Good morning and good afternoon to all of you, and welcome to this Volvo Second Quarter 2011 Conference Call. I have in the room here a slide from our IR people. We have our incoming CEO, Olof Persson. We have Mikael Bratt, our CFO, and we have business area leaders. We will take you through a number of slides that you can get on our web page. I will be beginning with slide two, the one that says group highlights. We had a very decent quarter. The operating income amounted to SEK 7.6 billion, and sales were just close to SEK 80 billion. Operating margin at 9.2% and a cash flow of SEK 5.2 billion. If you look at the business environment, Europe, we have put all together here as improved.
What's happening here is that Northern Europe and Central Europe, notably Germany perhaps, is doing reasonably well, even though they are still between 10% and 20% below where the peak was in Q2 2008. Southern Europe is doing very weak. You can say it's still two-thirds down compared to their peaks. At least we can say they are probably from these very low levels, probably now slowly improving with more of an emphasis on slowly than on improving. We have Greater Europe. You can take Poland, Russia, Turkey, and Eastern Europe. That seems to be coming on quite nicely. Altogether then that provides for an improved total characterization of the European market. In Asia and in China, I think we have said a number of quarters that it would probably be good if there was a slight pause in the hectic growth that we've had in China.
We think that's what's happening now. We see no reason to think that the market in China will be less important for us or as a market as we move forward, but that there is a plateauing in the Chinese market. I think Pat Olney will speak more to that vis-a-vis construction equipment especially. In Japan, obviously in the quarter we have had a significant impact with about SEK 300 million in operating result effect on construction equipment, SEK 100 million on the truck side, SEK 400 million altogether. Most of that seems now to be behind us. We are looking at Japan as a country with recovery from Q2 levels, but also with a slightly higher expectation of demand as Japan comes into a build-up phase after the earthquake events in the second quarter. In India, you can see a reduction in growth rates, but still solid growth there.
In many ways, you can say South America is the same here. We'll look a little more into some detail in Brazil here. South America remains a strong market for us. Interestingly to note, you can see that North America now is coming up, if you look at order intake quite well. The more long haulage and the more industrial production, the better. The more construction or even home construction, the worse the market. As you will see in the presentation, North America is now bouncing back quite nicely. If you look at slide three, the one that says Volvo Group, there you see us clocking in sales. Then there were 15% higher in sales between Q2 2010 and Q2 2011. That actually translates into 29% if you clear that for foreign exchange changes. So 29% real growth there.
If you look at it in operating income, they're traveling at a speed closer to 10% than to 9%. If you look at the pie chart, you can see that if the whole of the group grew by 29%, it's almost stable between, on the one half, North America and Western Europe, and on the other hand, Eastern Europe, South America, Asia, and other markets, which means that we're actually in a situation where the whole world grows reasonably equally and quite well. In the case of North America and Western Europe, it is off of very, very low levels. A good geographic footprint there as we see it. Interesting to note also, you see that we have noted here on the plus side increased sales of new products. You remember that we took a fairly heavy investment in R&D for future products during the crisis.
That seems to be paying off quite nicely now as we have introduced a number of new products, both on the truck side and also on the construction equipment side. Efficient, more productive, but also in some cases, architecturally from a group point of view, better products. They seem to be doing well in the marketplace. With that, we have an overall impression that we are gaining share in the different world markets and across the different business areas where we are operating. Obviously, the operating income benefits from that increased volume, both in terms of new products and from the market demand in itself. We have 100,000 people plus who have contributed to good improved productivity with the number of people coming in for assembly lines much lower than the actual production output.
We have said as before that we are focused on making sure that the cost decreases that we announced and made during the crisis would be held on to. We think we can tick that off and say that's sped down. With that, let me hand over to our CFO, Mikael Bratt, and slide four, the one that says cash conversion cycle.
Thank you, Leif. I'm happy to report here that we have managed to shave off one more day from our cash conversion cycle. I would say despite some inventory build-up, as you have seen mentioned in our report, the work, of course, continues here. We should get below the 20 days within some time frame here. The goal remains here as we move forward. Moving on to page five and the net financial position. We have during the quarter seen a change in the net financial position with a negative SEK 1 billion coming from, of course, the cash flow, but also that we actually have paid out a dividend to the shareholders here of SEK 5.1 billion in the quarter and some currency headwind here.
I would say that also in the quarter here, we had, quote-unquote, "an extra payment day" here as our payment cycle ended up in connection with the end of June here. We got some negative effects from that also. I would say that this, of course, repaired by itself over time here. That, of course, impacted it in the quarter, of course. We have slided back then above the SEK 40 billion here, which is a temporary thing. We should get back below the SEK 40 billion again within short here. As you can see, it's, of course, not a straight line here, but we are moving in the right direction overall. Going further to page six. Here we have the currency details for you here. I will not dwell on this. You have seen it before. I think you could summarize the currency impact in just two sentences here.
First of all, it is really related to our flows in the quarter. You see the spot rate here stands for SEK 1.7 billion out of the total here. We have also seen very limited impact between Q1 and Q2. Sequentially, it has been stable. As I mentioned before, also here, VC is taking about 50% of the effect here. I would say in absolute amount, I would say of magnitude, the rest is really in the truck segment, even though in some of the other business areas you have for the size of the business area significant impacts, of course. From a group perspective, you could place it like that. I will keep myself fairly short today here, and I will stop by that. Thank you, Leif.
All right. Let's go to slide seven then and the truck slide. There you can see we actually got SEK 50 billion sales in the quarter. Good progress there with 32% up, FX-adjusted. Much of what I said earlier on the market certainly is correct also to say for trucks with improved market conditions. We are increasing the order book, and we have an operating margin above 10% on the truck side, which obviously is something that we've been striving for. If you look at what we have in focus here, we are now seeing with the order intake in the U.S. and now also in Japan, we are in the midst of production ramp-ups there.
In quarter three, let me just remind you that when you bring a lot of people in, like new shifts, for example, in the U.S., it takes a couple of weeks before they are really productive in terms of getting to the same efficiencies that we have with the older, more mature workforce. Strict cost control, and we have, again, benefiting from, but also product introductions ahead of us, which we are quite happy with. We have, for example, the Condor range coming in Japan with the new medium-duty engine, the first application of our new medium-duty engine generation. Also hybrids in France with Renault and also environmentally sound trucks, DME Volvo, and also methane diesel coming from Volvo. New product introduction will give our customers the benefit of, for example, burning natural gas or biogas and also be able to operate efficiently, on good efficient fuel efficiency levels.
If you go to slide eight, there you see the net order intake. As you can see, we have good news there also. Of course, these are real data. We all read the same newspapers on what might happen in the future, but these are the real data that you can see in our order books as they flow in. Change Q1Q here, progressive over the year, then a yearly comparison with 34% up. There you really see now the strength of North America. As you can see, North America and South America now, even though South America has grown quite nicely, is beginning to be looking more like it should, that the North American market is considerably bigger than the South American market, which was not the case in the midst of the crisis. 129% up in North America. Europe, as you see, almost 30%. South America at 30%.
Asia then, which is really a consequence of Japan in the main, at 3%. Other markets still doing very well. If you look at Q1 to Q2, we have a normal seasonality. We were expecting a slower Q2 order intake. We still see, we think, quite reasonable numbers there, stable numbers with Europe and North America in plus territory, South America and Asia in some minuses. You see other markets actually doing quite well there. All of that combines into a curve that is pointing towards the upper right corner there on the slide at the total levels. If you look at the heavy-duty truck market in Europe on the next slide, we are basically saying, let's leave that as it is. That's EU members plus Switzerland and Norway. We also have noted earlier in the day that even outside of the U.S.
and to the east of the EU, we also see some strength in the market, but unchanged when it comes to EU members, Switzerland, and Norway. The heavy-duty truck market in North America, which is slide 10, the same point to be made there. We think that we have about the right 230, 240. We've obviously had a couple of months here that's been higher than that. We would argue and hope that it doesn't run away in the type of cycles that we had in 2005 and 2006 here. There's no reason to think that, of course, because we had a pre-buy effect in 2005 and 2006. It would be good if we could see a more stable development in North America coming above the historical trend lines, but to do that in a slightly less cyclical way.
I see some speculation now and then about the new emission rules in terms of fuel efficiency that could again create, you can say, a pre-buy effect. We don't think that that will be the case. The old emission rules and the ones that were impacting our sales in 2006 were really, from a customer's point of view, costly exercises to get our engines more clean. While we think that's good, nothing like that is going to happen for the future. There we actually see energy efficiency driven by, in some case, regulations and labeling. Those energy efficiencies will be translating into fuel efficiency for our customers. Therefore, we don't think you will see much of an abnormal pre-buy effect in the next couple of years.
More based then on the real replacement cycle and the economic cycle as we run through the next couple of quarters here in North America. With that, let me switch over to construction equipment. We have Pat Olney, our new leader of Volvo Construction Equipment on slide 11.
Thank you, Leif. Let me start then by saying that Volvo Construction Equipment had another strong quarter in Q2, delivering just under SEK 1.9 billion of operating income on SEK 18 billion in revenue for an operating margin of 10.8%. This was fueled by continued strong growth year-over-year, 32% growth in the top line adjusted for currency. That growth was really supported by both growth in the markets worldwide, you could say, as all the major markets were increased year-over-year, but also the continued development and reinforcement of our market share position in China, where we maintained the number one position, which was established in Q1. We can say the operating margin of 10.8% did suffer from some headwinds as we did have the impact from the Japan crisis affecting us for SEK 300 million negative on the bottom line.
Also, as Mikael mentioned earlier, significant impact due to the strong Krona in the second quarter affected the top line and the bottom line as well. Looking ahead, we continue to roll out the Tier 4i/Stage 3b product offering. We're pleased to be leading the industry in that rollout. We have many machines already launched in Q1 out in the field and meeting customers' expectations. If we go ahead to the next slide, we show here our position in China. Number one, again, in the second quarter with an 11.8% market share year to date. On a rolling 12-month basis, then achieving together with Volvo-branded products and SDLG just under 50,000 units in sales, which is a historic high position for us in the very important Chinese market.
As Leif mentioned earlier, the Chinese market, we've seen a softening in the last couple of months due to the government's efforts to curb inflation. We expect these effects to be temporary and see that the fundamentals in terms of fixed asset investment and construction demand, which underlie the market, are still quite sound looking ahead. We still have a very good outlook for the Chinese market, both in the medium and the long term. Finally, I would just like to comment that we, after a two-year hiatus, again held the Volvo Days event in Eskilstuna, in which we showcased the full range of our new products and our full offering with over 50 new models on display. We had over 10,000 customers, which is a record level of interest for us.
Now, of course, in focus will be to take that tremendous interest from our customers and convert that during the next quarter into firm orders. By that, I think I conclude the comments on Volvo CE.
All right, Pat. Good. Let's go to slide 13 there. We have Håkan Agnevall, our President and CEO of Buses. Håkan.
Thank you, Leif. Despite the weak market on the city side in North America and Europe, we had strong deliveries and improved profitability during the quarter. The global bus market recovered at a slow pace with good demand in South America, Asia, and the Middle East. The city bus segment in North America suffered from the budget discussions and could be down as much as 20% in 2011 compared to 2010. In Europe, the total market is at the same level as 2010, but we have a slightly lower demand in the city bus segment up to today. We had good order intake during the second quarter and in line with last year, and we have an order book up 17% compared to last year. Strong deliveries, mainly in North and South America and international, up 36%.
The result was SEK 275 million, close to 5% margin, and still in a negative currency situation. During the quarter, we made some important product launches. In Brazil, we launched for the first time a new front-engine bus, which we have developed together with Volvo Trucks in Brazil. Front-engine buses are a fairly big segment that we haven't participated in in the past in the range of 10,000- 12,000 units yearly. We have gotten a good launch, and the market is very positive to the new vehicles there. In Europe, we continue to introduce the new city range. We are with our product Intercity 8900 in serial production, and the 7900, a real city bus vehicle, will be launched in a couple of months.
The third one is the global hybrid rollout because after the success in Europe, we have now introduced our hybrid concept in South America, and we'll also launch it in China. Today, we have received almost 350 orders on our hybrid buses so far. The first one outside Europe is in South America with 60 hybrids, and it has been followed in Mexico for another 10. Once again, a successful introduction and launch of our hybrid vehicles out there. To manage the slow recovery in the market, we have to focus naturally on the order intake in North America and Europe and continue to improve costs and capital efficiency to improve our margins going forward. That was all from buses.
Good. Let's go to slide 14 and Volvo Penta, and Jan Gurander, who's the President and CEO, cannot be with us, so let me do that. We have a good development there. What is happening here is that we have a very weak marine market. That's even so that in the U.S., it's almost at historically very low levels, and a weak return of the market on the marine side also in Europe. What is really good news from Volvo Penta is that the break-in into industrial engines, which is to take the group's powertrain engines and do application engineering for them into different segments of industrial engines, is now beginning to pay off very nicely, both in terms of sales and in terms of operating income. We actually see strengthened market shares in both marine, which is again a weak market, and industrial also.
Industrial is actually growing and doing more in line with what you see, for example, at Construction Equipment from a total market point of view. If we look at what that meant, it translates into good double-digit margins for Volvo Penta. We now see in focus as we move forward, the real focus during the season here is to make sure in the Mediterranean and Scandinavia that we have a good service level for our European boat customers. To continue to increase marine market shares there, we are introducing, as you know, a lot of new technology. We spoke about electronics last time, new 400 hp D6s, and also the continuing success of IPS. Also, remember, and perhaps over time see as more important for Volvo Penta, a really good momentum now for growth in industrial engines.
We hope that with that growth in industrial engines, Volvo Penta will be more two-legged than one-legged for the future. That will return a good and stable operating income and growth for us as it did this quarter. With that, let's go to Volvo Aero. We have Staffan Zackeson, our CEO of Volvo Aero, and slide 15.
Thank you, Leif. First, about sales, it's down to SEK 1.6 billion. But adjusted for the investment of Volvo Aero services last year and the dollar impact, the underlying growth is 8%. The industry had a tremendous order boom placing aircraft, and especially the Paris Air Show was very successful. It's a + 200%, building a backlog up to 7,300 aircraft. The huge success during the air show was the new Airbus A320neo. That aircraft has currently got 1,000 aircraft on order or commitments right now. This is driven by the growth of traffic. It's 7% growth. This is above the long-term trend, but it's close to 5%. Of course, the fuel prices affect the airline profits, which are expected to be half what was announced by the International Organization prior this year. The orders are up, and that's because of the fuel efficiencies that the airlines want to get.
If we look on Volvo Aero's profit, it has improved from quarter one, but it's still a very weak operating income for Volvo Aero. It's affected by the dollar mostly, and we also have supplier issues on new product introduction. It's both on the quality and the volume side to their ability to deliver. We have signed an important contract for the PW1100G engines that will give us a bigger revenue over the next 50 years, over $40 billion. It's a nice addition to our portfolio of engine programs. This engine will power the Airbus A320neo. Of course, what the engine delivers is better fuel consumption and noise also with the new technology with the geared turbofan. What's in focus for us is a supply management initiative. We work with our suppliers to get their process stability improved and also their raw material situation. It's a long-term commitment from us.
We have inside our shops a productivity improvement program that is running to get cost out of the system as well and to meet the challenge of the dollar for us. Thirdly, the execution of this new program that's just entered the detail design is, of course, vital for our future. That ends the report from Volvo Aero.
Good. We have Financial Services and slide 16. If technology works, Marty Weissburg, our President of Financial Services, will speak to that slide. Marty?
Thank you, Leif. With our financial services operation, positive trends continued in the second quarter with a more reasonable result for the quarter. New financing volume for Volvo Group customers was SEK 12 billion in the quarter, and this is the best quarter of new business for financial services since the fourth quarter of 2007. It is approximately a 50% increase in new volume adjusted for currencies when compared to the second quarter of last year. This is, of course, driven by very strong group deliveries along with good Volvo Financial Services share or penetration in financing those group products. Operating income improved some again with a result of SEK 250 million in Q2. Gross income improved in absolute terms and also on a percentage basis, and this is indicative of improved portfolio fundamentals and some reasonable growth in the portfolio.
We had significant improvements in credit provision expense, which really drives the result and benefit from a Brazilian syndication, which I'll speak about shortly. Some of the highlights and further to what is helping profitability is in the quarter, all Volvo Financial Services regions were profitable. This is two quarters in a row now. Also, as previously mentioned, we syndicated or sold approximately SEK 4 billion of our Brazilian retail credit portfolio, and this was for global portfolio balancing purposes. This syndication had a positive impact on operating income in the period of SEK 45 million. This syndication or sale is similar to one that we completed in the second quarter of last year. Volvo Financial Services retains account servicing and customer relationships in all of these cases. I would add that our Brazilian business continues to perform and grow quite well.
Also in highlights, portfolio growth in all regions, and done so within our risk management and segmentation strategies. In focus, strong focus, and I would say good success in building skilled Volvo Financial Services teams in our growth markets, Brazil, Russia, China, and others. We're well established in these markets for many years, yet organizational buildup remains very much in focus. Syndication opportunities, as with Brazil in this past quarter, will continue to be in focus as we will continue to syndicate small portions of our portfolio on an opportunistic basis. This is in keeping with our portfolio management practices and is a key element in properly managing risk over the business cycle.
I'd say organizational development and syndications are just two of the many topics in focus within business cycle management as we continue to prudently manage growth in this upcycle and continue to be well prepared for all parts of the business cycle. Leif, that's the report from financial services.
All right. Good. Let's conclude then on slide 17, the one that says group summary there. You see earnings per share advancing from SEK 1.55- SEK 2.52, SEK 2.01 in the last quarter in Q1 2011 to SEK 2.52 this year. You see operating cash flow on the slide below there. We have in focus as we move forward, we are managing productivity and ramp-up. With that, you can say increased productivity both in the U.S. and in Japan, less so in the rest of the group. In some parts of the group, we are still also in a ramp-up mode outside of those countries. I should say, almost constantly, we have supply chain problems. They can be roller bearings or they can be tires or they can be certain materials. So far, we've been able to manage those quite reasonably well with very little impact in Q2 here.
We expect to be able to continue to manage that, but there are risks there when the supply chain in some parts of the world is as strained for capacity as it is. From our own point, you can say we are eliminating bottlenecks in many parts of the group. What we are trying to do here is to make sure that we can get the combined output of assembly factories, powertrain facilities, and, for example, gearbox facilities. So far, that's been going well too. I think we spoke last time about the need to look at capacity investments towards the end of this year, really trying to estimate where 2013 and 2014 or even 2015 would be in terms of capacity needs and how best to go about that.
If we look now, you can say perhaps at least in the short term here, a better way to look at that is to eliminate bottlenecks and then see how the world develops over the next, say, year or 18 months. We have a continued focus on cost and working capital control. We're happy that we shaved off another day here in terms of cash conversion cycle. We will not build inventories, and therefore, we expect to be able to make those adjustments. In the midst of everything here, those are not any significant issues, but we don't want to start a trend here of building inventories.
Finally, it is good to note that we have a very strong sales momentum right now, both in terms of underlying demand in the different markets that we are operating, but also in terms of having successful products to go to those markets with. With that, let me open up for a Q&A session and answer any questions that you may have.
Ladies and gentlemen, if you have a question for the speakers, please press zero one on your telephone keypad and you enter a queue. After you're announced, please ask your question. The first question comes from Mr. Nico Dil at JPMorgan. Please go ahead.
Good afternoon, gentlemen. I'd like to ask three questions, please. First one is on the drop-through in construction equipment. I just tried to strip out the $850 million in currency, the extra sales of $1.2 billion, and $300 million that were missed due to Japan. I know the drop-through of about 13% year -on year. Overall, the margin in construction equipment has been declining a little bit. I wonder whether you can give us some more explanation apart from the currency as well as the Japanese issues that you've been facing, as underlying the drop-through still seems to be a little bit low. Secondly, on China, wondering what you're seeing on the financing part in China within construction equipment.
I wonder whether you could talk here about the financial tightening that the government announced and whether that has been perhaps easing up a little bit already or whether that's still standing. Just an update there. Lastly, an update on Aero. How long do you expect the production disruptions and the raw material impacts still to last?
Let's see. Should we ask Pat Olney on the first two of those, or if Marty Weissburg has something to chip in there, you're welcome to do that too, Pat.
Okay. Thanks, Leif. First point on the drop-through margin, I assume it was Q2 this year over Q2 last year you're trying to estimate. I think our calculations, at least based on backing out the currency impact and the Japan crisis, would have had us somewhere over 14% on an apples-to-apples basis, which would have been a record. A slight difference maybe in calculation there. I will say we are, like all competitors, facing pressure on material costs, which we work to pass on into the marketplace. That's really the challenge that we are faced with. So far, we've been successful in pricing those costs forward. When it comes to the financing, I'll start by saying, first of all, it's been a strength for us to have access to captive financing through Volvo Financial Services in China. That's allowed us to continue to find financing solutions for our customers.
I'll also point out that still quite a bit of the business in terms of fixed asset investments in the country are financed via either cash or other basis and not actually requiring financing. It's about two-thirds of the CapEx in the country on projects is actually financed through other means than bank lending. We don't see as much perhaps exposure to the tightening in that segment. I don't know, Marty, maybe if you have some other comment on the.
I guess I would add, while the market has tightened, you know we have not. I would say that from Volvo's standpoint, Financial Services has ample capacity to continue to grow in a very good way. Our finance and truck and bus finance business in China and our credit appetite remains robust. It's a strongly performing portfolio.
Good. Alright, Staffan, you can speak to that.
Yes. Through our supply management initiative, we worked closely with our suppliers, and we expect to get results from that during the third quarter.
Okay. Just one follow-up question here. Did I understand you correctly that the 14, was it 14% or 40% drop-through rate there in Volvo Construction Equipment versus Q2 last year?
I think actually what Pat Olney was saying was the operating margin, if you clean out all the effects. It was not the drop-through rates there.
Okay. Okay. Understood. Thank you so much.
Next question comes from Mr. Fredric Stahl at UBS. Please go ahead.
Hi, gentlemen. Good afternoon. Could I ask you about the R&D productivity program and your R&D outlook? Could you maybe remind us of how you see the savings or the productivity increases developing in terms of time, how you expect these to scale up? Secondly, if you expect any significant changes in R&D spend post Euro 6 and then you have the Tier 4 introductions as well, obviously.
Okay. I perhaps should ask our incoming CEO to speak a little about the future on R&D.
When it comes to the R&D 30 program, we are running at full speed ahead, and it's a number of activities that we're doing, looking into tools, processes, and other efficient means in order to get the work, every sort of the efficiency out of every invested krona or dollar or whatever into the system. This is, of course, nothing that you do from one day to another, and this program is over a number of years. So far, so good. We have a steering committee that is monitoring this. The KPIs are getting into place, and we start to measure this in a stringent way, and we will continue to do so going forward.
When it comes to the R&D going forward, that's something that we, of course, have to judge over time here. You can say that if you look at over time, we have, of course, a Euro 6 that we're getting through. On the other hand, there are other things coming in into the portfolio as well that we need to take care of. I wouldn't sort of sit there and give you any forecast on the R&Ds going forward here long term. One thing and one message is clear that we're going to work very much on the efficiency to make sure that we have a very efficient R&D system in place.
Great. Could you maybe give us an accrued estimate of how much one of these engine regulatory changes cost you, whether it's Euro 5 or Euro 6?
I think we could, it's very difficult, you can say, to isolate it, frankly, Frederik. If you do, you know what we typically do, which is also what you see in our R&D cost, is that when we make big changes in the powertrain and the packaging of engines and gearboxes, then we also take the opportunity to make other changes in combination with it. It's a good opportunity, you can say, to change. To isolate, we are talking about billions over some period of time. I don't know that I really have a good catch-all number isolated Euro 5 or Euro 6. Big numbers.
Great. No, that's fine. Thank you.
Next question comes from Ms. Laura Lemke at Morgan Stanley. Please go ahead.
Yeah. Good afternoon. Just three questions, please. The first one is on capacity utilization. I was just wondering if you could give some indication by region and where you are right now, both for the trucks and the construction equipment segment. Secondly, could you tell us a little bit where truck pricing in Europe and the U.S. is versus pre-crisis level? This morning you spoke about pricing being relatively positive, but I'm just trying to get a feel of where we actually are right now. Lastly, could you also give a bit of outlook on your working capital development in the second half? Thank you.
Let me start with capacity. I think in general, we can say we don't have much of an issue when it comes to assembly capacity. There's some tightness in some of the supply chains that we spoke about before. I think the issue that might need to be addressed over the next 24- 36 months is capacity on heavy-duty engines and potentially also automated gearboxes, automatic gearboxes. In general, you can say what we would be aiming to try to do is to get those capacities when it comes to powertrain components in line with the regions where they are sold. For example, investments in North America for North American engines and over time investments in Asia, like we did with the medium-duty engine for the Asian markets, and then see how we spread that out.
Not an issue for capacity in general when it comes to larger assembly factories where we are older people, more of an issue of bottlenecks elimination on the powertrain side.
Sorry. I think you misunderstood the question. It was more about capacity utilization levels by region. If you can tell us a little bit of how high utilization is, for example, in Europe, in the U.S., and also, I guess, for the Construction Equipment division.
Yeah. I think in general, you can say, you know, if you take heavy-duty truck or heavy-duty engines, there we are in the range of 80% capacity utilization. It becomes a matter of looking at how to call 12 and 13 to get that right. You can say installed capacity when it comes to assembly factories is not that meaningful because it really has to do with people. I don't think that's much of an issue. I don't know that we can give you a catch-all number on the different factories there. What would you say about Eskilstuna, for example, Pat? Are we?
Eskilstuna, we're probably running into two-thirds, 70% utilization, still room to develop as we did the CSO9 program there a couple of years ago. The same comments for me as you made for the truck factories. The issues are not in assembly capacity for CE , perhaps with the exception of China where we've actually had to double shift operations in line with the market. It's more key components, hydraulic components where we need to make investments to alleviate the bottlenecks going forward.
I think on assembly capacity, you can say still lower utilization rates also on the assembly side, both in North America and Western Europe, higher when you move out there. Truck pricing has been in North America and in Europe quite reasonable in the sense that we have been able to get across cost increases driven by either regulatory regimes or from material increases. I'm not so sure that I know how to compare that to 2007-2008 because, as you know, we have fairly significant regulatory changes. Prices are obviously higher, but so is cost. I think the best perhaps way to look at that would be to look at gross margins and try to compare them where they are actually now, again, coming back to be quite good.
In general, on pricing, you can say in the markets where we see a good demand, we have been able to get across both cost increases in terms of raw material and regulatory costs. In line with what you expected me to say or what you wanted me to answer?
That's fine. Thanks.
Good. Then we had the outlook for, yeah, I thought, as you know, we don't give a forecast per se here, but as I expressed earlier on, we are confident in the target of 20 days when it comes to our cash conversion cycle here. I mean, the negative effect, if I put it like that, in the working capital in Q2 here was really a slight build-up on inventory, which has very natural explanations. I mean, we had some effect there from Japan, the Japan issue, so to speak, where we had some material incoming. At the same time, we got some problems with other materials from Japan, and we couldn't switch off the inflow of the material that actually didn't have a disturbance there. You got some raw material and WIP issues there.
We also have vacation effect currently here as we are shutting down in Europe for four weeks while we have U.S., for example, going for vacation only for two weeks. There you have some buffering issues to manage to keep on going in the U.S. while we are vacationing in Sweden and smaller things like that. That is a thing that will, of course, be straightened out as we move forward here. We had the so-called extra payment days on the payable sides here. It's really where in trade payables and inventory where we will make it happen to get down to the 20 days here. We are confident in that we will do that over time.
Okay. Thank you.
Next question comes from Mr. Jan Krogh-Vennemo at [Exame]. Please go ahead.
Hi. Good afternoon. Jan Krogh-Vennemo from [Exame]. Three questions, please. First, assuming that the current prices for currencies stay where they are, what do you assume qualitatively in terms of forex impact in H2 compared to what we have seen in H1? Second question for construction equipment. Do you see a sensitivity of profitability depending on China? In other words, would you consider that China has a higher than average profitability for you for construction equipment? Last point, in Brazil, there will be new entrants over the coming years, plus players having local production. Do you see the current huge margins changing over time or not?
On the truck side?
Truck side, yes.
All right. Should we start with currencies and ask Mikael to comment on that?
Yeah. As I said earlier today, to give guidance when it comes to FX impact is a very challenging task and nothing we intend to do here. What we had said is that we have given you some guidance previously on what kind of flows we normally have in the different quarters. When we look at the second quarter, we have really an impact coming from the dollar as we have seen the biggest movements there. I mean, everything else equal, I would say you shouldn't see sequentially that much of an impact between the quarter. I would say it all depends on what's happening. That's very difficult to give any guidance on. When it comes to the hedging impact, we only hedge our firm flows. We are not, I would say, taking advantage of what you might see as favorable currency levels at any particular moment.
We are following the natural flow of the currencies. What does then firm flows mean? I would say it means practically around 50% of the flows you see in the quarter is hedged over the time period.
Okay. Profitability China and CE.
I guess I'd start by saying don't quote specific profitability for specific markets in C, but I think you can say that given the size of the China business for us, we wouldn't be doing the result we were doing overall if we didn't have a profitable business in China. We can say that it's a profitable business for us. From that standpoint, you could say there's some exposure to profit in China. To tie to my market comments from earlier, when it comes to the softening in the market, even with the softening that we foresee, we still expect a very strong market in China up 10% to 15% year-over-year. Don't feel extreme exposure from that standpoint to the market.
All right. I think let me get the question of Brazil and the truck market and the configuration of the truck market with different competitors there over to Mikael. Mikael is our good expert on Brazil.
Of course, Brazil is a steaming market that attracts a lot of attention from players that are not currently in Brazil. I would say that there are certainly some movements for new entrants. I think you have seen some announcements from some of the players investing more in Brazil. I would say they are, of course, operating under the same circumstances as ourselves and with the challenges there. The only thing I can conclude is that we have a very good position there. We have been around for a very long time in Brazil, a very strong and good-performing dealer network. We have good products now where we're actually taking market share in our segment. I think we are well positioned to meet the new competition in Brazil.
Okay. Maybe your very last question, if I may.
A reflection on that theme, you see announcements every now and then of different players in the industry having set up factories and defined products. You know, over time, it is just as important or sometimes more important to build distribution networks that can do 24/7 service on a number of vehicles distributed over a large country like Brazil. The ways to quickly get up market shares are limited on the distribution side.
Okay. Thank you. Maybe last question. When do you expect the ramp-up in the U.S. to be completed?
Say again, when do we expect a ramp-up?
In the U.S. for trucks to be completed.
I think the way we see it right now, with the order intake we have right now, that we will be coming into Q4 reasonably well-placed.
Okay. Thank you.
Next question comes from Mr. Rodney Bridge at Evolution Securities in Switzerland.
Operator, you have quite a lot of disturbance on your line. We have difficulty hearing you.
Can you hear me?
Yes, yes, we can.
Good. I was wondering if you could update us a little bit on your penetration of own engines and gearboxes in North America and really whether this is making a difference to your business out there at the moment. The second thing is I was just wondering if you could give us a little more explicit guidance on capital expenditure going forward. I mean, should we expect it to be a fairly stable figure or should we expect it to increase in line with sales? Thirdly, some comments obviously in the presentations about industrial engine growth. Can you just sort of tell us a little bit more about that business, about who the end customers typically are and the geography of them?
I think on the penetrations of own engines and gearboxes in the U.S., which is now coming up into the 80% when it comes to engines and 35%, 40% on the gearbox side, that clearly is good news. It means that we will be coming into a spare parts stream of revenue that we have not had before. As we go through the cycles, you know that is always very good. We are doing well with that and happy with that. When I said those numbers now, those are the Volvo brand. On the Mack side, as you know, we have 100% own engines. Your second question was on.
CapEx.
CapEx, right? You want to speak to that, Mikael?
I can take that. The guidance we have given you when it comes to CapEx here is about SEK 10 billion for 2011. That is an increase compared to the previous year. As you know, we pulled quite a lot in order to reduce the CapEx during 2009 and 2010. There is, of course, some pent-up demand there that needs to be done. You should expect around SEK 10 billion for 2011.
Going forwards, one might be good to increase it with sales or?
No, I wouldn't say it. I mean, that is not the rule of thumb you should use here. I think it depends a lot on different things, where we are in the product cycles and other things also. I think let's take one year at a time here in terms of guidance. It's not that dramatic fluctuations over time, I would say.
Let me talk a little about the industrial engines. By the way, I think we have Dennis Slagle on the line too. Is that correct, Danny?
Yes, I am here.
Yeah. If you want to add something more on the U.S. side, feel free to do that. On the industrial engine side, the large segments on industrial engines would be everything that has to do with pumping, for example, pumping water or pumping different fluids in the chemical industry, etc. There is a big segment in power generation. Power generation is growing in many places because of inefficient grid and you can say smartness of grids. You also see a lot of power generation being used for safety reasons, for example, in hospitals or computer halls. Over time, what is quite evident is that there are a number of people in segments like cranes or different parts of mining equipment, etc., who now feel that with the much more advanced engine technology that they need to have to be able to meet regulatory regimes, are looking for two things.
One is a good engine, and the other one is actually the ability to supply spare parts all over the world in a global logistics system. I think the segment here where we have found Volvo Penta to be quite efficient is also actually to be able to deliver both application engineering into segments like that, but also in terms of being able to supply spare parts and support for those products regardless of where they are. Good. Dennis, anything you wanted to add on the penetration of own engines or gearboxes there?
First of all, your figures are correct, Leif. The one thing I did want to add is the tremendous success of the I-Shift, we call it MDrive for Mack. That has helped us because, of course, we only put that behind our engines. With CSA requirements, driver requirements, etc., this makes a marginal driver into a very good driver, and it's really starting to get popular. Frankly, our competition is not that strong in that area. We look forward to seeing using the I-Shift and MDrive as a vehicle to go even deeper in penetration.
Good. And Dennis Slagle there is our Head of North American Trucks. Good. Let's go to the next question.
Next question comes from Mr. Sebastian Wetter at Société Générale. Please go ahead.
Good afternoon. I have two questions on construction equipment. My first question would be since the start of the year, we have seen some Chinese players in this industry using aggressive selling techniques like a mortgage with zero down payment. I'd like to know what was your strategy in this environment. Have you used the same technique to be able to increase your market share? The second question is about the SEK 1.2 billion revenues lost due to Japan at construction equipment. Would you expect to recover these revenues in Q3? Should we see less seasonalities than usual due to this catch-up effect?
I think on the first question, you're asking whether we on the finance side are doing zero down payment and full financing, etc. I think the answer to that is clearly no. We are trying to keep up the discipline that we learned how to do in our case because they basically all is done. I'm not so sure that I hear, frankly, a lot about zero money down payment even from our industry. I'm looking around the table here to see whether anyone relates to that.
Marty can confirm this, but I think typically we see at least go for at least around 20% down, and then financing typically over a three-year period. We secure that there's always good equity in the machine, if you like. Marty, that's pretty much what we.
No, that's right, Pat. As you know, we collectively do not use credit risk as a way to build market share.
We've heard of some competitors having more aggressive sales promotions and perhaps discounting. Based on our positioning with the Volvo brand in the market, we certainly don't resort to that as a way to promote our product and our brand.
Could you repeat your second question? I didn't catch completely what you asked there.
I mean, the question is you've lost SEK 1.2 billion revenues due to the Japanese disaster. I was wondering if you would expect to recover these revenues in Q3 or Q4.
I think what we have said earlier in the day is that with what we know today, we don't expect to have any more significantly negative effects from the disaster in Japan. That is both true for construction equipment and trucks. I also don't think that we think that we can recover lost sales. If you look at what we lost in Q2, that most likely is what we have lost. Customers who are in the midst of buying products like that typically perhaps will have gone and made that. I don't think we can, you cannot add that into quarter three.
Okay. That's very clear. Thank you.
Very good. Thank you very much. That concludes the conference call for Volvo Group's second quarter 2011. It was my 57th call, and as always, it has been a pleasure to be with you. Next time, you will have Olof Persson at the helm. I wish him all the best and good luck. Thanks a lot and have a good summer.