Ladies and gentlemen, welcome to the Volvo Group year-end report 2014. Today, I'm pleased to present Olof Persson, CEO. The first part of this call will be a short introduction from Olof Persson, and afterwards there will be a question and answer session. Speaker, please begin.
Thank you very much. Good morning, good afternoon to all of you, and welcome to this telephone conference for the fourth quarter 2014. Just let me a few minutes to wrap up my main takes and the summary. As you know, on the web you have the full press conference and presentation from this morning, and then we will go over to question and answers rather quickly, as we used to do in those telephone conferences. If I would go for a quick summary, I would say that we have two trends in the fourth quarter. One is on the truck side, where we see that despite lower volumes, about 9% lower deliveries, we have managed to increase the profitability with around 10%. On top of that, we have historically a rather good order intake in the quarter as well.
On the other side, we have Volvo CE, the construction equipment business, who has had a really tough quarter when it comes to volumes and declines in many markets around the world. We're looking at actually a 30% overall lower volumes, which of course have led to lower capacity utilization in the factories that we have in our system. We can also conclude that the restructuring plan is continuing according to plan. We do have traction in cost savings, and you can see that in the material as well. If we look at the totality and total number of employees and look at the full year numbers, we can conclude that we have during the year reduced our total employees, both blue and white collar, with almost 5,800. In the fourth quarter now, about 1,100 white collar left the company in conjunction with the efficiency program.
We're also seeing a good cash flow, a seasonal good cash flow in the operations. We have continued to strengthen the balance sheet. As you remember, there were three key focus areas for this year. One was the cost efficiency relating to the efficiency program. We talked very much in the beginning of the year of the balance sheet strengthening and the balance sheet efficiency. It's good to see now that if you take the full year number, we actually have reduced our net debt with around SEK 10 billion, leaving us now with a 14% net debt to equity ratio. With that, I think most of the information is out there, and instead of me summarizing more, let's open up for question and answers.
Ladies and gentlemen, if you have a question for other speakers, please press 01 on your telephone keypad. That is 01 to ask a question. We have a first question coming in from Mr. Klas Bergelind from Citi. Please go ahead.
Yes. Hi, guys. It's Klas from Citi. Olof, I have some questions on construction equipment. Firstly, I know that you don't report under absorption effect anymore, it would be really helpful if you could give us some sort of indication of the margin impact on the back of the inventory reduction. We could obviously back it out if you could help us with firstly the volume amount of the inventory move, how much was finished goods versus parts.
Okay. I think actually I hand over that question to you, Jan, to elaborate a little bit on that one.
Yeah. First of all, I think the CE organization, I think you can see that on the charts. They have really managed this, I would say, quite dramatic downturn. I mean, we actually have a volume decrease of 30% compared to one year ago. You can see that we keep the book-to-bill ratio at 100. What we have managed to do is to actually stop up the production in a way that we have not built any kind of inventory of new products, also managed to stop the supply chain. We have actually managed to reduce the inventory quite a bit in the fourth quarter for the whole group, that is also including CE as well. I would say when it comes to CE, the way we handle the downturn there now, operationally, has been so far very good, actually.
How should we think about sequential margin progression here? If we have the spring season in Europe, that's going to be a help. Demand is weaker in North America. I guess the comp year in China on the back of the spring season likely to be much worse year-over-year. Thinking about the margin progression, is it likely that the margin will land around 2%, 3% in the quarter?
We never comment on any kind of margins. I think if you look upon the seasonal pattern that we have, usually in CE it's of course that the fourth quarter is a very weak quarter. During the first quarter, it gradually comes back, as you correctly mentioned, due to what we call the spring season. If there is a spring season, how big it is this year in China, I think that's very difficult to judge. There is an underlying seasonal pattern.
Okay. Just on CE and the savings. The incremental savings at the group level last quarter was SEK 3.5 billion for the group. The 1,000 people leaving in CE is a fairly small part of that, maybe SEK half a billion. The first question on the savings here is, out of the SEK 3.5 billion, how much is undisclosed savings in terms of real capacity closures on the fixed side?
I'm not really sure. You mean the SEK 3.3 billion that we show in the SEK 10 billion, or what do you?
Yeah, the SEK 3.3. Okay, sorry.
The SEK 3.3 billion is, as you can see there, it's about selling admin, R&D, and then we have the first one, which is the structure cost reductions you can say basically within fixed manufacturing to keep it in the gross margin. That one has been reduced now since the base year, which is 2012, with SEK 1 billion. There is actually no effect from CE in that. As you know, the restructuring that we actually announced in connection with the Q3 report is now being put in place, you can say gradually over the first half of this year. We will not have any structural cost reduction effect in CE included in that SEK 1 billion. That will come gradually during the course of this year.
Yeah. I am aware of that. I'm trying to gauge the incremental savings ahead for CE, because if you think about this, only if you take half of SEK 3 billion to come in CE at the current demand level, that would be 300 basis points on the margin. That would take the CE margin at current demand levels to 7%, assuming that China will not come back, and I think we all agree with that. That would assume a very sharp recovery in developed markets to basically get back to peak margins. My question is really, are we accepting that we will not reach a peak margin for CE, or are there more savings to come, basically, a new announcement?
You can look upon it in this way. What you heard, the thing that we announced in the third, that was a restructuring basis structure cost reduction that we would have done more or less regardless of what we have seen in the market. We are now short-term focusing very much about adapting our production capacity to the present and demand in the market, which I just mentioned now. We are, at the same time, also then putting a lot of emphasis and focus on what we can do on the OpEx side and R&D and so on. Whether we need to do more than what we are already working with, that of course, we will see if that's necessary, and if we take any kind of decision, whatever we do, we will announce it in that case.
Of course, we have to value it a little bit, how this goes forward now in the next quarter and so on.
Great. Thank you so much.
Okay, we have a next question coming in from Mr. Martin Viecha from Redburn. Please go ahead.
Hi, this is Martin Viecha from Redburn. Thanks for taking my questions. I have two questions, if I may, regarding the slide 24 in your presentation. I've noticed that there's one item missing, which used to be in the restructuring presentations before, and that's the R&D net capitalization impact. In other words, once we include that impact of net capitalization of R&D, the SEK 10 billion figure would drop to, say, SEK seven or SEK eight billion instead. Ultimately, the savings which we will see in the P&L will be in the region of SEK seven to SEK eight billion. I just wanted to confirm if this is correct or incorrect. Second question would be, we know that the SG&A and R&D in the restructuring slide includes the currency impact. I wanted to ask, does the gross income in the first line include currency impact as well? Thank you very much.
Yeah. Regarding the cash R&D, this is really the cash outlay that you have in a company. I refer to the capitalization, amortization as you can say, a bookkeeping effect. To keep the cash flow and also to balance out the R&D resources going forward, the cash R&D is what we focus on, and that is a part of the SEK 10 billion program, the way we now wanted to describe it as of the third quarter last year. That SEK 10 billion is the cash R&D included in no effect of capitalization or amortization. We are now coming gradually out of this effect that we had where we actually capitalized a lot in connection with the development of the new Volvo and Renault ranges. Then after that, we have had, you can say, the negative effect of less capitalization and also slightly higher amortization.
That effect is now gradually coming back. If you look upon the fourth quarter, that is more or less you can say the level of capitalization, amortization we will see going forward in this year. Year-over-year, you will have almost no effect from, it's a little bit tricky to do that, but as far as we can see, it will be on balance compared to the year before.
Sorry, compared to year 2012, when I think there was a net capitalization of about SEK 2.3 billion. Compared to 2012, in what sort of region? Are we going to see net amortization or net capitalization in 2016?
Martin, we'll have to come back to that. We don't want to give forecasts that far into the future, it's not unlikely that you will see capitalization starting to increase again as you have new generations of trucks and other products that will gradually start to come closer to production decision. If you take it into 2016, capitalization might start to recover a bit, and that of course has an impact on the P&L.
Okay. Thank you.
On the currency effect, we do have a negative currency effect, especially on the selling expenses, but also on the R&D expenses, since we have that in other currencies than SEK. It is actually quite a significant effect in the fourth quarter. That we have said, the SEK 10 billion is still there. We will not change our targets on that one due to the recent currency movement that we have seen. When it comes to the currency effect on the structural cost reduction in gross income, I think that if any, they are very limited, I would say.
Okay. From now on, would the FX impact be included in that line, or only some of the FX impact will be included there?
They are included in the line.
Okay. Thank you very much.
We have a next incoming question from Ms. Laura Lemke from Morgan Stanley. Please go ahead.
Good afternoon. I got two questions, please. The first one would be on trucks, and I was hoping that you could maybe help us a little bit with regard to incremental margins in 2015, because when I look at the different regions, you're obviously at different points in the cycle here. For example, in Europe, we're kind of, let's say, on an upward trajectory, more early stage, whereas in North America, we're kind of close to peak, then obviously in Brazil, we are at least some way into the downturn now. I'm just wondering if you could help us a little bit to better understand how the incremental margins are changing. I.e., are incremental margins, for example, in Europe going to be the same as you had last year? Are they lower or higher?
That would be actually really helpful also for the U.S. because as I understand, your capacity utilization is quite high now on the second shift. How much can you really squeeze out on the current shift model, and how much of that additional revenue is really going to drop down to the bottom line? That's my first question. Then on Construction Equipment, you said that China was break even, if I understood correctly this morning in Q4. Now, if I just look at the FX-adjusted clean EBIT in Construction Equipment, you were at -1.7% margin. That to me suggests that something else must be loss-making. I'm just wondering, can you talk a little bit about that, where the additional problem areas are? Thank you.
Okay. Thank you. If you look at the incremental margins going forward, I give you some input to it. If you look into North America and looking at the market that we foresee here, we have said that one part of our activity is very much now to balance market share and pricing, and I was also clear today that our ambition is, of course, to make sure that we have a good pricing structure in North America going forward. When it comes to capacity, we are increasing the capacity step by step in the American system, and we do that in a very controlled way. That means, for instance, that we do not plan as per yet to change the shift structure, for instance. We are filling up now within the present structure.
That we will have to see then going forward what that would mean on the margin side. That's the activity we do. In Europe, I would say that as you can see also in the book-to-bill, we are pretty much balanced in terms of the production and how we have set up the production. It remains to be seen how the development goes. Of course, if we fill up the factories, in the Renault factory, for instance, with extra trucks, that would of course have a better coverage when coming out in the profit and loss.
In Brazil, you have the reverse, where we actually need to then both in a very tough pricing environment as it is in Brazil, and also we have to reduce the production, as we said, with six out of 13 weeks now being stop weeks in Brazil. That would be the major movements in terms of the actions we're doing in order to make sure that as much as we can then secure that we get the incremental development that we would like to see given the market situation.
Okay, if we take China, as I said earlier today, I think we are broadly around the break-even. I think that was more or less what I said. Look, the China effect is not only a China effect that we see. We also said that we have a lower demand in mining, you can say, generally speaking, especially in Southeast Asia and other parts of Asia, and also some other parts of the world as well. That has also affected us. We have actually, as you know, sales going into Russia as well. We do have, you see I think one of the pictures we say that we have, which is correct, the 21% capacity utilization. That is, of course, extremely low.
Due to, you can say, that is, of course, is not only China. It created capacity utilization in Wuxi our component factories as well. That cannot be offset by any other regions, where we are in a more, what you say, positive situation.
Okay, great. On the 21% capacity utilization, that was just the China number, right?
BRIC.
Say it again. BRIC?
BRIC countries.
Okay. Perfect. Thank you.
The next question comes from Mr. Alex Potter from Piper Jaffray. Please go ahead.
Yes. Thanks. Couple of questions here. I guess, first of all, can you comment on your market share group wide in North America in terms of orders for trucks? There's been some speculation over the last several months that these extremely high order numbers that we're seeing in North America are due to, potentially one OEM taking unusually large numbers of orders, stretching out several quarters. I don't know if you guys have seen that, or if you think the strength in orders is equally strong across all of the OEMs in North America. That's the first question. Second question is just if you can comment on kind of what your strategic priorities are for the Dongfeng joint venture, just what the highest priority actions are in the near term. Thanks.
Okay, Krister here. I take the first question. Basically, you can say we are getting the share we would like to have in that North American order intake. We have a fair share of it. Okay. When it comes to the strategic, there are a number of strategic plans and activities that we now start to embark onto since a couple of weeks when we have officially now got the joint venture up and running. You can divide them into two major areas, I would say. One is on the technology side and the other one is on the marketing side. On the technology side, we are looking at technology both when it comes to the transmission, but also when it comes to the engine side. That's projects now being started up for that.
When we look at the marketing side, it's still early days, we are sort of developing those strategies together with our partner to then see how we should fulfill the overall objective with the strategic alliance. That is, of course, to strengthen the Dongfeng and also the Volvo in China by utilizing the common strength, both from a technology point of view, but also from a presence point of view. Also see how we can develop Dongfeng to become an international brand over time. Those are still early days in those kind of things. When it comes to the technology side, specifically on the transmission side, we are moved ahead quite rapidly on that one, the next one will then be on engine side.
Very good. Thanks.
Okay. The next question comes from Mr. Michael Tyndall from Barclays. Please go ahead.
Hi, there. It's Mike Tyndall from Barclays. Thanks for taking my questions. 2, if I may, just one touching on China and CE. You certainly mentioned that your inventory is in good shape at the moment. Olof, I think you mentioned on the Q3 call that the industry as a whole had a fairly significant backlog, you thought it would take several quarters to clear that. Has that got worse or has that got better over Q4? Any color you can give on when you think that might actually correct itself? The second one, just in relation to U.S. orders again, I don't know if you have a measure of duration, but are we looking at an order book that looks the same as it did 12 months, 13 months, three years ago?
Are truck buyers ordering further in advance than they were previously? Thanks.
Okay. I would say on the China CE and the inventory and the whole pipeline, which I talked about on Q3, I would say that it is fairly stable. No major movements in any direction in that one. Still, it is definitely an S after the word quarter when it comes to the time it will take to clean out. We are talking about quarters to do that. As we have pointed out a number of times, we are definitely making sure that from our side, that we are pushing everything we can to make sure that we are balancing our own system as quick as possible. It's a lot of hard and very detailed work going into this to make sure that that is happening.
When it comes to the order book in North America, I would say that when you are looking at and going in a book-to-bill ratio that we are right now, and you have the market strength as we see in North America, we're keeping a very close eye on the order book to make sure that we have a very good quality in the order book. There are two ways of doing. Right now, we are in a four to five months delivery time, depending on a little bit, but you can say that as an average. If you look at it, we also now then increasing our capacity in our factory step by step to make sure that we can balancing the order backlog in a good way. So far, so good. We haven't seen any sort of worsening of the quality in the order backlog.
We have processes in place to make sure that we keep a very close eye on that.
Okay. Can I just one quick follow-up? You mentioned increasing production step by step, but not increasing shifts. Can you be a bit more specific? Are you just adding more people or adding more overtime? What do you mean when you say step by step?
The very short answer is that yes. It is both. We are adding more people. We are utilizing more hours, so to say, overtime and other things in order to increase then the line rate, and that is what we're doing. It's sort of a taxing line rate increase that we're putting there step by step during the spring. We do it step by step because we want to make sure that we managing the whole pipeline and managing also suppliers and everything, not to rush into too high of a production rate. We're doing that, and we're doing it in a controlled way.
All right. Thank you very much. Cheers.
Cheers. Okay. For the moment, there are no further questions. Therefore, as a reminder, it is 01 to ask a question. Thank you, operator. I think we can conclude the conference here. Okay, no problem. Okay. Thank you so much for joining, if not before, talk to you again presenting the Q1 in April. Thank you.