation we have seen in North America, we are pleased to see that we took firm decisions, actually both at the end of the year and the beginning of the year, to take it down because there is always this discussion how much we do, what will happen, will we lose out, etc. But I think so far so good when it comes to managing this.

Erik Golrang

Thank you.

Hampus Engellau

Hampus Engellau, Handelsbanken. Three questions, starting off with North America, we note price competition in trucks is increasing. On top of that we also noticed a 10% drop in used truck prices. My question is have we seen this effect already in your P&L in first quarter? Or is it something we should expect in second and onwards? Second question is on the recall cost, if you could quantify that, for this 18,500 trucks.

Last question is on Europe. Scania gave a very bullish view on the southern parts. You're talking about more on market share. Could we discuss a little bit if there's a difference in footprint or how we should view that, please?

Martin Lundstedt

First, when it comes to North America, I think it's fair to say, exactly as you mentioned, Hampus, that we have seen price pressure. And that is pretty natural also when you're coming into a downturn, and in particular it goes about the delta of inventory you have from coming back to normal stocks. And here it tends to be that you're a little bit impatient, so to speak.

So on that part, of course, we have seen a certain price pressure and we are now realizing the stock levels, and thereby also having discussion together with our dealers how to do that, in a way. And that is also, of course, as you said, related to of course the pressure on the used truck side, 10% to 15%. But so far so good.

We are managing the flows in a good way, and that's the reason why we have been also pretty aggressive of really slowing down production. So we're not feeding an overstock with the same discussions that you have already with us, so to speak. So I think here so far so good, and we are continuing to follow this. For the time being, we are not planning any structural downturns more. If needed, we will manage that by stop days or stop weeks. The important thing is really to get the balance between stock output and production.

We will not comment on vehicle cost specifically. But of course, here it is about safety, containing customers, do what is necessary to do; the organization has done a fantastic job. We have had good communications with customers, dealers and authorities, and that is continuing to be followed. But of course, as you said, it was a reasonably big number of trucks concerned here.

And then when it comes to the market share, of course, it's the effect of both. And we see the same pattern, as you described, southern Europe, it is not straying from low levels. An improvement is percentage-wise to start with big, but all. So in absolute numbers, we see that. And I had confirmation also today on the SIA figures coming out, that of course you see a pronounced effect in southern Europe. And that we see as well. And also in Eastern Europe, as a matter of fact, Poland and some other of the markets. And then we have pretty strong levels already in Northern Europe.

So when it comes to our footprints, we are well spread, as you know, and we feel that we have a good momentum, both when it comes to market shares, not at least then for also that we are working actively with our core markets.

So I think – do you want to add something on that?

Jan Gurander

No, no.

Hampus Engellau

Can I just do one follow-up, specifically on Germany, both Scania and Volvo is taking market share massively from Daimler. Could you speculate a little bit about how that will play out? Will we see tougher pricing? Or will that keep pricing – or will it keep pricing from improving if the demand trend continues in Europe?

Martin Lundstedt

I think it's too short-sighted trends to have a specific view on that, basically. And in our particular case it is a market share gain, that's for sure. But it's not a big one. So here I think we should be a little bit patient to see what it takes. But also for us, of course, price management now in an upturning market is of course a very important part of the total scope. If something, I mean, we all need to also work with our price realization where you have an upgoing market, yes.

Bjorn Enarson

Bjorn Enarson, Danske. Two questions, one on UD trucks and the previous or ongoing restructuring, if you can shed some light on where you are versus your hope for that brand in terms of earnings development.

And secondly, where are you in the process when you're phasing out doing construction equipment, the products? How long should we expect that to continue, when you have the mix that you desire?

Martin Lundstedt

Yes, thank you, Bjorn. On the first note, of course, UD trucks, we are seeing improvements. We have done a number of measures that in the short run has caused some disturbances, as we have already reported, when it comes to linking a little bit more to the product and production item systems, the PDM, as we call it, systems for the Volvo Group.

The reason for that is really that we are better linked also when it comes to the modular system using in a smart way group components. At the same time, we are also separating operational activity a little bit more for UD trucks to make sure that it will stand on its own merits when it comes to what can that value chain afford to have, given the customer base, given the coverage of markets, etc. So we see a positive trend, but we are far from being satisfied where we should be. And that's the reason why we continue to do this.

We are also happy to see Joachim and his team now has full focus on this. And I think it's worthwhile noting also what Joachim Rosenberg and his team did also on the global truck sales when it comes to the cost base. The last 15 months has been – we see that coming through now, and the similar activity is also what we're working with now in UD.

Then when it comes to Volvo construction equipment, of course this is one of the key elements for us, to continue to see in a transparent way, where do we have not only short-term opportunities, but in the long run, what is our sweet spot for construction equipment. We have a number of segments, geographies where we have extremely strong positions, and make sure that in a good way we're not diluting that with activities that will not, so to speak, develop.

For the time being we are satisfied with what we have done when it comes to product exits. We are continuing to follow the streamlining all products, and make sure, as we do with trucks, that we can follow the product in the market earnings for every single product and markets, to make sure that we have no unnecessary drags. You can have it for the short term, but not in the long run. So that's the same principle.

Bjorn Enarson

Thank you.

Anders Trapp

Hi, Anders Trapp, SEB. I have three questions, two very simple, one-word answer only required, and one more complex, maybe. Did you say when do you think the US market or the inventories will be stabilized? Did you say summertime?

Martin Lundstedt

Yes, during summer, that is our – I mean, we said – it has to be transparent. Last reporting we said during quarter two. We all around may be a little bit stretched. So during summer is our estimate.

Anders Trapp

Coming back to cash flow, just to clarify, are you disappointed or not with the cash flow in the quarter? Or is it more like expected?

Martin Lundstedt

When you look upon the reason, it's fairly easy to understand why it is so but we are not happy with it, of course not. But that is understandable, so to say.

Anders Trapp

Finally, if you could come back to the market share in the US, when I look at the trend over the last years even maybe, on retail size market share US, you had a negative trend, more or less, and that was made even worse now recently in the last quarter, not only, so it's sales to end customer is down quite a lot. And some of your explanations, of course, were valid, but it's a big drop. Is it the campaign that really matters mostly here? Are you concerned about this trend, basically?

Martin Lundstedt

Of course, it's always a concern when you have a drop, and it looks very dramatic, of course, when it comes to the Volvo truck brand, as we said. I think it's possible to see that we have, so to speak, turned the curve for Mack here, mainly that segment mix related.

But of course, when we do the scrutiny around Volvo trucks, they are all three main effects, basically. The on-road dependence. We had a strong market last year, as you know, and a good trend to Volvo trucks, and we feel that also when it comes to the customer feedback as a matter of fact. So here we lost a little bit momentum. But we have the on road, and that is a pretty big part.

And we have also deliberately been less aggressive on some of the bigger fleets, to have a better mix when it comes to retail fleet customers and the right proportion, if I may say so. We also had a little bit of a seasonal effect, we shipped in pretty big volumes in quarter four last year. If you really look at the volumes for quarter four, and specifically then, as we see it more you cannot see it in December as a matter of fact. So that made a slow start.

And then we have the quality campaign, and that was a drag in March and the proof of the pudding of course of that will be in quarter two here.

But I'm most pleased with – that we did it in a very decisive way. It was no compromise whatsoever, and what matters here, that is customers' safety and contain the fleet, so to speak. But you should always be worried but you should do the right action, so to speak, but that is to be followed, and it's one quarter we are talking about so far.

Agnieszka Viela

Agnieszka Viela, Carnegie. I have three questions. The first one is on the North America. If you look at your profitability development, so far, do you think that Q1 might be the bottom for you, especially when it comes to the underutilization costs?

The second question is on Brazil, and the outlook for the trucks there. I wonder if you don't see whether the heavy trucks segment has begun to stabilize? And what do you think about the easier financing terms in Brazil right now for the truck industry? And lastly, just on your CapEx requirements for 2016?

Martin Lundstedt

I guess I'll do the first two, maybe, Jan, if you comment. When it comes to North America, as Jan commented, there I think we have shown a strength also. We have managed the downturn. Of course we have extra costs related to the downturn, two things that has been very important. Take it down sufficiently and firmly enough.

So in my perspective, at least when it comes to the downturn management, we have with our current estimates taking the majority of the heat now. But we will continue to adjust when necessary, and that we will do for the time being with the stop days or stop weeks if necessary. And that's really related to inventory, and we will be firm on that, not hoping before we have seen. That is a strong message.

When it comes to Brazil, yes, I think it's difficult to say. That's not stabilizing, and when it's like almost approaching zero. We are at 30,000, and here you have really a necessity of replacements coming in. It's tough to see it will become much lower. And for us as a brand, with 20% market share, of course, that will not affect so much more. We have done a lot of adjustments. We are continuing to overlook what we can, we can do.

But the most important is how do we actually maintain the full value chain in Brazil when it comes to the supply network, when it comes to the dealer network, and really to work with that is the main priority now. So when it comes to if it will be 20 or 25 or 33, that's not the big question now. And I think also the finances side we have – we are working close with our dealers. It's 7% of the – I don't think the financing is an issue. It's really down the line demand in the market, that will…

Jan Gurander

You can see agriculture is the only sector that is continuing to take a little bit more on. It's not normal, but more – close to normal volumes, if I may say so.

Martin Lundstedt

I won't have any hopes for improved economy if it helps or not actually, it's a much more structural problem.

Jan Gurander

We actually discussed it also, what is normal in Brazil?

Martin Lundstedt

It's an interesting question in itself. We were about to going back to normal, and then we said, we don't…

Jan Gurander

We were so close writing we are going back to normal. So what is that? If we get that question, what do you mean with normal? We say, okay, we are – well, we come back.

Martin Lundstedt

I think it's fair to say also that we have to continue to look through our cost base in Brazil as well, actually. We're – I'm pleased with what we have done so far actually, what we managed to take out the second shift that we did during last year actually came to an end the first quarter. But we need to continue to work through that.

Jan Gurander

And not to destroy long-term value, as we said, in the value chain, because this has been built up over a long period of time, given the fact that you have localization demands, etc. And if you have a number of bigger hits, for example, among suppliers, that will completely change your ability in an upturn, so this is maybe the most important part.

Martin Lundstedt

And then in terms of CapEx, we are now on the same levels, what is it, two years, or something like that, after the big product introduction that we did in 2013, and we have – the plans are to stay on this level as we are today.

Olof Cederholm

Hi, Olof Cederholm, ABG. Just a couple of questions. First on the cost development from here, obviously you've restructured for a couple of years and there are still things happening. Could you talk a bit about the sequential cost and efficiency improvement going forward throughout 2016?

And also, you've been talking about asset sales. There aren't maybe not that much left, but used trucks in the U.S., for example, is that something we should be seeing sold during this year? Thank you.

Martin Lundstedt

When it comes to the – I mean the SEK10 billion program, as I mentioned before, it's there. And as you can see actually in the figure it is delivering. Apart from that which we tend to forget from time to time, the SEK10 billion program was the structural cost reductions that we are doing. But apart from that, we are also working quite a lot actually with improving our logistic cost, the material cost and so on. And in some of these areas, we actually see quite an improvement as well that comes through and supports our gross margin as well. And that is kind of ticking in, we can say, month-by-month, quarter-by-quarter. So, and I think that is our what's kind of underlying supports the result that we see, despite that the volumes are coming down actually. But you will not see any kind of big jumps. This is the nitty-gritty work that gradually comes through in the gross margins.

And that really comes to the – yes, we have the assets held for sale. And, of course, when you have assets held for sale, you have the plan to sell it, and that is very difficult to speculate where – when it will happen if it will be this quarter, next quarter, this year or something like that. Of course, it does not become easier when you have kind of the correction that you have in North America for the time being and, as was mentioned before, lower used truck prices. So, we'll see when the timing is right actually. But it's difficult to speculate when it will happen.

Kina Wileke

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

Operator

Thank you. [Operator Instructions] We've got Klas Bergelind from Citigroup on the line with a question. Please go ahead. Your line is open.

Klas Bergelind

Yes, hi, Martin, hi, Jan. It's Klas from Citi. A couple of questions, please. Firstly on your production levels in North America, it appears as if March was a big month for you than I thought when I look at the industry data. Based on what you see at dealers, Martin, how do you think production will run in the quarter? Is the March level a good guide? Or was that just temporary? Do you need to count from that level going forward?

Martin Lundstedt

No, I should say that the concept that we have done for the time being now and that is in the magnitude of approximately 30% or one-third. That is where we are standing right now. We will continue to do, as we already said, adjustments according to how the stock levels are developing, actually. And here is the main priority, really, not to be too positive, but, really to manage the stock. So, I think what we are starting to see here is might be serving as some sort of guidance. But I – if I was you, I should also wait for a number of months to look over that as well because there are always a little bit of different effects when you have just seen a month there.

Klas Bergelind

Yes. And secondly, on people leaving in North America right now. Is the capacity reduction fully done by April? Or do you still have some staff that will leave in the second quarter?

Martin Lundstedt

What we have said is that it's more or less done as from – with the full effects during March. So, as from second quarter, it should have been done with a reduction of approximately 1,200 people in the U.S.

Klas Bergelind

This is interesting, right. So if we deliver a margin of 7.8% now and you typically have more volumes seasonally in the second quarter, the under-utilization is going away. Then the margin can improve quite a lot here in the second quarter.

Martin Lundstedt

Klas, I mean – I think – I mean, I think that's your job basically.

Klas Bergelind

Sorry. Then my next question is on emerging markets, when you look at China construction, South America trucks, and particularly on South America trucks. Are we seeing any margin improvement this quarter or are we still at this depressed level?

Martin Lundstedt

We are – I mean, if you put it this way, we have a slightly better situation the first quarter this year compared to what were the first quarter last year. But that is, of course, due to the fact that we took out, you can say, the effect of, as I said before, the second shift that we actually effectively took out January this year that hasn't improved, you can say, the result in Brazil this year.

Klas Bergelind

Okay. My absolute final question is on market shares, and thinking about Mack. Vocational is a strong segment in general, construction-led, the headwinds from oil and gas are going away. But this also means more price pressure, at least what we're hearing in the market, as everyone is chasing this segment. You're gaining share, market share here. Is this the relaunch of the Mack brand that you did in 2014 or is this coming from that you're a little bit more aggressive on price?

Martin Lundstedt

I think on that note, of course the main factor is that customers are – to start with, not too opportunistic when it comes to specialized segments. And Mack has a very strong position in those segments. So, I mean that's the main effect. When those segments are moving, we get, so to speak, a positive segment mix effect for Mack.

The main effect on pricing what we have seen in North America as I said has been how we have realized the excess inventory basically, but otherwise, we feel that we have a strong position. The products are well perceived in the markets. We are continuing now to launch product news into the Mack brand, the new engines that we are moving in now for the greenhouse gas emissions to new crawler gears are also coming into the Mack brand. So, here is a lot of good news for the construction customers.

Klas Bergelind

Thank you.

Operator

Thank you. Our next question comes from the line of Alasdair Leslie from Societe Generale. Please go ahead, sir. Your line is open.

Alasdair Leslie

Hi, good morning. A few questions, please. Firstly on Renault, it's good to hear obviously that you're taking share with the new lineup. But I understand the key focus was to realize the pricing and margins. So are you starting to see that come through as well? Can you give a sense of maybe how the margins look now relative to 12 months or even 24 months ago?

The second question is just trying to gauge the scope for pricing to still firm up in Europe. So how do you maybe compare pricing quality today in a market such as the UK, that's already seen a strong recovery in volumes, with those that are still weaker and starting to recover?

And then the final question is really on telematics. I think within your telematics business you've got – that includes a wireless car which services the automotive OEMs, and I believe that's now being carved out of Volvo IT which you obviously sold. Can you give us a sense of how maybe the size of that business in terms of sales growth rates and maybe how integrated that is with the truck business? Thanks.

Martin Lundstedt

Yes. We'll start with – thank you, Alasdair. I'm going to start with the first question on the Renault Trucks. It's true as you say, we actually have got the trucks into the market for quite a while now and the customer feedback is good. And that is also what we see actually when it comes to the core markets such as Spain or France, for example, but also Poland, we also see progress. It has been and should continue, of course, to be a strong market for a foreigner.

When it comes to price realization, in general, I think that we have a job to do also in the organization now, given the upturn, as I said to manage prices in – I mean, for both brands basically. And what is the key factor for us when it comes to Renault is now when the products has been in the market for a while also to manage the residuals and really get the message through what a good upturn and productivity we have with these new products in the Renault brand here. So, we're working hard on that. And that is also one of the parts with the new brand organization that we have a fully dedicated team under the leadership of Bruno Blin to handle that.

When it comes to telematics, of course, we are actually now working with and overlooking how we'll continue with the strength that we have in telematics. As we mentioned, we have 500,000 connected units for the Volvo Group, but also as mentioned here, we have a pretty big number for cars in wireless car operation, but that is considerably small when it comes to turnover, et cetera. But both operations are important to understand what is the value that you can bring into the different segments and customers, et cetera. So, that is where we stand for the time being, so to speak.

Jan Gurander

I think the wireless car is I think a fantastic example of how strong we are in telematics, actually. Because here, we're actually using our competence and knowledge that we have on the trucks side and providing services to premium automotive makers and that's not only our kind of Swedish premium automotive maker, but it's also German ones and so on. So it really shows us on how strong we are in the segment actually.

Martin Lundstedt

But I think, as a matter of fact, one of the themes of also having increased focus on services is by leveraging also the platform that we have on connected vehicles.

Alasdair Leslie

That's great, thanks. Thanks, great detail. Just I think one outstanding question is we just – will you see still marked differences in the pricing environment between some of the stronger European markets and some of the weaker ones, just how much of a catch-up there still might be to come?

Martin Lundstedt

Can we take it just I didn't follow the – sorry, Alasdair, can we ask you to take it a little bit slower or…

Alasdair Leslie

Yes, sure. I was just trying to gauge just the scope of the pricing to still improve generally across Europe, across the different markets, because clearly some have been stronger over the past couple of years, and others are just starting to see recovery in the Southern European markets. So really it was a question around pricing quality, I suppose, and the potential for pricing to firm up and just trying to gauge the difference between, say, markets such as UK and, say, France?

Martin Lundstedt

Yes. We are not in particularly disclosing different price points between different markets, but we can say that the pattern of prices – prices and conditions between different markets has not changed dramatically. So, that is pretty stable actually. But the more important thing, of course, with the recovering market is that one of the key is for us is to be able to drive and to monitor the price realization of course.

Alasdair Leslie

Great. Thanks. Thanks very much.

Operator

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

Graham Phillips

Hey. Good morning, thanks for taking my question. Just a couple on service. The 23% sales and the flat development in trucks, can you talk a little bit about that and why that's not growing? Because I think the previous comments that were made on previous conference calls about that segment was it was benefiting particularly in the US about increased own engines and own gearboxes?

Martin Lundstedt

Yes. And I think it's a fair comment. And of course, I mean this improvement has gradually been taking place as you know in recent years mainly on the full transmissions, et cetera. And in U.S., you have a particular situation, of course, that you have a prolonged volatility situation for powertrains. So, this will gradually come into play when it comes to the captive powertrain situation in U.S. but definitely we will see an effect out of that. But I think this is as a matter of fact also a strong synergy.

We see that we have a business potential when it comes to parts and services in the group given the strong platform that we have and we will drive that focus even harder. I think with the recent developments the pretty low shift in volumes in Europe, et cetera. It's not strange that we don't see a strong growth, but, of course there are rooms for improvements here.

Graham Phillips

And do you think – I think Scania gets close to over 30%. Is there any reason that should be structurally higher than Volvo trucks?

Martin Lundstedt

Sorry. Once more, I didn't – Scania?

Graham Phillips

Scania I think in service and contribution to sales is above 30%. Is there no – any reason why that can't be an aim or a direction of where Volvo can go?

Martin Lundstedt

I mean, we see that we are starting – if I was you I should shake that figure of 30%, but without saying more comments on that. But 23% of course is where we are now, and what we are saying is that we see that there is business potential for us when it comes, I mean the service revenue relation to full top line. But – and that we will continue to drive. And not only for us, but also for our customers, we see when we have a contract penetration, financial contracts, we have a higher retention also. So, it's bringing value for our customers and we will continue to drive that.

Graham Phillips

Okay. Just two quick financial questions. On the R&D capitalization, was there also an increase in amortization? Or was it – was that the net figure, when you're talking about that capitalization benefit?

Jan Gurander

It's the net.

Graham Phillips

It's – sorry, it's the net?

Jan Gurander

Yes.

Graham Phillips

Okay. And finally, just on the cash flow, I think you still haven't paid the EU truck fine, the credit provisions being made for China, and I think there's some restructuring expenses. Is that still correct to come out of the cash flow at some point?

Jan Gurander

When it comes to the European Commission, first of all, we don't know the outcome. We have put the provision in 2014 of €400 million, obviously then not a cash effect. When it comes to the China credit losses in total, approximately €1.7 billion on provisions in the balance sheet, very little of that is utilized. So, from that point of view also so far a very limited cash flow effect.

Graham Phillips

And in restructuring, [indiscernible].

Jan Gurander

And restructuring – no, restructuring is closed as of 2015. We will not have any further restructuring charges going forward.

Graham Phillips

Okay. Thank you.

Kina Wileke

All right. That's a wrap up. Thank you so much for coming today. And we look forward to see you all again in July. Thank you.

Martin Lundstedt

Thank you.

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