Good day, and welcome to the second quarter report, 2016 conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Patrik Stenberg. Please go ahead, sir.
Thank you. Good morning, and welcome to this conference call on the second quarter results. The conference call will take about one hour. Present today, our President and CEO, Alrik Danielson, our Senior Vice President and CFO, Christian Johansson, Theo Kjellberg, Press and Media Relations Director, and myself, Patrik Stenberg. As usual, we'll start by presenting the results, and after that, we'll continue with the Q&A session. With that, I will leave the word to Alrik, please.
Thank you. Ladies and gentlemen, good morning, and thank you for listening in today. With that said, I will now move to slide number 3. Today, we released our report for the second quarter, 2016. Demand for industrial customers in Europe is stabilizing, while demand in China and North America continued to be challenging. Demand from our automotive customers were good in Europe and in Asia, but continued on a low level in North America. All in all, organic sales development was in line with our expectations, 4% higher than previous quarter and 4% lower year-over-year. I'll talk a little bit more about regional performance when I get to that slide. Although markets remain challenging, our cost reduction initiatives, including the profit improvement program within automotive, are materializing according to plan. This contributed to an 11% operating margin, excluding one-time items.
All in all, we generated an operating profit for the group of SEK 2 billion in the second quarter. Cash flow generation, excluding divestments and acquisitions, was a solid SEK 1.2 billion, around SEK 500 million, higher than last year. This continued resilient performance is a sign that we're on the right track in our effort to shape SKF into being leaner, more customer-focused, and competitive. Turning to the next slide, and our sales development per region compared to last year. In Europe, demand started to grow again, with an increase in organic sales of almost 2%. Industrial activity continued to be low in North America and Asia, where we saw organic sales declines of about 13% and 6%, respectively. Sales in Middle East and Africa grew by about 2% in the quarter.
If we move to the next slide and the development by customer industry. Sales to both cars, trucks, and the aerospace industry performed well in Europe, while sales to industrial distribution and the railway industry were stable, and sales to industrial general and energy industries were slightly lower. Sales to heavy and special industries were lower. In North America, sales to aerospace and energy industries were relatively unchanged, while sales to all other industries were significantly lower compared to Q2 last year. In Asia, sales to the automotive industry were higher, while sales to most other industries were significantly lower or lower, with the exception of aerospace, which was on a similar level as last year. Now, to some examples of new business. We have started to deliver main shaft bearings to Rolls-Royce's new aircraft engine.
SKF has a long history of cooperation with Rolls-Royce, and we are now expanding our business and continuing to support them on their new generation gas turbine engines. This is a very interesting project with a new agreement that increases our share to Rolls-Royce. The new contracts are worth SEK 1 billion, and SKF's main shaft bearings will be used in a number of Rolls-Royce engines, including the Trent XWB gas turbine engine. The Trent XWB is the sixth generation of the Trent family of engines, designed specifically for the Airbus A350. We expect to reach the full rate of delivery by 2018. Next slide. We have secured a three-year contract with Compañía Minera Antamina to provide proactive reliability maintenance services at the company's open-pit copper mine in Peru. Antamina is jointly owned by BHP Billiton, Glencore, Teck, and Mitsubishi Corporation.
They have jointly invested over $3.5 billion on the site, making it one of the largest mining investments in Peru's history. Next slide. We're also making a good progress with our automotive business. Recently, we have entered into multi-year agreement with an automotive tier one supplier to manufacture and supply bonded pistons for its dual clutch transmission system. We already make bonded pistons in North America and Asia, but this is the first manufacturing program for bonded pistons in Europe. The components will, will be manufactured on newly, fully automated lines at our manufacturing site in Leverkusen, Germany. The deal is worth about SEK 350 million. We have also developed a new low-friction truck hub unit. This wheel end solution offers 30% lower friction and significant fuel reduction compared to standard wheel bearing sets.
One European truck manufacturer has already placed an order for this low friction wheel end solution. In June, we announced the consolidation of our manufacturing facilities in North America, including the closure of the site in San Diego, California, and Baltimore, Maryland. This will strengthen our position in North America, making us more competitive and better able to support our customers by improving the utilization of our manufacturing assets. They also provide the foundation for investments in future development or of our manufacturing process and technologies. We will invest SEK 100 million in upgrading machinery and manufacturing processes in Hanover and Flowery Branch, part of the group's strategy to implement world-class manufacturing technologies. We're also making changes to our operations in China, where production of bearings in our plant in Pinghu will be moved to other manufacturing facilities within the respective product lines.
A leaner actuation manufacturing organization will remain in Pinghu. Next slide. We're also working to further improve our logistics and distribution operations by focusing on warehouse technology and concentration, transport optimization, global trade optimization, global inventory planning. Two recent examples are the technology step up in logistics in Tongeren, Belgium, where we have implemented a new goods-to-man picking technology to faster serve aftermarket customers with lightweight products. This is part of a major initiative to improve efficiency and reduce employee workload. During the quarter, we initiated the transfer of distribution and packaging operation in Hebron, Kentucky, to the facility in Crossville, Tennessee. The move is done in order to consolidate the vehicle service market distribution and packaging business in the US. This is a sizable undertaking, and the initial move has not been trouble-free, with some unfortunate shipment delays affecting the quarter as a consequence.
With those comments, I leave the word to you, Christian.
Thank you, Alrik, and good morning to all of you. If we turn to the next page on the sales development, we see that total net sales decreased with 8% in the second quarter. The structure component in the quarter was negative 0.6, and relates to the divestment transactions that we completed last year. The currency effect year-over-year was negative 3% in the quarter, and is primarily related to currency in, in Asia and Latin America and the US dollar. Next page. The decline in organic sales that we have reported on the last quarters continue to follow a typical cyclical pattern. I would say historically, a cycle is over a downturn or an upturn, is somewhere between 5-7 quarters.
On next page, the trends on operating profit, excluding one-time items, it was in the quarter SEK 2.02 billion, down from SEK 2.577 billion last year. The rolling twelve months of the second quarter was SEK 7.7 billion. On the next page, the operating profit bridge. I would say that the year-over-year bridge is -SEK 508 million, and the impact from currency and from organic sales decline combined is -SEK 560 million. So that's in summary, what it's all about. Cost development is unchanged year over year. So if you look in the detail in the bridge, we see that the one-time items year over year was +SEK 57 million when calculated in the comparable exchange rates. We had slightly higher charges to cost reduction restructuring activities last year.
Savings from the ongoing cost reduction program that we implemented last year, which is estimated to SEK 180 million in the quarter. Other impacts is take away SEK 173 million out of those, I would say, and I will come back to that. Divested and acquired companies is a negative SEK 12 million in the bridge. Some comments to the other impacts, I would say mainly this relates to negative volume effects in the manufacturing side, and also to that, we had an inventory valuation that was due to lowering of production costs, negative. On the cost item, it is a very small part of that SEK 170 million. Next page, operating performance by segment. Industrial, to start with. Net sales within industrial declined with 5.5% in local currencies versus last year. European sales were relatively unchanged.
By industry, sales to the aerospace industry were higher. Sales to industrial distribution and the railway industry were relatively unchanged, while sales to industrial, general, and energy were slightly lower. Sales to heavy and special industries were lower. In North America, sales were significantly lower in the quarter compared to last year, and by industry, aerospace and energy, relatively unchanged, while sales to all other industries were significantly lower compared to last year. In Asia, sales were significantly lower in the quarter, and by industry, aerospace were relatively unchanged, while industrial, general industrial distribution were lower, and other industries were significantly lower compared to second quarter, 2015. Operating margin in the industrial side, excluding one-time items, was 12.7% in the second quarter, compared to 15.5% last year.
The margin decrease is primarily due to a negative mix, to lower manufacturing volumes, and to currency. Going over to automotive, net sales within automotive declined by 1.8% in local currencies in the quarter. Sales in Europe were higher compared to last year, with significantly higher sales to the car and light truck industry, and higher sales to the vehicle service market, and to customers in the heavy trucks industry. In North America, sales in the quarter were significantly lower, including significantly lower sales to the truck industry and the cars and light trucks industry, as well as to the vehicle service market. In Asia, sales were higher compared to second quarter 2015, significantly higher to truck industry, slightly higher to the cars and light trucks industries, and significantly lower to the vehicle service market.
Operating margin for automotive, excluding one-time items, was 7.1% for the second quarter, compared to 6.5% last year. And we continue to improve year-over-year performance, despite, I would say, quite a strong comparison quarter in second quarter 2015, where we already at that time, saw good cost savings from our turnaround plan. I would say it's mainly cost improvements that contribute to the margin margin increase. We move to the next page, the income statement for the group. Gross profit, if we adjust for one-time items between the years and currency effects, gross margin was lower in the second quarter by 1%. The drop was caused, I would say, equally to mix and to lower production volumes.
Selling and administration expenses, adjusted for one-time items, acquired and sold companies, and currency, was 4% lower, or around SEK 120 million, as the ongoing cost reduction programs had a positive effect year-over-year. Financial net in the first quarter was negative SEK 219 million, and last year included a positive exchange rate effect of around SEK 80 million. Taxes in the quarter was negative SEK 950 million, of which 386 relate to the divestments of Fly-by-w ire and Kaydon Velocity Control. If we exclude this, the effective tax rate was around 34%. We turn to next page. Cost management. Cost reduction remain a high priority for us.
We see positive development of our fixed costs, and this slide shows since end of, in the last quarter, 2014, excluding one-time effects and in fixed currency as an index. Second graph shows number of employees, including agency workers and temporaries over the same period, and the reduction in second quarter was 768, whereof the main part relates to the divestments. If we look at the total since quarter four, 2014, we have reduced more than 3,700. And if we exclude the divestments of this, we reduced 80 in the quarter, and we are close to 3,000 lower than in the end of 2014. Fixed cost index increased somewhat in the quarter, related to annual wage increases and product-related costs in the quarter.
As you've heard from our risk activity-based cost reduction continues, for example, the manufacturing footprint in the U.S., as you heard. Next page, cash flow, and balance sheet as well, continue to be high in focus. We achieved a good cash flow after investments before financing, if we exclude acquisitions and divestments as well, was close to SEK 1.2 billion, compared to SEK 670 million in second quarter last year. In this slide, we are excluding, acquisitions, divestments, and the EU payments made in the second quarter, 2014, and the twelve-month trend, is around SEK 5.5 billion. Next page, net working capital. As percentage of annual sales, we are at 30%, exactly, the end of second quarter.
And as you know, we have increased our ambition to work towards a target of 25% of annual sales over a business cycle. And the ratio now, compared to last year, is an improvement from 30.9 then. Next page is about the divestments that were completed in June here, and then, as you've heard, we announced them already in first quarter, and I would say we are very pleased with the outcome of these two agreements. If you look at the financial effects of the transactions, we received cash flow, we will receive cash flow net of taxes of SEK 2.739 billion....
Of this, we in the second quarter received SEK 3.125 billion at the end of the quarter, and the remaining, roughly, SEK 380 million of taxes will capitalize, be paid in the coming quarters. We have recognized the negative effect on net income in the second quarter of SEK 380 million, which fully relates to taxes. And this is also in line with what we announced already in the first quarter as the probable effect of these transactions. Go to the next page about our net debt financial position. If we adjust for pensions, we are reducing our net debt in a very good way, and with about SEK 1.5 billion in the second quarter. So we continue to make good progress on the deleveraging the balance sheet.
Net debt, excluding pensions, is now 49% of equity. Provisions for post-employment benefits have increased by SEK 1.9 billion in the second quarter, and by SEK 3.3 billion since the end of the year. This is a result of low discount rates, primarily in Germany and the U.S. and U.K., and also some currency effects. As a result, the total net debt equity is now 118% by end of June. On the next page, we have the guidance for this year. We expect a finance net of about SEK 250 million negative in the third quarter, and based on present exchange rate, we expect a negative currency impact of about SEK 100 million.
For the full year, tax level of around 30%, excluding effects from divestments, and we expect to keep the current pace of investments when it comes to cash effects of that at about SEK 2 billion for the year. Moving over then to the next page on the demand outlook, and, just a reminder of, of the definition of it, we have it in the slide here. It's an outlook that represents the expected volume development in the coming quarter, and, sequentially is based on raw data and not seasonalized. And with that, I leave the word back to you, Alrik.
Thank you very much. So if you look at the demand outlook for Q3, demand compared to the third quarter, 2015, the demand for SKF products and services is expected to be relatively unchanged for the group, including both automotive and industrial. Demand is expected to be slightly higher in Europe, relatively unchanged in Latin America, slightly lower in Asia, and significantly lower in North America. Demand compared to the second quarter, 2016, demand for SKF products and services is expected to be lower for the group. Demand for industrial is expected to be slightly lower, and demand for automotive is expected to be lower. Demand is expected to be relatively unchanged in Latin America, slightly lower in Asia and North America, and lower in Europe. With those words, I leave over to you, Patrik.
Thank you, Alrik. With that, I believe we are ready to go through Q to Q&A. May I remind you to try to limit yourself to one question at a time, so being cautious of time and making sure that as many as possible can get through. Operator, please.
Certainly. If you would like to ask a question at this time, please press the star followed by the digit one on your telephone. Please ensure that the mute function on your phone is switched off to allow your signal to reach our equipment. Again, in the interest of fairness, please limit yourself to one question at a time and re-queue for any follow-up questions thereafter. Again, please press star one if you would like to ask a question. We'll pause now just for a brief moment to allow everyone signal. We can now take our first question from Marcus Almér from Kepler Cheuvreux. Please go ahead, sir.
Hi, Marcus Almér here from Kepler Cheuvreux. I'd like to start to talk a little bit about North America, and can you talk a little bit about the trends you saw throughout the quarter, and also sequentially talk a little bit about what you saw in Q1 versus in Q2 versus Q1? We seem to have seen a deceleration, at least year-on-year, but can you talk a little bit about what you saw sequentially, and also, as I said, throughout the quarter? Thank you.
Yeah, I would say, Christian here, if we start on the industrial side, we expected some inventory bounce back in the quarter that we, in fact, haven't really seen. So from that point, it's a bit of a disappointment. I would say it might also relate to a bit of discussions we have with some of our bigger distributors on contractual terms there. If you take the industry segments in general, I would say, it is still quite low demand. We don't see a change in the quarter, so I would say, there is no improvement in the underlying demand on the heavy industry and in those segments.
If you take on the automotive side, I mean, we have reported since quite a while now that we have some platforms where we are not participating, which in the short term then or in the past quarters have impacted us. We have, except for that, somewhat an effect of delayed deliveries related to this logistic change we've had, not major ones, but somewhat. But except for that, I mean, if we look forward on automotive side, say, from the levels we are, we do believe you can never be certain, of course, but we do believe that we will see some growth here going forward.
When we talk about contractual terms, just to understand, we're trying to get rid of, you know, this end business that you are going towards a target for the year, and you do these pre-buys in the end of the year. We are still talking to some of our distributors about how to solve that. But of course, during that period, you don't get the stock orders that you that are normal at this point. So just to clarify that.
Thank you.
On the Hebron side, I would say maybe we're talking about the order of maybe SEK 100 million being pushed over from one quarter to the other.
Just to clarify, I mean, if you look at the trend in the quarter compared to Q1, would you say that demand is relatively unchanged sequentially, or do you see slight decline?
No, the underlying demand, as we said, on the for us important industries is unchanged.
Okay. Also throughout the quarter?
Yes.
Okay. Thank you. I'll get back in line.
Thank you. We can now take our next question from Peder Frölén, from Handelsbanken. Please go ahead.
Yes, thank you. Good morning, Christian and Alrik and Patrik. My question will be surrounding the price and sort of the mix effects during the quarter and also year-on-year, obviously. You have conducted a quite significant change in your sort of discount and price levels. Are you pleased with the development so far? Do the distributors sort of appreciate these efforts? And how should we look upon price and mix in the quarter? Thank you.
Yes, we are pleased. I mean, these kind of changes, what you do, I mean, quite, I think it's close to 10 years since we did a major price list structure change last time. They are not that easy. So of course, it takes some time to work that through with each of our partners out there. But, I mean, I would say the implementation goes as expected. When it comes to the mix price as a level, as the outcome, and if you see it, I mean, quarter-over-quarter, you asked, we see somewhat an improvement.
Mm.
I would say also, if you say year-over-year in Q2 versus Q1, we see somewhat a better mix price in Q2 versus Q1.
But, but you're still in negative territory, right?
Yes.
Oh, and any possibilities to, to help us with the magnitude here? Is it between 0 and 0.5 percentage points? Is that a good ballpark?
Yeah, I mean, you, I think you can calculate that from our organic sales numbers also, I mean, when it comes to volume and so on. So yes, we are in that magnitude, yes.
Okay. I get back in line. Thank you.
Thank you. We can now take our next question from James Moore from Redburn. Please go ahead, sir.
Yes, good morning, everybody. I wonder if I could ask a little bit about your EBIT bridge and the other line, that there are some moving parts inside that, that are quite difficult to understand. I wondered if you could help us there, in terms of Unite, how much that was, and do you still think 250 for the year? Could you maybe talk about the raw materials in there? Was that a high double-digit, sort of positive to go with the better price comment, and the absorption impact within that? And quantify any of these shipment delay effects or wage effects that you mentioned that sit in there, because there's lots of moving parts. If you could help us understand that a bit, it would be great.
I'll see what I can do. If... I think we're clear on that the organic sales, what we report is the loss in contribution on the sales side, with some effects then on pure volume and price. If you go to the other line, and you're talking about the volume effects, we are clearly-- we don't have a stock build-up affecting the quarter in terms of production, volume, and absorption. We have on the quarter, year-over-year, we have a negative volume effect. I would say, as I said, I think that combined with that, we have an inventory valuation in a negative territory, explains almost the whole 170.
So the net effect of, let's say, cost management, cost reduction programs, Unite, material, raw material cost development is roughly flat.
That's very helpful. And just to wonder if you could help us break out Unite. I get the impression it was a smaller SEK 20-30 million impact. It last-
Yeah, I mean, Unite, as we have, you know, a base also for what to capitalize and so on. And, we have been in quite an intensive build phase now.
... and build activity create, we create value. So in the quarter, we have capitalized part of, we have the increased spending in the race that we have planned, so I mean, everything goes on in the way we have set out and communicated. If you look at the single quarter, we don't have a big Unite effect. It's flat year-over-year, the cost part of Unite, huh? So but it depends on the content of what we do. I mean, if it, when we come closer to roll out, the more, you know, education, training, that part, that will not be capitalized, then you will see a cost effect in the bridge. And I foresee that towards the end of the year, you know?
So, just to be clear, you think that there's more of a year-on-year headwind in the second half from Unite?
Yeah.
For raw material, does that change in the second half?
No. I mean, we see quite a positive development on material cost side, yes, we've had some rebounds on the raw material prices, but I think we have quite good activities there, so I expect that to continue to have positive effects from the purchasing and material side.
Thank you very much.
Thank you. We can now take our next question from Andre Kukhnin, from Credit Suisse. Please go ahead.
Yes, good morning. Thanks so much for taking my question. Can I just ask on the guidance, on for year-on-year, for Q3? When running through your geographies, you seem to imply that European growth picks up, to somewhere around 5% and maybe above, to kind of keep the whole equation flat. Would that be the right read? And if it is, then what do you expect, to pick up in Europe, maybe by country or even better by industry vertical, please?
Yeah. What we see is actually, if you take the absolute underlying market effect, we see it's actually leveling up in many areas, if you take it as a whole, huh? Many geographies as a whole. And of course, Europe for us already this quarter now starting in a good way. But underlying, there's gonna be a similar kind of trend. The heavy industries we still see are difficult, but the general sort of demand for our products with distribution and so forth is now flattening off. So there's no sort of big changes in the underlying demand, but from that point of view, that we see a real rebound.
But on the other hand, as Christian alluded to, if we are in some kind of cyclical normal phase, we see now how as we are showing in this when you see the volume per quarter how we are now coming closer and closer to the zero line, and this is the development we see. Then if what you are looking for, when you talk about countries and so forth, yes, there's been a lot of talk about Brexit. You know, SKF has about 2.5% of our sales in the U.K., and we have 1,000 employees in the U.K. There's a lot of speculations about the effects of Brexit. We don't see that exactly like that.
We see more that, you know, there's been a very meager investment climate for a long time now, and sometime industry just need to start investing again. And basically, if you take it, the Lehman crisis was 2008, and there's been a long, long time now since there's been sort of a downturn, and now we see how it's leveling off. And this is, I think, how we should take it, and it's in many, many geographies.
That's very helpful. Thank you. And may I just follow up quickly on the comment that underproduction, kind of overproduction was stable in the quarter, i.e., there was no meaningful impact on the bridge. Is that right? Because we saw inventory kind of ramping up, I think, by SEK 470 million or something like that on the balance sheet versus end of Q1, while effects shouldn't have been... Well, should have been actually a negative within that. So just wanting to double-check on that, please.
Yeah. I don't think I have the same number on inventory balance sheet as you have, huh? When I comment, I talk on fixed exchange rates, so you might have some effects from that, but I'll-
Probably, yeah.
In my books, we are roughly SEK 100 million up quarter-to-quarter, I mean, Q1, Q2. You don't have an impact from inventory build there. And if you take the full quarter on built volumes, we are negative, and we have a negative effect on that in the bridge.
Okay, got it. I thought inventory was 15,146 versus 14,719 at the end of Q1, but I'll double-check our numbers.
Yeah. Yeah, I mean, maybe you, we can, if you contact Patrik afterwards, we try to clarify if we, if we have been unclear on, on the numbers, huh?
No, that's, that's clear. So as long as you're saying that there was no underproduction, overproduction impact in the bridge, then that's, that's very clear. Thank you.
Thank you. We can now take our next question from Andrew Wilson, from JP Morgan. Please go ahead.
... Hi, good morning, everyone. Just a quick one for me on North America, just trying to understand exactly what you're seeing there. Do you, can you comment a little bit on what you're thinking on market share there, and whether you think you've lost any share, whether that be particularly to do with this consolidation project or anything else in the market? I'm thinking on the industrial side rather than the automotive, where I guess you've been pretty clear about the state of play there. Thanks.
No, we on the industrial side, we don't see that it is about, it's a share issue. That's not what we see. On the automotive on the other hand, due to the fact that we are not on some of the high-selling cars and light trucks, due to this that we have discussed now for a while, we are trading below market. So you could say that we are losing share, if you will, of the total American market. We're working hard to regain that. We have some really good traction with discussions with many of our customers, and we see how rather soon we will start turning this around. And, you know, in the automotive, the cycles of PPAPs and new programs, they're very long.
So this has been, as we said, is going on, but we see now, going forward, that the difference between the last year's figures, et cetera, will start going into a more positive territory on the automotive. And if you take the vehicle service market, when due to the Hebron changeover and postponing some of the deliveries into the vehicle service market for some distributors, there's of course been a delay, but that is going to be recovered during the coming weeks here in July and the beginning of August.
Okay, so in terms of the industrial side, then, it's purely a volume and a market side. It's not, not anything else to be concerned about?
No, you know, still, if you look at the underlying of oil and gas and agriculture, et cetera, it's still weak. Our customers there are still weak. We don't see any really takeoff, but with the same logic, you know, it's been quite a while now since the industries have been oppressed. And I don't know actually whether or not the discussion, how the political discussions in the U.S. can influence the future business sentiment. That's beyond my expertise.
But if not, well, what we see is now sort of a leveling off of the demand for SKF, and going into a different kind of dynamics, where it's not going down like it's been doing before.
That's perfect. Thank you.
Thank you. We can now take our next question from Ben Maslen, from Morgan Stanley. Please go ahead. Your line is open.
Yeah, thank you. Good morning. I just want to clarify, if I can, the kind of inventory effects on the quarter, because I think they're... it's a bit confusing. So if we could split it into two parts. Firstly, the production effect. So Christian, you, I think you said that there was SEK 100 million quarter-over-quarter inventory build. I think that was SEK 250 million last year. So in essence, you built less inventory ahead of this summer than you did last year. So the drag of production on the inventory side, that's the first thing I want to try and understand, please.
That's correct.
Okay. And then, your, your, your answer to James on the moving parts of the other line, I didn't quite understand the answer to that, that the most of the SEK 173 was an inventory, I think you called it revaluation. Can you explain a little bit more about what that was? Is this a one-off? And in reality, you know, is this, is there an exceptional effect that we should add back here to kind of get a, a clearer picture of what the underlying margin was in the quarter? I don't quite understand, your answer to his question. Thank you.
It's fair. No, it's not mainly an inventory valuation. I bundled two things. One is lower production volumes-
Right
... so we under absorption from that, which is the bigger part. And then we have the smaller—and that goes every quarter, you know, or every month, you do your valuation of your inventory valuations, and that goes in both directions, and this quarter, it was slightly negative, huh? So it's mainly an issue about which follows, of course, the overall sales pattern, that we produce less in the quarter than what we did last year, giving a negative absorption on our fixed cost.
Okay. But then you can't, you wouldn't break out, split the 173 between the two effects?
I would say, I mean, the volumes, in my average, I have 110.
From the producing less?
170, yes.
From producing less than last year. Okay, fine. So then the residual is the, the revaluation effect?
Um, yes.
Okay. Many thanks.
Not, not fully, and then you have a little bit on the cost management, as I said, also.
Yeah, okay. Got it. Thank you.
Thank you. We can now take our next question from Olof Cederholm, from ABG. Please go ahead.
Hi, and good morning. Just a question on the cost development and fixed cost focus here. I just noticed that the number of employees have come down since Q4 2014 by around 5-6%, but your fixed cost index is only down about 2% then. Can you talk a little bit about what you're doing here and how we should think about the fixed costs going forward? Do you think it will be positive to lower fixed costs, or is it just difficult to get it done?
I think, I think firstly, you should recognize that, I mean, in 18 months, if you take the underlying labor cost development in 18 months, it would, on that part of the fixed cost cake, it would be, let's say, 3%-4% up, huh? So, and if you take your fixed cost, the labor part of that cake is quite sizable, as you can see in the annual report. So what you have is you have a 2% negative, or let's say, a reduction compensating also the inflation. So that's my first statement. Then what we have underlying also, and that we have reported, if you take this time period, we are spending more on your IT and IT, which is also then absorbed in the development.
I would say that, I mean, to reduce fixed costs is not easy, and it will never be easy. But, I mean, we continue with this. It's strongly our ambitions that this curve should continue to go downwards, huh?
And, and here, Ulrich, just a comment. You can understand that in this environment where volumes are not going up, and you are even really, I think the manufacturing and logistics people have been really skillful in managing the inventory during this year. It's even more difficult in the short term to keep the overall fixed cost in check. And, and that's just the way it is.
All right. Thank you.
Thank you. We can now take our next question from Andreas Koski from Deutsche Bank. Please go ahead.
Yes. Hi, good morning. Can you hear me?
Yes.
Perfect. So I would like to continue on the cost side and the fixed cost increase that you talked about during your presentation. So the index has increased from slightly below 95 to 98, and you mentioned this is related to salary inflation. That implies salary inflation of around 3%-3.5%. Would you say that is the right level to look at?
Yeah, but I mean, I don't have the global number of it. I know what we had as an assumption, and, you know, this comes in, I mean, in different countries, it comes in the second quarter, some it comes later and so on. So I cannot give you... But, I mean, you know, in a global business, you have high inflation countries, we have Latin America, we have Asia, we have Middle East, Africa, and so on, some of them. And we have, let's say, more of the low inflation part of the world. And in a mix, in the ballpark, you're right, of course.
And looking at the-
Go ahead.
Looking at the index, so it was about at 98, also in Q2 2015, but then it came down to 95 from Q3 and onwards. So I guess this part is in the other line of the bridge, and as long as you're not able to take down cost from here, that should start to have a negative impact year-over-year from Q3 and onwards. Is that right?
I mean, you're into some details where I cannot comment. I mean, of course, I mean, our costs is in the bridge. It's not in the organic sales development, it's only in the currency, it's in the rest. So for sure, that, that's where you will have it in the bridge. If it will be negative or positive in the quarter, I cannot comment on that one.
But I tell you, this when you talk about fixed costs, and you are in a relatively sort of still declining, and there are some, of course, you know, variations between the quarters, there are some things you're doing in the factories, et cetera. There will always be some swings up and down. Our ambition going forward is that we will lower our fixed costs still through both what we're doing in terms of sourcing, et cetera, and what we're doing in our manufacturing footprint and our step ups.
Yeah, I understand that. I understand that you will not keep on your hands.
Announced the changes in, for instance, the manufacturing, but they have still not been executed, and you cannot still not see them in these kinds of... Because they have to be sort of carried through, when you fully see them in this kind of table.
Yeah. Can I just clarify-
Long, mid, mid-term, long term, I'm really positive in our ability to continue to drive down our fixed costs.
Yeah. Can I just clarify on two things? So firstly, on raw material prices, you said that you expect continued positive effects, going into the second half, but is that on a sequential basis or on a year-over-year basis?
On a year-over-year.
Okay. On a sequential basis, what do you expect from raw material prices?
If you say raw material or if you say material as a whole?
Let's say, let's say material as a whole then.
Yeah, that's a detail better.
On material year-over-year, we see about the same level of improvement as we've seen in the previous quarter.
Do you think costs will start to increase now because we have seen raw material costs increasing?
Yeah, but I mean, you are, yeah, in a. If you take that percentage of that part of the cost cake, and we see other things we do, or design change and so on, I cannot say the split that out.
... Okay. Yeah, and that-
To clarify, we expect still that we will be able to continue to have positive cost influence in SKF, due to what we're doing in changing processes, changing suppliers, and working with lowering the material cost as such, that is stronger than the increases we've seen in the raw material price as such.
Yeah. And then lastly, on Unite, do you still expect the cost increase of SEK 250 million in 2016 versus 2015?
Are you on Unite?
Yeah, on Unite, yeah.
Spending, yes.
But in the previous quarters, you have said that it's on the P&L that you expect the SEK 250 million increase.
Yeah, the PNL effect might be somewhat lower now, because we... So that's the answer. So spending, yes, we are following that spend increase plan.
Okay, so you are capitalizing more than you previously had expected?
Yes.
Okay. Thank you very much.
Thank you. We can now take our next question from Daniel Schmidt from SEB. Please go ahead.
Yes, hello, good morning. Can I ask you, quite a different question? A couple of years back, there was a lot of discussion about the Japanese competition that you're facing, and especially the depreciation of the Japanese yen versus a whole lot of sort of major currencies. That trend has, and there was statements from your competitors saying that they were hurting on the back of this. Since 15 months back, the trend is reversed, and the yen is up quite heavily versus the SEK and the euro and the dollar. Are you seeing any dynamic effects on the back of this, especially in the industrial space?
You know, what happens usually, is that, and I think what we saw when the yen went down is that we're two, two, trends. One was that actually the profitability of our Japanese competitors actually improved. And of course, they had the possibility of being a little bit more aggressive, of course, in that space. On the other hand, you also realize that labor cost of the total cost of bearings made in Japan is not everything. There's also raw material, energy prices, et cetera, in Japan. Now, with the yen going up, they—it's, it's of course, so that for some businesses made in Japan, it's now more difficult for them maybe to be aggressive. But the biggest change will come from a possible... So we see no change.
I mean, I don't see any exceptional aggressive change in that there is an increased aggressiveness of- from Japanese competitors, but I also don't see them at this point, withdrawing from the market. What will influence this is, of course, the overall demand. This is usually what happens when the demand of bearings go up in Southeast Asia and Japan, there will be then a tendency, of course, of Japanese competitors always to withdraw from some of their sort of more opportunistic business opportunities. But that I can't say that I have seen yet.
All right. Okay, could I, could I ask you a different question also? You had a very weak development in North America that we've discussed now for some time, and part of that was due to the delays in the Hebron, change, and that's going to come in Q3. You are saying that you are seeing soon improvements on the automotive side. Still, you're guiding for North America to be significantly down, still in the coming quarters. This changes that will take a bit longer than just a quarter then, or are you overly, sort of modest in your guidance?
I mean, the guidance you comment is sequential, and then you have, of course, seasonality, in that. So the year-over-year guidance is relatively unchanged now.
No, that was actually the year-over-year guidance that I mentioned is that significantly lower in North America.
Yeah. Sorry, sorry, okay. You talk North America only.
Yeah. Yeah, that was a sort of a regional comment.
Yeah. Sorry. Yeah. Yeah, I think that it's – they, there's still so that there's been a situation in North America, especially on the automotive side, that is still until now making the comparisons year-over-year still difficult for us. What I'm talking about is absolutely the underlying trend that we see going forward in the next quarters with now in the guidance, it's with the raw data, with the... We are not adjusting for seasonality. So when I'm – but when I look at the underlying demand in the U.S., this is what we're talking about.
We see now an improvement in automotive, in the sense that the decline is going to start; it's tapering off, and we see the same development in the U.S. Where what I think we underestimated as far as this quarter was... Of course, little bit that we thought that the underlying industrial customers were going to start restocking quicker than they did, and this is the deviation that we have seen. But again, I reiterate, we don't perceive that it is a market share issue on the industrial side in the U.S.
All right. I still don't really sort of understand the significantly lower guidance on North America, given what you said, but we can, we can discuss that after the call, I guess. Thank you.
Thank you. We can now take our next question from Erik Golrang from Nordea. Please go ahead.
Thank you. I have one question. If we could get an update on your push or move into more into the product or mid-end side of bearings, how that is going, if you have a firm formulated strategy there now, and what kind of products you are launching? Thank you.
Yeah, well, you know, there is. This is, of course, like everything, there's a cycle in this, and it is a constant long-term work with engineering products for the kind of demand that is there out in the marketplace, and it takes time. But one of the things that I think that we have been able to do in what we used to call drives and compressors, where we have seen that our work to sort of customize more our product into the industrial side, has enabled us to retain and increase our presence with some of our customers, as opposed to coming with just the standard solution.
That's actually been happening gradually, since we started with this, this approach. It takes time. It's gradual, and it takes time, but, well, you know, when we put our minds to it, I see that we can do it, huh? We can defend our turf and take, regain some of the place that we may be consciously left with this new approach, and I see that working well. I can't quantify it, and you have to understand it takes... The lead times when you are discussing new, new programs and new products with customers take some time, but it definitely is working.
Thank you.
Thank you. Because of time, I believe that was our last question. Thank you very much, all of you, and we wish you a nice summer holiday. If you have any additional questions, please give us a call at IR. Thank you.
Thank you. That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.