Ladies and gentlemen, thank you for standing by, and welcome to the SKF AB Third Quarter Report 2012 Conference Call. At this time, all participants are in a listen-only mode. There'll be a presentation followed by a question-and-answer session, at which time, if you wish to ask a question, you'll need to press star and one on your telephones. I must advise you that the call is being recorded today, on the seventeenth of October, 2012. And I would now like to hand the conference to your first speaker today, Marita Björk. Please go ahead.
Good afternoon, ladies and gentlemen. You are very welcome to this conference call for the presentation of SKF's 9-month results, 2012, and this teleconference will take 1 hour. Here from SKF are our President and CEO, Tom Johnstone, our Executive Vice President and CFO, Tore Bertilsson, Ingalill Östman, Senior Vice President, Group Communications, and myself, Marita Björk, Head of Investor Relations. Tom will start by presenting the results, and then after this, there will be a Q&A session. Over to you, Tom, please.
Thank you very much, Marita, and ladies and gentlemen, hello. We just shortly ago released our report for the third quarter of 2012, and I must say, a very interesting quarter. For me, it seems more and more that the summer is the time for changes in global demand outlook. At least that seems that way for me for the last four or five summers, and this summer was no different. I think you're all pretty well aware of the changes that took place in the macroeconomic environment during the quarter. And, of course, that indicated a clear softening in the business, and this influenced us as well. If I look at SKF specifically, though, what we saw was a weakening trend as we went through the quarter, and particularly a weakening trend in a weak September.
So as a result of that demand being much weaker, we adjusted our manufacturing during the quarter. And again, I'm particularly pleased with how our operations reacted and adapted the manufacturing and costs to what was a new lower demand level. But at the same time, we continued to take out inventory as we planned. By being able to react quickly, allowed us to deliver a very good result in the third quarter, and similar in terms of an operating margin of what we did in the first half of the year, even if we were faced with lower volume in both sales and manufacturing. I think also a particular highlight is that we were able to deliver a very strong cash flow in the quarter.
Now, whether when you look at it, the macro environment, of course, was one factor in the quarter, which was quite prominent, but that was not all that was happening, and we continued to take steps during the quarter to strengthen SKF through acquisitions, gaining new investments, making new business, sorry, making new investments, and the launch of some new products. And I'd like to start by looking at some examples, if I could. Firstly, we completed the acquisition of General Bearing Corporation in the quarter. And as you know, they operate under the brands General and Hyatt, and they will, within SKF, join Peer as a second brand business. GBC mainly focus on the automotive and truck and trailer markets. Now, let's switch over to some of the new business we gained.
And they're in the report, but I'd like to highlight them if I could. There are the new business for magnetic bearings. We'll supply them to projects in turbo gas expanders and two new gas projects in Australia. And by the way, we are the world market leader in the supply and manufacture of magnetic bearings. Second good one, I think, was the contract with LKAB, where it's a new five-year contract for maintenance services such as condition monitoring and diagnostics, and that builds on our previous contracts in cooperation with LKAB. In China, we signed our third strategic partnership agreement with China's largest steel producer, Baosteel. And at the same time, we opened our third industrial service center with Baosteel, where we recondition and remanufacture bearings in continuous casting units for their group.
I visited these operations when I was in China recently, and I must say they are very, very good operations indeed. Another new business was the business we gained for our BeyondZero portfolio solutions, one of them, the SKF bus door actuator. We talked about that back in May, that we had been doing testing on that. Now we've gained the business on it, and we will supply that to Volvo Bus starting early next year. And we gained some important business in bonded piston seals, where we have a very good technology there, and this will be used in automatic transmissions for Mazda in Japan. So a number of good businesses in the quarter, these are the ones we can talk about. There were many more businesses we gained.
Also, in the quarter, we opened three new SKF Solution Factories, one in Cleveland, in USA, at the start of the quarter, a new one in Bucharest, in Romania, and we also expanded the existing one in Torino, Italy. We moved over to a place in Moncalieri, just outside Torino, and we expanded the activities there. These three Solution Factories are all different. They're all focused on the businesses for their markets there. They all do engineering, training, monitoring, et cetera, but they have specific skills. For example, the one in the USA is focusing a lot on customized steel and bearing manufacturing and remanufacturing. The one in Italy, the new one in Italy, they do the same, but they also do remanufacturing of complete gearboxes and remanufacturing of continuous casters for steel mills. We...
I must say, when we open these Solution Factories, we receive very, very good positive feedback from customers as they see what we can do in the Solution Factories, but also when they use them going forward. So I think these are a good investment for us, and we now have 20 of these Solution Factories worldwide. Supporting our distributors is important for us as well, with our distributor, SKF Distributor College, continues to develop, adding new programs. And in the quarter, we issued our 160,000th certificate. I think this is a great testimonial to how good our Distributor College is, and I raise this particular milestone from a little bit of a nationalistic viewpoint, because the distributor that got it, or the person that got it, was one of our Scottish distributors there.
So I was very proud of a Scotsman getting a Distributor College certificate. Moving on to, I'd say, what was one of the main highlights of the quarter, and that was our celebration of 100 years of doing business in China, which is really quite a remarkable record. We held a number of meetings to celebrate that, and we called them Knowledge Conferences, which we held with customers, with distributors, and with suppliers to support the development of our next 100 years of business in China. During that week as well, we opened a new factory in Jinan, which, as you know, will supply products mainly to the truck industry.
We did the groundbreaking ceremony on our new Northeast Asian warehouse, which will support faster and more efficient deliveries to our customers in that area, but it'll also help us reduce inventories in relation to sales. We also announced the establishment of a new campus in Jiading District, which is a district of Shanghai. In that campus, we will build a new factory for the automotive business, making hub units, primarily making hub units for our customers in China. On the same campus, we will locate our existing SKF College, our SKF Solution Factory, and we'll significantly expand that, and we'll also locate there a new Global Technical Centre. You know, you were there with us, or many of you were with us, two years ago when we opened the first phase of the Global Technical Centre, and we have around 88 people working there.
With this new building and new facility, we will increase the number of employees down there to 400 within the next three years. So that was a number of things in investments. We also launched some products, and I won't go into them in detail, but there was a number of key products for the railway industry, as we want to strengthen our position in that industry, and some new lubrication systems for the food industry. So a number of activities were undertook during the quarter. But I should now go back a little bit more to the financials and maybe start at the high-level figures before going into detail on what was happening from a demand viewpoint.
Our sales were around SEK 15.5 billion and were down some 6.4% in the quarter in Swedish krona and, about 4%-4.5% organically in local currencies. Both the industrial businesses were down by some 5%-5.5%, and automotive was down around 3%. From a geographical viewpoint, North America and Latin America still showed growth of something around 5% and 8% respectively. While we had drops in Europe of some 7%, and in Asia, it was down a whole 11%. When you look at these figures, and you look at them from the different BAs in the regions, you'll see the main change that's taking place in our business.
That is that the industrial business has weakened in the quarter, and while Europe was somewhat weaker, Asia was the one that really came down a lot and surprised us on the downside. So let's maybe go into the regions in a little more, little bit more detail. I'll start with the region, one of the regions we saw good growth, North America. It was good growth, as I said, but the growth rate was probably a little bit lower than we'd seen at the start of the year, but that we expected, and we indicated would happen. The growth, again, was led by an increase in sales in the automotive industry, which is a similar pattern to what we saw in the first half of this year.
Light vehicle production in the USA was up year-on-year, by, I think, something around 12% in the quarter. And this, combined with the new business we gained, resulted in a very strong growth. We, we grew well ahead of the marketplace in North America, and that will continue also in the, in the fourth quarter. Our industrial business, however, did not develop as positively as in the first half. Our sales to general industries such as pumps, compressors, small gearboxes, et cetera, were down slightly in the quarter. Our business to off-highway, it was okay in the quarter, but, but it's weakened, and we can see that, a weakening trend, especially from an order book viewpoint there. Our sales to renewable energy were, were down a lot in North America, but that, as you know, is not such a big market for us.
I'd say if you look at North America, not only was the automotive, the sales to the car and light truck industry strong for us, but another bright spot was our sales to distributors, which held up very well, and our sales to the aerospace business. If I move over to Latin America. Latin America, we also saw a positive development, as we'd seen earlier in the year. A number of markets showed good growth for us. Markets like Peru and Colombia, but, of course, the big market, Brazil, was very important, where we saw good growth in the vehicle service market, for example, and we saw signs that the government incentive program for cars actually started to help our sales in that area as well. Let me turn to Europe, where the development weakened further in the quarter.
In Northern Europe, I'll start with Northern Europe. Our business was down in Germany and in the Nordic region, continuing the trend which we saw in the second quarter. In Southern Europe, we didn't see a big change in the trend compared to the first half. It's down a lot year-on-year, but seems to be staying around that level, although it's different country to country. East Europe developed well overall, with especially markets like Hungary, Russia, and Turkey developing positively. But other markets for us, like Poland and Czech Republic, didn't develop so well. If we look at it from an industry viewpoint, then in fact, with the industrial market, if we exclude aerospace and renewable energy, who both grew in the quarter, then all other main industries declined year-on-year and sequentially. Aerospace, you know, is going pretty well.
Renewable energy is due to the fact that we've gained some new business. It's not that the market itself is developing well. In the other industries, we saw declines in general industries such as pumps, compressors, gearboxes, as we saw in USA, and in heavy industries such as metal, cement, and paper, and we also saw industrial distribution going down for us. Our distributors are, of course, influenced by the macro development, and I'd say also they're seeing lower demand, but they're being much more cautious due to the macro development and the lower demand that they're seeing there. If I turn to the automotive business in Europe, then we saw big declines in our sales to the car industry and the truck industry, and, we also saw a year-on-year decline in our sales to the vehicle service market, although it does seem to have stabilized.
It's not no longer going down as much in Europe sequentially. Let's look now at Asia. Here, as in the first half, we saw the biggest decline in our business, and it didn't develop at all as we expected. Well, the main impact was similar to the first half, being a drop in our sales in China and India. We also saw some weakness in other countries such as Australia, Taiwan, Korea, and Thailand. In China, our decline in sales remains mainly in the industrial businesses. Renewable energy continued to be weak. We thought it would get better as we went through the year, but it's remained very, very weak. The railway business was weak a little bit for freight cars.
Well, that means it didn't grow for freight cars, as the new tender was delayed, and the announced stimulus for the railway industry has not really had any impact. Our distributor sales are still not developing as well as we'd hoped, I must say, and they face a weak end market demand from key segments such as steel and mining. Even the industry, which actually was a bright light for us in the first half of the year in China, weakened. That is our sales to general industry, so gearboxes, pumps, compressors, et cetera. We saw a decline in the quarter. If I turn to automotive in China, our sales were impacted there due to model mix, but that improved as we went through the quarter because there were incentives put in place for certain models.
So we didn't see the same, drop-off, and actually saw an improvement as we went through the quarter due to these incentive programs. In India, our sales declined in the quarter. We faced a very weak development in the industrial market. Renewable energy was down, general industry, et cetera. Really, a quite broad-based down in the Indian market, as well as our sales to industrial distributors was down there. From an automotive viewpoint, I'd say mainly the highlight was the sales to, heavy trucks, which were down a lot as well. Turning to one other market I put in Asia before I, before I go further, which is Indonesia. And Indonesia is one that we've talked about before, our two-wheeler business there, and, we saw a drop in our two-wheeler business in Indonesia due to a mix of the business.
That is, we are on motorbike, and the trend is much more to scooters there, and we're not so present on the scooters. And there's a general drop in the market due to the new financing rules that are in place in Indonesia. So that's a quick view of what we saw during the quarter, around the world. So our volume was down some 5% compared to last year, and also down sequentially, which meant we had to be quick and flexible in reducing our manufacturing as we went through the quarter to meet the lower demand and to reduce inventory. And so our production was down really significantly compared to the same quarter last year. With that, maybe I turn to profit development.
I think if you compare the result in the third quarter to the first half of the year, we can see that, as I said, the volumes in sales and manufacturing were down, but we were able to keep the operating margin level at around 12.4%, which is a good performance by the team, in my opinion. We used short time working and flexibility agreements with our workers to be able to manage our costs in the quarter. And if you look at the different BAs, you'll see that SI had the big drop, and they faced the biggest challenge from a profit viewpoint, because they had the biggest drop in volumes in their manufacturing.
When you look at RSS, you see a good operating margin of 14.3%, but this includes the SEK 75 million profit from the sale of the distributor business in Australia and New Zealand. And if you exclude that, it's around 13%. By the way, while we have this gain of 75 on RSS, we have some other more normal one-off costs centrally and in the operations in other areas. So for the group, although it's SEK 75 million there, that was quite well offset in the other areas. Yeah, so there was nothing significant for the group at all as a one-off in the quarter. Price mix was positive in the quarter, but a little lower than what we've been normally used to.
So less price increases we announced in Europe and North America are in place, and we had some positive impact of these, but the price mix was negatively impacted by the mix of business within the business areas and especially the intra-divisional mix. Moving over to currency. The currency impact was lower than we thought at the start of the quarter, and that was due to the major changes that took place during the quarter. We had some SEK 75 million plus in operating profit, versus the two hundred and twenty-five million that we forecast. And with this change in the currency, it also impacts what we're seeing for the full year. So we expect the gain for the full year to be some SEK 200 million, instead of what we thought a quarter ago, which was 350.
Quite a drop in the change in the currency development for the SKF Group and the impact on operating profit, which means minus SEK 50 million due to currency on our operating profit in the fourth quarter. Our cash flow was very strong at some SEK 1.7 billion, if I adjust for the acquisitions and divestments. We have a lot of focus on cash flow in the group at the moment, and particularly on inventories, which we took down by a SEK couple of hundred million again in the quarter. One year ago, I spoke about the actions which we'd put in place to reduce our inventory, and if you remember, there were three actions. Firstly, to work more closely with our customers and try to improve the forecasting into our operations.
Secondly, to work to improve flexibility in our manufacturing, and thirdly, to work to get better supply and better visibility with our suppliers. All these three actions we're seeing some good progress on, and since we started this real heavy emphasis in the summer of last year, we reduced our inventories from some 22.5% of sales to some 20% of sales, despite the fact that we've been lowering our manufacturing volumes. So I think the actions are taking effect, and I've got to say, at the same time as we adjust inventories, we get a good service level to the market. But we still have some way to go. We still have a long way to go to hit our target of 18%. Let me probably now move over and look at the outlook for the fourth quarter.
And I stress, I want to stress this, the outlook you see in our outlook statement is outlook for SKF. It's not an outlook on the market because there's a lot of SKF specifics there. We expect to see demand lower year-over-year, with slightly more sequentially and lower year-over-year for the group in total. It's quite broad-based, with the only basically aerospace in both Europe and North America showing a positive sequential development. Our sales to the car industry will be relatively unchanged sequentially, but this is due to the development we have in North America, in Latin America, due to the incentive programs in Brazil, and in Asia, due to the programs that are in, especially in China. Since we really expect Europe to be down quite a bit.
So this is very SKF specific due to the business situation we've got. Our sales to the railway industry will be relatively unchanged sequentially in Europe and China, are the main areas for us there. In China, we expect a new tender for bearings for the freight industry, and that will help us in the fourth quarter there as well. But when you look away from these areas, all other industries are down sequentially there, which means all businesses will be slightly down sequentially as well. If you look at the SI and RSS, what that means is they will be down year-over-year.
While in automotive, we expect to be relatively unchanged in the fourth quarter, year-over-year, because, and we must stress that again, automotive started to go down already at the end of the third quarter last year, so it was already going down in the fourth quarter there. From a geographical viewpoint, we see a similar development year-over-year as we saw in the third quarter, with Europe being down lower year-over-year. For Asia, it will be slightly lower, both sequentially and year-over-year. And in North America, it will be down sequentially, but probably relatively unchanged year-over-year. In Latin America, relatively unchanged both year-over-year and sequentially. So overall, for the group, what does it mean? It means we're going to be lower year-over-year in the fourth quarter.
From a manufacturing viewpoint, we will slightly lower the manufacturing from the third quarter level, which means it will be lower year-on-year. Please remember, we started to lower production also last year in the fourth quarter as well, so that's why it means it will be lower year-on-year, and we still expect to reduce inventories a little bit. Turning now to look at raw materials. I would say raw materials, they will be relatively unchanged to what compared to last year, but a little bit better than the first quarter. This is due to lower surcharges, not a big change in the base prices. Looking forward, we're working with our suppliers to finalize the contracts for next year, so it is too early to give a view on that yet, but be sure we're working on that now.
When I look at the macro environment, allow us to say I expect some improvement in our purchase prices as we go forward into next year. One last point before I wrap up, and that is on the ERP program. We announced we were starting the ERP program last quarter. We started to work on that. The preparation work is quite well advanced in that. Of course, the first introduction is probably still some 18 months away, before we implement the first system, but the work is underway to prepare for this. We've built our project team, and we have system specialist support, external support. A lot of work is underway to try and, you know, nail down all elements of the project there.
I cannot, at this stage, and will not at this stage, give you any indication of the total cost since this is still being finalized and there's a number of details still to be worked on. For example, within this, you have to decide what do you capitalize, what don't you capitalize? Secondly, what are internal costs, which therefore means that we're moving activities and not replacing these activities elsewhere, et cetera. How much are additional costs? So these things are still being all finalized. So I hope in the early part of next year to give you a better view of how I see the program costing us.
I can only say at this stage, so the work we've got underway in the just now is, of course, costing us, and I think in the fourth quarter, it will cost us some additional SEK 50 million to work on the ERP. But you cannot take that figure and extrapolate that going forward, because there's a lot more work to be done in that. So let me wrap up by giving my view, what all this means from a demand viewpoint, et cetera, when you look at the fourth quarter.
I would say, though, if I look at the fourth quarter, I think from a demand viewpoint and from a manufacturing viewpoint, I think it will be our toughest quarter this year, since we'll have the lowest volumes of the year in sales and manufacturing, and the mix of the business will not be in our favor, with automotive doing respectively a little bit better than our industrial businesses. We face a currency headwind as well as the additional cost for the ERP project there. So it'll be tough, tough there. However, and as you know this well, we are working and have worked actively to minimize impact like this. We have a three C program, where we focus on the customer, cost, and cash. We're already increasing our number of customer visits and being more active in the marketplace.
I think the investments we made in front-line people over the last couple of years are supporting the fact that we are making more customer calls now. We are more active in the market. In terms of cost, we're addressing our cost using, in the factories, short time working and flexibility tools, and of course, looking at what discretionary costs and other costs we can eliminate. From an input cost viewpoint, I've already said I expect it to be relatively unchanged year-over-year, but lower than what we saw in the third quarter. For the third C, which is cash, we have a high focus on cash, as you saw in the third quarter there, and we expect to reduce inventories a couple of million SEK more in the fourth quarter.
So let me close off by saying, I think when you look at the weakening and uncertain business environment, during the quarter, we had a good third quarter with very strong cash flow. We've taken some important new orders, we've continued to invest in the business, and we've made what will turn out to be a very, very important acquisition for us. So with that, I'll turn back to you, Marita, and then pass over to questions. Thank you very much.
Thank you, Tom. Now it's time for the Q&A session. Could you please say your name and company name?
Ladies and gentlemen, if you wish to ask a question, please press star and one on your telephone and wait for your name to be announced. Your first question comes from Andreas Willi from JP Morgan. Please ask your question.
Good afternoon, everybody. My question relates to, first, to these, other one-offs you had, in the results that you said offset the, the capital gain. You called them normal one-offs. So it's a strange comment. Either they're one-offs or they're normal. So should we add them back, or is that something you have every quarter in terms of some small incidental negatives? The second question, you alluded to, further restructuring measures. Should we expect any, any, anything soon in terms of charges? And kind of what, what's the guidance here of, the effect on, restructuring for the next few quarters? Thank you.
On the one-offs, in every quarter in our business, there always are little things that we do there. Because you're always looking at inventories, you're always looking at assets and doing things, et cetera. Some of them are held centrally, some are held locally. So we do have some things there. And as I say, when we look at these one-offs and look at the one-off from the sale of the distribution business, it's not significant when you get it to the group viewpoint. The reason we highlighted it is we wanted you to be aware that the... Because we normally, when we netted them out, it wouldn't make any difference.
But because it's such an impact in the RSS business, we wanted you to be aware of that and not to assume that that 14.3 margin was a normal margin there. So we didn't want to mislead you, that viewpoint. So that was much better to be clear on that, so as not to mislead you, that there was a one-off in there. But of course, we have normal things in other areas that we took in the quarter as well. And actually, most companies have one little things that they take that are not fairly significant there. In terms of restructuring, yeah, that's a good point. Let me just say a few words on that. We are, of course, looking at the demand situation we see now.
We saw the volume go down, what, just less than 3% in the second quarter, down 5% now. We know we have issues to address on our, which we've focused on a long time, on our manufacturing footprint. Therefore, we are looking at a number of things that we can do in order to accelerate our activities on our manufacturing footprint and on restructuring. I would expect that we will take probably something during the fourth quarter, a couple of hundred, or a few hundred in the fourth quarter there, but I can't be very precise because nothing is finally nailed down yet. We will be, I would say, expect us to do something in the fourth quarter. Okay, Andreas? Thank you.
Thank you, Andreas. And next question, please.
Your next question comes from Ben Maslen from Merrill Lynch. Please ask your question.
Yeah, good afternoon, everyone. It's, it's Ben from Merrill Lynch. Tom, You said it, kind of, the demand weakened as you went through the summer. I wonder if you'd give us a, a run rate for the volume growth that you saw in September, a sense of perhaps how you kind of enter the fourth quarter. Secondly, just on the inventory reduction, you said you're destocking in Q4, but I guess the longer-term objective is to get to 18%. Does that mean that you're going to keep reducing inventories, as we go into next year? And then finally, just on the, the kind of time banks and short-time, work arrangements, is there any way you can quantify the benefit that you had in the quarter from that, as you used to do in, 2009? Thank you.
Sure. Yeah, September was the weakest month of the quarter for us, and quite a bit weaker than the average we saw for the quarter in total. So it really, it really weakened. I mean, July, August is always difficult to judge with all the holidays moving round about. September is normally the month where you see things bounce back. It did not. In fact, it went the other way for us. So September really was the weakest month, and I say weaker than what we saw for the quarter in total. In terms of destocking, yeah, we'll take, as I said, a couple 100 million SEK out in the fourth quarter, and we will, during next year, take inventories out as well. So we'll keep working on our inventories. I can't say the exact amount.
I've not finalized that for next year, but expect us to take inventories out next year. We're not going to do a hard push, though, to get to the 18% next year. We're around the 20% level, and of course, we must realize in the 20% level, there were two influences we had in that, which is important to note, is one is that we had currencies, which when you look at inventories, helped us in terms of the relation to sales. But on the other side, we brought in the inventories from the GBC, et cetera, and we changed the inventories that way. So they wash out. So the 20% is a pretty good figure of where we are.
We're not going to do a hard push to get to 18 next year, but we will underproduce a little bit as we go through next year as well to bring our inventories down there. In terms of benefits of short time working, I don't have the quantified amount for that there, but we did use it. In some of our operations, we were losing between 5% and 10%, let's say, hours that we were not working there. Some of them were unpaid, some of them were using time banks, et cetera, which helped us reduce the working there. So it's not as significant as it was when we saw the benefits in the 2009 time frame there, but it was an important bit of managing the lower volumes there, but I don't have an exact figure.
We reduced agency and temporary people by 200 as well in the quarter, just to show you know that, in total.
Great. And Thomas, if I can just follow up on the September run rate. I mean, you said that, I guess, the growth rate was weaker. Would you expect the volume drop year-on-year in Q4 to be bigger than the 5% you saw in Q3? I think you're bound to get that question.
Yeah, I knew I would get the question, and then you are not going to answer it, Ben. But I don't intend to answer that. But you asked. I just wanted to stress that this. You asked a question linked to that in September in your previous question, how has Q4 started? I'd say it started in a similar way as September finished for us there. So it's not getting better.
Thanks a lot, Tom. Cheers.
Thanks.
Thank you, Ben. Next question, please.
Your next question comes from Alexander Virgil from Berenberg. Please ask your question.
Thanks very much. Hi, Tom.
Hi.
Just a couple, please. On the price contribution, obviously, you pointed out that it had got sequentially worse, but that you have already implemented your price raises, I guess. How does that look going forward? I mean, how do you expect the price increases that you put through to come through in the numbers? Or should we expect that sequential decline to get worse? And then the second point, just in terms of the industrial goods distribution outlook, I think it got a lot worse in Europe and softer a little bit in North America sequentially.
What are your customers saying there in terms of, you know, are you seeing signs that people are wary of, or the potential fiscal cliff in the U.S. is causing problems with respect to their decisions on orderings? Or can you give us any comments on that? Thanks.
Mm-hmm. If I take that one first, in distribution, I think, actually, what's happening in USA is not just impacting distribution. I think it's impacting quite a bit in a number of areas in USA, and that is the cautiousness around what will happen with the presidential election, who will get in, how will they address some of the challenges there, and as you say, the fiscal cliff that's there. So I think that is impacting it, and we saw that, as you rightly point out, in our distribution, that they're being a bit more cautious in what they're bringing in. The business still held up well for us in distribution there, but it wasn't the sort of growth that we had seen previously in there.
So I think it's more a case of just cautiousness up there. Because if you actually look at it, many factors in the U.S. economy don't look that bad. I mean, retail sales are not bad, are improving in a reasonable way. Housing's improving somewhat there. If you look at the unemployment rate, it's better there. So I mean, there are some things that are there, but I think there's much more cautiousness in the business community over there, and that impacts us. And similarly in Europe as well, what we see is Europe, there's a combination of two factors, which is that the end market demand is down a bit for our distributors in Europe. But in addition to that, there is nervousness in putting things in, and that applies also in other areas.
I would say there's a more cautious nature taking place there. If I go back to your question on price mix, yeah, as you rightly pointed out, the price mix was weaker in the third quarter compared to what we'd seen earlier in the year, despite the fact that we moved prices in. And that's a combination of mix of businesses that we have within there, within each business unit, but also the mix between the interdivisional area. And as I said earlier, I don't see that getting better in the fourth quarter. It's going to be a tough fourth quarter due to the mix of business.
Okay, great. Thank you, Tom.
Thank you, Alexander.
Thank you, Alex. Next question, please.
Your next question comes from Aaron Ibbotson from Goldman Sachs. Please ask a question.
Hi there, good afternoon. Just a couple of questions from my side. Firstly, just one on China. I think you in Q2 commented that China was sort of weaker on a year-over-year basis than Asia as a whole. So judging by your comment, that seems to still be the case, and I just wanted to see if you could confirm that. Secondly, just and relatedly, how are you seeing the competitive situation in Asia in general and China in particular? 'Cause you seem to be sort of very weak there relative to some other data, and also if you look at the price mix, I was just wondering if you had seen any change in competitive landscape, maybe on the medium end.
Then finally, just a clarification, maybe I missed this, but did you, did you say that you thought the fourth quarter would be the toughest quarter? Did I get it right? And if so, is that an indication, although I know you don't appreciate guiding, that we should expect margins to go down in the fourth quarter. Thank you.
On China. Yeah, if I take China, first of all, yes, China is weaker than Asia in total for us there as well. As you probably, part of the Asian business in total, I mean, if you look at some of the figures that you get out from Asia, they don't see declines, one would say, as we say, if you listen to GDP and industrial production areas there as well. I do not believe, and I don't see signs that we're losing market share down there. I think it's more, in terms of the businesses we're in, I think it's more the exposure to the businesses that we're in, and also exposure to certain markets. For example, India, we have a good position in India, and the Indian business is really impacted at the moment.
I think there is a lot of things happening in the Indian market just now, especially in the industrial arena, with being held up due to basically an action from a government viewpoint. If you go in China, we have been performing differently to the Chinese market due to our exposure to the renewable, due to exposure to the railway business, et cetera, and a negative mix in the automotive business there. So it's not a competitive landscape thing per se, that is changing, for us so much. It's more a case of the situation of the industries that we're serving is doing somewhat, probably worse than the general marketplace in total, which means our volumes are impacted that way. And Asia did weaken more in the quarter than we didn't expect that in the quarter there.
If you go back to Q4, yes, I did say, I think it's the toughest quarter in terms of the fact of the volumes we will have there, 'cause we're gonna be slightly down sequentially, and we're also gonna be slightly down in our manufacturing. So it's gonna be our toughest quarter in terms of sales and manufacturing. As I highlighted earlier, we have the somewhat negative mix in our business more in that quarter as well, with automotive being a little bit better than the other two areas. So it was more a case of just trying to give you a view of how I saw the fourth quarter rather than give a guidance and profit, 'cause as you say, we- that's something we don't want to do.
Okay, perfect. Thank you.
Thank you, Ron. And next question, please.
Your next question comes from Martin Prozesky, from Bernstein. Please ask your question.
Good afternoon, everyone. Two questions from my side. In terms of the effect on gross margin we had in the quarter, with volumes down 5%, weak price mix, some de-stocking, can you give me a bit more color on just how you're able to maintain gross margin? Was it this temporary kind of temporary labor effect that you alluded to, or was there also some input cost relief? First question, and then in terms of mix, given that we've seen probably a lot of OEM volume fall, I would have expected the service mix to improve and therefore margins to have been supported by that, so price mix to have been a bit better. Can you explain why that hasn't happened in Q3, and why you're also not expecting that into Q4?
Yeah. If I take first of all, on the gross margin, I mean, the gross margin dropped quite a bit, for us, there, and, the impact in the gross, and if you... That was basically what took, what took down our, operating margin in total, and that was driven by the, the lower production volumes, in one side, significant lower production volumes, the lower sales volume, which was the sort of headwinds in, in that side, for us. In addition, the, input cost actually was somewhat higher in the quarter there, so that was a negative for us there. And we spent a little bit more on R&D there. On a positive side for us in total, as a group, the currency was +SEK 75, and we had the positive price mix.
So on one side, you've got these two positives. On the other side, you've got the minuses of sales volume, manufacturing volume, input costs, and a little bit higher R&D. And when you actually put them together and put factors against it for absorption and other things, et cetera, it comes in line to show why our profitability went down. And that's what hit our gross margin there.
Just on sequentially, the gross margin was flat, right? It was 25.9--
Yes.
-- 22, and 25.
Yes. Yes, yes. Because, I mean, we're working hard as well to manage costs in that. So, we really are doing a lot to use schemes to reduce costs in our operations, to reduce discretionary costs and other costs there, to try and manage the volume. So I think the... As I said, the team did a good job there in doing that. If I go on to the price mix one there, price mix at 0.5%, I think it's an interesting point you raise.
I mean, with the price movements that we put in place, you could have expected somewhat better, but we were influenced by the two major factors, which was the negative mix of the business within the business areas, which had some impact on us, and also on the other side, the intradivisional mix. Because the two industrial businesses were down more than the business in automotive. So relatively speaking, we had a negative intradivisional mix there. And that negative intradivisional mix will continue in the fourth quarter.
But within the industrial divisions, did you not see an improvement in some of your service businesses relative to?
Sure, sure. And remember, as well as we go through the year, the comparison is pretty tough because we did good price mix development in the, as we went through the year, last year.
Okay. Thank you very much.
Thank you, Martin. Our next question, please.
Your next question comes from James Moore from Redburn London. Please ask your question.
... Yeah. Hi, everyone. Hi, Tom. I've got three questions. Firstly, I see you've lowered your sequential outlook for VSM, two-wheeler, energy, industrial OEM, distribution, quite a number of markets, but not automotive and truck. I just wondered if you could give us a feel for what you're expecting for auto and truck production by region into the fourth quarter compared to the third quarter. Because I know there are a number who've talked about a worsening car production market, maybe going from 8%-15% down next quarter. So I'm just wondering whether you think it's better than that, or it's an issue of customer restocking, or the fact that actually it's only a fifth of the auto division, and there's truck and there's other stuff from VSM and other geographies.
Secondly, I wondered if you could give us what the clean inventory reduction for the third quarter was, excluding FX, and was that all finished goods and work in progress, or was some of it raw materials? And thirdly, China organic sales growth. Could you give us a feel for what the third quarter looked like against the first half, and how you see that developing?
Mm-hmm. If you do the car and light truck area, James, then we expect, of course, vehicle production to be down a lot in Europe, in the fourth quarter. The latest figures I've got is it'll be down, I don't know, something around 10%-11% year-on-year-
Mm-hmm.
In the fourth quarter, there, which is a bit more than what it was down in the third quarter there. So we expect a very weak European car and light truck market. North America, we see it will be up year-on-year, but not up as much as it was last quarter. There, but actually, even sequentially, it's holding up pretty good as well.
Mm-hmm.
For the Asian region, I think the figure that we see is a growth a little bit better, probably 8%-9% type growth year-over-year there. But of course, Asian being more influenced by the mix of business. Latin America, I don't have off the top of my head, I must say.
Mm-hmm.
So if I look at that, why do we have the arrow flat? And the reason we have the arrow flat is very much due to the combination of North America, with the businesses that we've got in North America, and how. And we're performing significantly better than the market over there in North America, but that's very much specific to us. Secondly, in Latin America, we saw signs that our car business is somewhat better in Latin America, as we went through the quarter there, and that's due to, as you know, the stimulus program they're putting in place in Brazil, markets like that. And in Asia, we were helped as well by the fact that, especially in the Chinese market, certain vehicles were given stimulus, and we're on these vehicles, and that will continue for us.
So it's more to do with us than to do with the other area out there.
Okay, thanks.
In terms of inventory, yeah, we were down around, not far from SEK 300 million through each quarter in inventories. Not, not that far, in that area there, as well. A lot of it was in finished goods, work in progress. It wasn't so much into the, the, the raw materials area there. China, organic growth in China, as I said, the growth or decline, actually. The organic development in China was down a little bit more than the, the Asian region was down for us.
If you just compared the third quarter in China, the number, without giving the number against the first half number, has that number got a bit better or a bit worse?
The number-
Or a lot worse, or?
- has got better, and that is because of the fact that we were down in China during the already into the third quarter last year. Because we started to see in China some change in the third quarter. So the number has got somewhat better, but the level has not got better.
That's what I'm sort of driving at. I'm wondering, do you see it getting to zero in the next couple of quarters or not?
I hope so. Yeah, I think to be fair, I think really looking forward in a couple of quarters out. If I look at China in a longer perspective, I would say, I think we'll still see some tough things in the next quarter, but going in, into next year, and especially into the second and third quarter, I believe that when the new president's in place, and as the stimulus packages that we've put in place start to kick in, we will see some improvement. And, and not just because of the year-on-year comparison, but I think some improvement in terms of actual growth coming back into our business as we go into next year.
All right.
Maybe not the first quarter, but definitely as we go through next year.
Okay, thanks, Tom.
Thanks, James.
Thank you, James. The next question, please.
Your next question comes from Guillermo Peigneux, from UBS. Please ask your question.
Hi, good afternoon, everyone. Hi, Tom, hi, Marita. I have a couple of questions, actually. How much in your mix price picture, how much was mix, how much is pricing, roughly? And then secondly, when it comes to the future, when you think about growth, how much growth do you actually need to get your... Let's say that your inventory is normalized at some point, but without under absorption and everything, how much growth would you need to actually get back up to your 15% EBIT margin? How much time do you need without actually having to restructure the business even more to get to that 15% EBIT margin target?
The price mix, I don't have the split between the price and mix for the total for the group. I know that when I look at each of the three business areas, and I look specifically at the RSS business there, their improvement was related to price in the business there. But I don't have that as a total there for it. In terms of your second question, Guillermo, I would say that it's not significant growth. We must realize that we're actually, in terms of overall volumes, we're not at a bad level. It's the fact that we are underproducing just now, which impacts us, and we are breaking the production, which impacts us.
I think we will need to take some steps to get a better cost base in the group, and that is an important part of us going forward. If you remember, we placed 3 initiatives to drive our margin. 1 was growth, profitable growth in our business, which was focusing on elements like the BeyondZero portfolio, taking full advantage of our platforms and on the service business. Secondly, we said, in order to get there, we must continue to reduce costs and eliminate waste in our business. So that is an important element for us as well. And, of course, as we invest in growth, which I will not talk about just now. So for me, it's not just an absolute, you need X% of growth.
It is, you need to be able to operate with your accelerator, which is growth, and with your brake, which is cost. And that's why, as I say, we're re-emphasizing our three C program in SKF, which is spend more time with the customers, capture more of the customer's business, so that you can get better business, a better mix of your business. Drive the BeyondZero portfolio, which will be better for us in terms of our ability to get margin. At the same time, let's find ways of taking cost out. Cost of doing business and manufacturing costs, and become more efficient and effective. So you need a combination of two. So I don't want to say you need X% growth to get there, because I think it is a combination of the accelerator, which is some growth, and the brake, which is some cost.
At the moment in time, there's probably quite an emphasis on the brake to take cost out, because the growth in the macro viewpoint is not there at this moment.
Okay, maybe a follow-up. Your acquisition, GBC, is two months incorporated in the numbers, if I'm right?
Yes, correct. Correct.
So that's actually three months into September. Sorry, from the fourth quarter onwards?
Yeah, I mean, that'll be three months in the fourth quarter onwards. So therefore, that structural will be a little bit better in the fourth quarter, yes.
Yeah. And then your operating profit in the quarter is in the corporate line, I, I assume, right?
Yeah, it is. It's outside of the three business units, yes.
In the corporate line, your operating profit actually dropped, if I back it up. Is that because of the costs of basically incorporating GBC?
There's many factors that go into that. Remember also, when you acquire a company, just now with the new PPA rules and other rules, that what you've got to do, either if you acquire a company with good profit, you have to mark your inventory up to that level, so you don't make-
Got it.
a profit in these companies up front.
So that will normalize in Q4?
Yeah, I'd say you probably will go through Q4. It'll get better as we go into next year.
Okay. Okay.
Okay.
Thank you.
Thanks, Guillermo. Thank you.
Thank you, Guillermo. We have time for one or two more questions.
Your next question comes from Colin Gibson. Please ask your question.
Hi, it's Colin from HSBC. Just two questions, please. Firstly, circling back one more time on the price mix question, could you just comment on whether the regional mix had any impact as well? I heard what you said about the intra-divisional mix and the product mix, but I was just wondering as well about the regional mix that you saw in Q3, with, I guess, Asia underperforming your expectations particularly, but also Europe weak, whereas the Americas were relatively strong. And then the second question, please, even if you exclude the capital gain, Regional Sales and Service managed to maintain earnings pretty well in Q3.
Yeah.
despite a significant revenue slowdown. I'm just wondering how you managed to pull that off.
Yeah, yeah. I think if you look... And that's where I would say that, you got some benefit in RSS from, the pricing that they put into the marketplace, there as well. As I said, when you mix in between all the three, you lose a lot in intra-divisional mix. I'll answer your price mix one up first, though. The price mix, from a regional viewpoint, it doesn't, it... There weren't big differences. It was much more driven from an industry viewpoint and industry market viewpoint than a regional viewpoint that impacted us, there. As I said, in terms of RSS, yeah, they did a good job. They managed their costs in a good way. And remember as well, they don't carry a huge amount of assets.
So even if volumes drop a little bit for them, they don't have the big impact. They don't have the big swings that you get in other areas. And of course, as I said, they moved the prices in the market, so they had a little bit better development that way. As you rightly pointed out, they did a good margin. They were at 13%, which is good for them. Up a little bit from where they'd been in the first half.
Great. Thanks.
Thanks, Colin.
Thank you, Colin. Now I think it's time for the final question, please.
Your final question comes from Arnaud Brossard, from BNP Paribas. Please ask your question.
Hi, everyone. Hi, Tom.
Hi, Arnaud.
Question on your balance sheet. I'd like to know what you think of it at this stage and how open you are to potentially large acquisitions or returning cash to shareholders?
Yeah, that's a good question. I mean, if you look at it, we've just taken the step to issue the EUR 500 million bond. So our balance sheet, we've got a good amount of cash on our balance sheet just now. We're actively looking to see what we can do to repay back some of the, the, the bond for next December and some of the loan for 2014. So we're doing some work on that, which will do things and impact a little bit the cash there. And also going forward, of course, we're on the lookout for potential acquisition opportunities, and we're working on potential acquisition opportunities. Not huge ones, but ones that will use some of the cash that's on the balance sheet there.
I think also with the uncertainty that we're seeing right now in the business environment, it's good to go into this with a good balance sheet. And that's why I think the step that we took to raise the money in the market was a good step to take. It gives us that flexibility to manage. If things get even worse, it gives us the flexibility to manage that.
All right. Thank you.
Thank you.
Thank you very much, and that brings us to the end of this presentation. Thank you for joining us, and if you have any more questions, please do not hesitate to contact me. I will be available for questions right after this call.
Thank you very much, everybody. Thank you. Goodbye.
Ladies and gentlemen, that concludes our conference for today. Thank you for participating. You may all-