Volvo AB

STO:VOLV B

Earnings Call Transcript 2018-Q3

[Kina Wileke]

Good morning, everyone, and welcome to this press and analyst conference covering our third quarter. We will, today, have 2 persons on stage as always, We'll have our President and CEO, Martin Lundstedt; and our Deputy CEO and CFO, Jan Gurander. We will start with presentations, and then we will keep going with questions from the audience and for those of you participating over the phone. And since this is a webcasted event, I would kindly like to ask you to use microphones. Martin, stage is yours.

[Martin Lundstedt]

Thank you, Kina. Thank you. And also, from my side, obviously, most welcome to this quarter 3 reporting for 2018. Before -- welcome. Before coming into the results and our views of the market for quarter 3 and going forward, I would also like to give you my view and the latest update on the press release regarding degradation of an emission control component that we were releasing this Tuesday. As you know, and I will -- let me tell you the background on this also. And as you know, to meet emission limits in different forms, we have different systems for that. And in this particular case, we're talking about the engine of the treatment system that is physically placed after the engine and in this -- and in after-treatment system, you also have the selective catalytic reduction system, the SCR unit, that is actually then taking nitrogen oxides into nitrogen and water, respectively, by also adding urea or AdBlue as it is called in our business.One of the components in the SCR catalysts have shown, in some cases, that the degradation -- and degradation in this matter is like if it was a mechanical component, a premature wear and tear over the life cycle. And in some applications and segments and possible geographies, we see that it might occur that the degradation is quicker than anticipated. This component is designed to withstand the whole life cycle of the vehicles and equipment. But in specific cases, we see an increased risk that it will not do so. And therefore, we have taken actions, obviously.What has happened is also important to say that we have detected this in our internal monitoring process that is ongoing all the time when it comes to the fleet in the field. And when we have, so to speak, come to the conclusion that we will have a risk of certain applications to be needed to have some sort of action, we have obviously also had a proactive contact with authorities. And eventually also, when we have looked through this matter, a disclosure that we did this Tuesday through a press release. I think it's important to say that, again, the reason now, when we are doing this very thorough analysis is that it is, as I said, a wear-and-tear matter. And we need to understand the pattern where it is happening, why and how can we actually then make sure that we are doing this preventive actions in a good way together with our customers. We have already identified the problem. We have ring-fenced the problem. And we are now, as we speak, implementing and will continue to implement solutions. It goes without saying, obviously, but I will say it anyhow, that this is worked through now with the highest focus with the best experts we have, together with the concerned authorities. But it is important now, when we have identified the solution, how do we actually look at the full scope of what is really the affected population in this matter. And that, we are doing again, as I said, in close cooperation with authorities. All vehicles and equipment, are and have been, so to speak, on the right levels at delivery and fulfilling the certificates and conformity of production. And therefore, production is not affected. And customer performance also when it comes to uptime availability and performance features is also working as planned. And in the case, obviously, that a degradation has occurred in a specific unit, Volvo is, together with customers, but Volvo is taking, of course, the full responsibility. I understand that all of you have even more questions about this -- want to know more about the details, et cetera. But we have said, it's very important now that we take this matter, of course, extremely seriously and that we are working with this with high attention, high focus but also with quality, and so we can ring-fence and come back to relevant stakeholders with the right type of figures. But again, on our own initiatives, a degrading matter, a problem that we have identified and solutions that are ongoing as we speak. So that is the update on this press release from my side.So by that actually, we are moving into the next stage, and that is the quarter 3 reporting for Volvo. And as you have already seen, it has been a strong and solid quarter for the group. Sales continues to increase, and we are reaching a record level for quarter 3 of SEK 92 billion. That is an increase of approximately 13% when it comes to sales excluding FX; and an operating margin, as we have seen, 11.1%, both for the group but also for Trucks. And Trucks, it's good to see that we are getting the leverage that we have been talking about for a while here and a very good job done by our Truck business areas. We also see improvements in the other nontruck business areas, so a strong quarter. Then when it comes to the volume development. Also in this case, I should say that we are rather satisfied with the volume development, plus 14% for trucks. It was actually almost 40% for North America. So even if the supply chains are stretched, and we are reiterating that, once you'd understand that, while we are now increasing obviously, new bottlenecks will be detected while we are removing other bottlenecks. That is the nature of the business. And if you think about global industrial machine, increasing 15 and certain regions 40%, I think the organization has done a good job here. And we are concentrating efforts to continue to drive this together with suppliers but also in our internal processes. Machine deliveries also showing a good trend, 17% up, where SDLG is standing for -- 35% on the SDLG-branded machines and 5% up for Volvo. The service development is also positive for us. We have 7% plus excluding currency. And that is a good growth rate, of course, mainly driven by high activity level in the different regions but also a strong focus on services in the organization. The contact penetration of repair and maintenance contracts, for example, is continuing to increase. And that is extremely important for us as you know also when it comes to our resilience through the cycle. But even more important that, that is showing us that we have a good and close contact with our customers. Also, new penetrations when it comes to selected segments or given results here. For example, Volvo Trucks have been putting a lot of focus in Europe on the Construction segment that is also promising when it comes to the contract length of the first owner and not at least in construction. As we can see, all different business areas are showing progress. And in particular, we are pleased to see the progress in buses as well.When it comes to Trucks, I will keep it short here. The main sentence to remember on this slide is the first one: Good demand in key regions. And the rest I will cover in the coming slides here. When it comes to innovation, very interesting quarter obviously. We were pushing through this world premiere of what we call Vera. So she was shown the first time actually in Berlin at our Global Innovation Summit with big interest, and some of you were there, actually. And we were very proud to show that, that this is a fully autonomous, fully electrical and fully connected unit for certain transport applications, primarily for fixed goods flows of a pretty high volume. The starting point here will be that it could be operated fully autonomous but also for certain specific tasks through a control tower application as well. We are now developing the solution as such together with selected customers and other partners. And some of the features here is a -- and that is interesting by the way. When you're talking to about production flows, because this is a typical tool for production flow, speed is not the most important when it comes to the average speed. We're talking about the starting point is 40 kilometers per hour. And that is maybe not impressive, but the impressive thing is that you can control it an even flow as you're talking about, for example, in the production environment. And then you can obviously -- the limitation is not 40 kilometers, but we will have an even flow when it comes to that, up to 32 tonnes, 200-kilowatt hour batteries range of 100 kilometers to start with and a full infrastructure and systems solution thinking, so very promising, high level of interest.Other thing that has happened this quarter, obviously, is the IAA exhibition in Hannover, one of the biggest truck shows in the world every second year, where we actually also showcase a number of important events for the Volvo Group. We delivered 1 million FH, a milestone for us, celebrating 25 years since inception, big success for Volvo Trucks. You can see on the upper-left side there. We introduced Volvo Connect. That is our new platform of connectivity where the customers actually can take their view of connectivity and group their, so to speak, features, applications; the Volvo applications but also applications from other partners. And that has been well received also when it comes to functionality and easy to use and easy to connect. Vera, again, you see there. That was one of the highlights, obviously. We were introducing the new coach series for Volvo Buses in Europe, the 9700 and 9900. And the 9900 got the sustainability award of the year. In the middle, on the down row, the full range of battery electric vehicles in distribution and waste collection, both for Renault and for Volvo Trucks. And also, well represented, press conference is about our news here.If you're coming in then to our views of, as you know, we are today revealing our first views of 2019 and the forecasts. As always, we say that it's early days, but we are of course taking it from the angle we see now and also some of the macroeconomic indicators we're getting in from around the world here. And if we start with Europe. As you can see, a little bit of uptick already 2018, meaning that the strong demand continues. And as a forecast for next year, we are guiding around 300,000. That is minus 5%. It's still early days to say, but what we forecast is stable demand on high levels to continue. I've been discussing that before also. It is a good activity level when we read our customers or we talk to them but also the structural things happening in the market. For example, with e-commerce, will also actually support that we will continue to have a good level as we see it. North America continue also to be very strong. 310,000 is continuous uptick then. And if anything, there is a pressure that it could be even be stronger, but this is what we see for the time being here. And as you know also, part of this has been hampered by the supply chain also in North America, which is also given a situation where the used truck situation is good now in the United States because capacity is needed, basically.So also there, 310,000. We're guiding up slightly in Brazil. Of course now, we're waiting for the second round in elections in Brazil. But the general, so to speak, sentiment in Brazil is that it will continue. And as you can see also on this graph, there is certain replacement need in Latin America and, in particular, in Brazil. So if anything, this is also a forecast that can have strong support upwards. Japan, flat. In China, we're taking up 2018 with 50,000 unit to 1.3 million. And next year, we forecast somehow a decline of approximately 150,000 units, a little bit related to macro and tariffs and the general economy. But also in our industry after a number of very strong years, new legislations, prebuys, the transition into tractor segments, construction has been keeping up, et cetera. It is reasonable to think that you will have stabilization and somewhat a decline here but still a very good and solid levels, obviously. And in India, we are continuing to see an uptick of approximately 25,000 units up to 425,000 for medium- and heavy-duty combined.When it comes to orders and deliveries for Trucks, you can see a solid quarter continued to be very strong when it comes to the order intake. If I start with 28% up and if I start with Europe, positive to see that even that we have high comparison figures now quarter-on-quarter. We are moving north, 5% with orders and 4% with deliveries. And also North America, extremely strong. I could assume without knowing what questions you have in your back pocket, what is the quality of the order book? So maybe I should just take 1 minute on that. You need to be sober when you're judging the order book, obviously. So what we are doing is that we take it pretty firm for the coming 2, 2.5 quarters that we know that we have the right quality. And the rest of the order book, we are actually revisiting as we are rolling it forward together with customers and dealers. And that, I think, has been an improvement in our way of working. So we are actually revisiting and see what are the orders that are working and what are placeholders, et cetera. So I think we have a good system on that. And as you can see also, the gap between orders and deliveries are still big here. 40% is still a good figure, I feel, for uptick in deliveries on North America. Also, very strong in South America, both for orders and deliveries from low levels. But as I said, we see that the activity level is good here, both when it comes to the general cargo but also in specific sectors, such as agriculture. Asia, orders down, and that is almost entirely related to Middle East and 2 countries there. And that is Iran and Turkey basically with the turmoil that we are seeing. And in Africa and Oceania, then it continues on a good level here. Market shares. Europe, relatively stable. We are sliding a little, little bit in Volvo. Depends a little bit on the market mix and where you have market share. We have also been pushing prices a bit. We have been thinking that, that has been necessary now given the good market situation. It's a question we've had and deliberately said that we need to find the right balance here. But still good levels for Volvo if you think also about the historical perspective. So I think they are managing in a very good way here. Also, the stabilization and somewhat uptick for Renault continues. As we have said, quality in the business is the prime focus and stabilize the market share. The organization has done a very good job here. And this is heavy duty, and we see also good progress in the medium and light duty for Renault.North America. Good progress for Volvo, keeping up with the pace in the market and even taking market shares, good reception of the new VNL. Strong order books, well-received product when it comes to performance and 10.5%. Obviously, there's more to go there, but we are working hard on the supply chain. Mack, losing a little bit, not due to the introduction of the new Anthem that is super well received. We have order books that is covering a very big part of next year. But more related to the changeover obviously to start with. But after the changeover, to really get the machine and the full supply chain, including our internal processes going. The organization is focusing a lot of that, and Martin Weissburg and the team have all hands on deck to continue because the demand is there and there is a huge excitement about the Mack Anthem. Good progress in Brazil. Also good in South Africa and Australia, where we are keeping very strong positions now that we have built up during the last years. And in Japan, a little bit the same situation for Volvo Trucks in Europe. We are balancing, so to speak, market shares also with the performance in duty, where we see good progress actually. And that is the most important focus that we've had there.Construction Equipment. Good market momentum, Europe and North America. We'll come back to that. China is something. The growth rate slowing down. Natural obviously, and I've already been into the reasons and very similar to Trucks. We see it more also coming now. It started in wheel loaders, but we see it also coming in excavators. But the order intake overall, good, 22% up and deliveries 17% up. Unveiled also a full electric compact excavator will be used in city centers, urban areas, where of course, both from an emission level standpoint but also a noise emission standpoint, very interesting. And then, on the next slide here, maybe also a little bit on that moving here, the Electric Site concept that we are starting now to test together with Skanska, and we are doing that in Vikan Kross. That is one of the bigger quarry sites in Sweden. Actually, situated -- it's well situated, I should say at TCM. And so from, so to speak, it takes a mechanical system perspective, we can work very closely together. This will be conducted now during a couple of months really to test the full system both with loaders. You can see these fully autonomous load carriers together with hybrid wheel loaders and also with full electric big excavators. And the aim here is considerably reduce the CO2 up to 95% if we are successful and total operating cost with north of 20%. So very exciting product to look into here and to follow during this fall.When it comes to then the market situation, what you can say, Europe, very quickly, we are guiding a little bit upwards for 2018. Then as you can see then, we are forecasting a little bit same as for Trucks, the stable situation on high levels for 2019. North America, also there, we are guiding up for 2018 5 percentage points, so between 15% and 25% growth. And then also, we are forecasting growth for next year. And if anything on that growth rate, we foresee actually that the growth will primarily take place on the heavy equipment in North America and maybe not so much in compact as we have seen historically -- or this year, I should say. China, again, upgrading the total forecast for this year with a 5 percentage points, whereas, we for next year are talking about, yes, maybe a minus 5% set a little bit coming down but still on good and solid levels. If anything, we think that wheel loaders will be more stable and maybe a little bit bigger drop on excavators but early days to really see that. Otherwise, I think Asia following the same pattern as China, you can say, but also good levels, somewhat of a small, small decrease but still on solid levels. Let's see. There we have it. Orders, yes, we've been into it pretty straightforward. Strong order intake, 22% driven from Europe, 53%. I should say part of that has been driven by prebuy in compact equipment upfront legislation. But still, if you take the GPE or the general purpose equipment, the heavy side, even in that sector, we have a growth of 22% in Europe. So even if you take away, so to speak, the prebuy, solid and strong demand, and North America, the same, very strong. It has been driven by compact, but we see also the heavy side coming. And then generally speaking, it continues on a good level in the rest of the world as well. And delivery's keeping up, and there we have had less problems or less challenges than we have had on the truck side. Now the truck side is keeping up here.Buses. Good order intake after a pretty slow order intake in 2017. That was a slower year when it comes to tendering activities, not at least in the Nordic market but also in some of the big countries in Asia. Now that is coming back, mainly driven by U.K., the Nordics and, as a matter of fact, India. The deliveries decreased but Jan will come back to that, that we see the buses are doing a great job in compensating that through other factors. And I was into also that we have introduced now the 2 important coaches for the European markets, 9900, 9700, and we got this award.Penta, also solid 8% increase order intake. If you take away the prebuy, and then you have high comparison figures already from last year, it is only 1%. So the prebuy effect is pretty big here. But still a very high level of order intake also given good activity level already last year. Deliveries also continue to increase and new features for all of us that are interested in having a nice vacation. Obviously, with the new positioning systems, the Active Ride Control decreasing, so to speak, the rolling feeling when you're out and also Active Corrosion Protection when you're using current actually to take down certain type of corrosions.Financial services also, finally, good development continue to be good. Penetration rates are stable around the globe, but financing on new businesses are reaching record levels and also with a very solid performance. We have also been working actively to show that we are, together with the customers, when needed, as I also started this press conference. But also here with the Hurricane Florence, we are working together with our customers that are unfortunately affected by that in a good way. And we have also introduced a number of even more integrated offers with our different business areas. So also here, very, very good progress.So by that actually, I will leave the word to Jan Gurander for the financial figures. So please, Jan.

[Jan Gurander]

Thank you, Martin. So where we talk about the financials and the figures a pretty straightforward quarter. I think also, worth remember, the third quarter is usually, season-wise, a pretty -- actually the weakest quarter that we have. And I think, pretty proud to be here to say that this is actually the best third quarter that we have ever had in the group. Looking into the sales. Sales is up with 21% for the quarter. If you exclude the currency's effect, which is pretty substantial as you can see, almost SEK 6 billion, we have a growth of -- underlying growth of 13%. And as we can see here, it comes really in all regions with the strong developments that we have seen that Martin showed before.The operating income goes -- and here, we have the adjusted operating income, is going from almost SEK 7 billion the year before. Last year, we had a capital gain of SEK 400 million. That's now excluded in these figures, up to a SEK 10.2 billion this year, 11.1% operating income all in for the group. And we can see here that it's -- once again, it's always very fun is to stand here and say that it's actually all business areas in the group are contributing to the improved results. So when we see that this broad-based improvement, continuous improvement that we have it in the whole group, I think we can be very satisfied. Obviously here, I think we have gained quite a lot in the group by the fantastic performance that we've seen in Volvo Construction Equipment. I think this quarter now, I think we can really see here that Trucks has really taken off in this quarter compared maybe a little bit to previous quarter, have good leverage in the truck operations in Q3. One word about currency. That's something that you always want to know a little bit about when it comes for the future. When we look into the fourth quarter, when it comes to the transaction exposures, taking away the effects from revaluations of the balance sheet. We foresee a similar size of the positive effect that we have had in this quarter, approximately SEK 0.5 billion. And we don't do any forecast for next year yet when it comes to the currency effects.Doing the same thing here. See what factors that affected the result. It is obviously about volumes and, of course, a better capacity utilization in our factories. Anyway, I think what is -- it has a good development over the year. We started to see it in the first quarter when it comes to how we work with price and price management. Of course, given the good demand that we have, the bottlenecks that we have in our production, it is, of course, important to work with that side of the equation. We saw it gradually coming in, in the first quarter, more pronounced we saw in the second quarter. And it continues in the third quarter as well. Good and solid, both on vehicles but also in our service operations. Material cost is, of course, same thing as we have had before. We are struggling with raw material prices, also effects from tariffs. We talked about that before, especially regarding North America with the tariffs on steel and aluminum. But with the same time, due to good work that's been done within our purchasing organization. We managed to offset that more or less 1:1. As a matter of fact, we have a small positive effect if we net the work that we do on the price side with the raw materials. And that, we see going forward as well. The ambition is still to offset the raw material with the work we do on the price side. There, we see here that service sales is, of course, improving our results quite a bit. It is an important component, both in good times, but of course especially, when you're coming downturns, because that's a very, very good cushion to have then for the results. We see that also -- we are helped -- we are in a situation right now where we capitalize more than we amortize in our P&L, and if we here also look for the forecast for the coming quarter, it is approximately an effect of SEK 0.5 billion for Q4 that we foresee, higher capitalization than amortization. The things that are affecting us on the negative side, selling expenses. We are growing as a company. We have higher top line. And of course, there are things and factors that increase our selling expenses. We are very careful on when we add on this costs that we have here, try to keep them as flexible as possible. So if and when the downturn comes that we have the flexibility to take care of that, extremely important, hard-working that in the organization for the time being. And then as we have said before, when it comes to the cash underlying R&D expenses, they are gradually coming up here, and this is according to plans that we have internally. And they will also, in a cautious way, continue a little bit up for us as well. Cash flow. Third quarter is -- sees otherwise the weakest quarter we have in terms of cash flow. So from that point of view, maybe not so much to say about. It's more or less on the same level as we have seen the last couple of years actually. I think it's -- anyway, this is a scenario that we are not 100% satisfied with. And this is, I would say, especially on the inventory situation. Now when we come into the fourth quarter, it's a high focus in the organization to basically secure that we get down the inventory. I mean, we trust a good market that we have out there, high demand and so on. We need to continue to keep the high focus on that. Part of the problem here is, of course, when you have the disturbances that we still have, and I will come back to that on the truck operations, the disturbances that we have on the supply chain, it means that we -- you have a little bit higher inventory. You don't have the perfect efficient organization, components are standing a little bit longer than what they should. You can also, from time to time, miss the delivery slot to customers and so on. So it's not efficient. But it's definitely more to do there on the inventory side. The payable side is kind of a seasonal effect that we have every time in the third quarter before we start to ramp up the production.Truck sales. Deliver trucks, as we said, strong growth almost 40% in North America. Europe, 4%. As a total, 14%. And total sales, when we take away the currency effect, is 15%. Service is 8%. I've always said if you're north of 5% in services, if you start to come up to 10% in this type of business. It's a really good growth rate that you have. And in total, if you take away the currency, 23% up in sales.The -- here, the trucks -- as I said before, we are so happy to see now that we're 11.1% in the third quarter. Good leverage as well, approximately 22%, which I think it should be actually under pretty normal circumstances. It's a good leverage for the truck operations. SEK 4.2 billion up to SEK 6.8 billion. And on the margin, I'm going from 8.5% to 11.1%. And as you can see here, it's basically the same explanation factors when it comes to the good and positives and the minuses on the result explanation. Truck is so big, of course, in the group. So that's why it influences the whole group as well. But it's worth to mention here, we do still have it. We are not perfectly fit on our -- we still have constraints on the supply side. We are not 100% efficient. The reason why we don't mention it here is that, that was the situation in the third quarter last year as well. So you can say the increased cost level that we have still have in the third quarter this year is more or less on the same level as what we have in Q3 last year. But you can say, the elevated cost level that we have due to that is not gone yet. So that machine is not 100% ticking as it should do. Then on Construction Equipment, 17% up in delivered machines, 7 -- 16% up in -- currency adjusted in terms of sales. We have here also services, 6%, healthy levels. We see also a pretty good market -- product mix as well, large and medium machines up 19%, smaller growth rate on compact. SDLG is usually actually a negative thing on the product mix, but we have pretty healthy profitability right now in China in SDLG, so it doesn't affect us so much on the mix side.Here going from SEK 2 billion up to almost SEK 2.6 billion, an increase on the operating margin of almost up to 14%. Same story here as we have seen before, managed to take care of the growth. We see that of course sales, service sales and the capacity utilization is helping us on the profitability. Leverage of approximately 16%. We maintain also the cost discipline in Volvo Construction Equipment, which I think is very good. And it's of course obviously important when we have taken all the measures in rightsizing in Volvo CE to be able to take care of the good increases we see on volumes while maintaining cost is important to us. Very good. There may be a question on why don't we see the effect of the results on property in Korea in the third quarter. Year-over-year, it's not a difference because we sold a dealer in the U.K. last year in the third quarter. It's more or less exactly the same effect. But we had 200 million in this quarter. But if you compare the results, it's not an explanation factor quarter-over-quarter.Buses coming down in delivered volumes, as Martin said before, of course, and also affected -- affecting our sales with almost 20% on the vehicle side. Very strong service operations, and I think it's due to the fact that we have the service operations that we managed to increase the profitability from the -- in terms of operating margin from 3.3% up to 4.4%. And I mean, as we said before, high focus now to lift what we have said we want to have Volvo Buses, as a start, about 5% stable. That is the first thing. That's important. And historically, I think buses have been more the level of breakeven, taking it up to 3.5-kind-of percent, got a little bit stuck. Now it's time to move on there, and it's a lot of hard work being done here. I think also we have -- currency effect is helping us. But I think this is the entity that has managed to have negative currency effect, I think 14 quarters in a row, so they deserve a little bit of a positive currency effect.Penta. I mean, it's just a fantastic result, 19.6%. I was joking with the -- with this Penta organization a little bit, "Couldn't you manage to take it up to 20%? It only means another SEK 13 million." It would have been nice to have it, but I think that's maybe the only thing that we can complain about, if anything. But I mean, it's just a great result, helped obviously by deliveries of engines but also very good service development. We had a good product mix, a lot of heavy engines, big engines, 60 liters going out to the market. So -- And of course, to see a result over SEK 600 million for Penta, it's not that long ago that, that was the actually full year result.Volvo Financial Services. They are also continuing their journey. We are obviously to the strong markets that we see right now, North America, also the fact that Brazil is coming back and China as well, increasing the portfolio quite a bit. 1 year ago, it was SEK 125 billion. Now it's a little bit above SEK 140 billion. And as I said before, we see more or less growth everywhere. Operating income above SEK 600 million, a strong and healthy portfolio, continued delivery on return on equity, once again, a solid result from Volvo Financial Services. And by that, Martin, welcome back on stage.

[Martin Lundstedt]

Thank you.

[Kina Wileke]

Now it's time to open up for questions, and we're going to take turns. We're going to start on the floor. And then we will take the questions from those who are participating over the phone. Who would like to begin?

[Martin Lundstedt]

Erik.

[Erik Golrang]

Erik Golrang, SEB. I have 2 questions. The first one, I don't know if you won't -- I don't think you want us to ask more questions on it, but you'll still get one from me on the defect emission component. And my question is really to the extent that this leads to a material charge or a fine in any way, would you expect that if this isn't resolved or if you haven't been able to estimate the cost of this before you propose a dividend for this year, will you be citing this as a key reason for holding back?

[Martin Lundstedt]

First of all, I think you should divide those 2 questions. First of all obviously, I mean, you know the cycle of -- our discussions regarding dividends. And I mean, normally, -- or not normally. It will happen this time as well, the board, and obviously in discussion with management, will propose something in relation to quarter 4 reportings. And so I mean, there is where we all want it on constant on the time line. And then when it comes to, so to speak, the degradation now, I think it's important to understand the we understand the root cause, and we also are -- know what solutions we will -- we are and we will put in place. Because this is a degradation over time. This is not something that is happening at delivery or something like that. So what we are working with is to understand what could be the potential population in those affected segments and applications and geographies. And there, we would like to be precise that we should be when we are giving a figure. But we have the arms around the situation. And the vehicles that are out in the market is working accordingly, obviously, to the most of it that is in the market. So I will not speculate today about the time line. But of course, we are as eager as anyone else to really clarify furthermore. But we don't want to do that without quality in our message, so to speak. And that is the only thing I can say today. So we will not wait if it's not necessary.

[Erik Golrang]

Then the second question is on -- and on Renault and market share in Europe. It's up a bit, but it seems as if the progression there, the recovery of lost market shares from history is moving perhaps a bit slower than you've been targeting. What's the reason for that? And could you do anything to speed it up? I assume you do, but what's holding it back?

[Martin Lundstedt]

No, it's done. No -- put it like this, Erik. I think it's important to say that the first and most important was to really stabilize, and stabilize the level with good quality in the business because we have a great product offering. We have a great service offering. And the good news is that, in the key markets of Renault, we have done that it in a good way. We are actually steadily increasing in those market. What we need to do now is step by step also come back to certain key markets, where we actually did lose some market shares, and that, we're working on. But we will not do that to the expense of the quality of the business because that has been hurting the Renault organization before and now when we are standing on 3 solid legs because here we're talking about the heavy duty of just south of 9%. But we are also making progress in the medium duty, and we have a very good progress also in the light duty. So if you really put there together around Renault, I think we have a good progress according to plan actually, and not to the expense of making bad choices when it comes to the profitability for Renault.

[Kina Wileke]

Thank you. Let's take the first caller we have online.

[Operator]

Our first question comes from the line of Klas Bergelind of Citi.

[Klas Henrik Bergelind, Director]

It's Klas from Citi, a couple of questions, please. Firstly, the guidance on Europe, so yet another 300,000 year when we look at '19. I just want to understand the reasoning. We're seeing trade volumes peaking, cost inflation building for the carriers. We see diesel up, wages up, and that could put pressure on carrier profitability. And then fleet age is now below 5 years. The replacement cycle seems to be over. And so 300k to me can feel a bit of a stretch. If you could comment there, Martin, a bit about how you think about Europe.

[Martin Lundstedt]

Yes, and a little bit the same message that we have had before. When we -- I agree that there are certain elements in the market that obviously can put pressure on the forwarders' profitability. But having said that, we should also understand that they have a historically good profitability level when we talk to our customers. And that, I think, is also a good starting point also for next year, if I put like that. Another factor that we have seen is that a big part of them, I mean, we have almost anticipated that it could be even higher volumes already this year. But one thing that has hampered that growth rate has been the lack of drivers actually and really to find other type of solutions. So I think there is anyhow a pressure that volumes will continue to -- because you have some structural measures also as we have said, for example with e-commerce, et cetera. So if the midpoint in the historical trend line should be maybe 175, 180, or 270, 275, I think we all rather a couple of percentage points higher, given the structural change in Europe also when it comes, for example, to e-commerce. So again, when we look at activity level, when we look at our mileage from different sources, the connected trucks, et cetera, and when we talk to the -- I mean, customers and also customers' customers, yes, some sort of stabilization that we have guided for, but still, we are forecasting as relatively solid levels.

[Klas Henrik Bergelind, Director]

Okay. And my second one is on the drop-through in Trucks, the operational gearing. So yes, well done, now almost firing on all cylinders, but I'm interested on -- in what can happen on the way down obviously, I guess, particularly on the service side, if we see them unfolding. Deliveries might be stable next year as you guide, but orders are facing a very tough comp, particularly in North America. Can you remind us of how the service business developed in North America in 2015/'16 when vehicle orders were in free falls? And North America often used by you as an example of how you improve profitability versus the previous cycles. Any word on service development in a downturn now, that would be very helpful.

[Jan Gurander]

I think North America there, I think we -- as an effect of our strategy to go more and more for captive drivelines, and obviously, fleet that is increasing then with more and more captive engines and gearboxes as well. We managed very well through the downturn between '15 and '16, actually. If you look about it historically in Europe and other parts of the world as well, as a matter of fact, service is very stable in downturns, maybe not continuing to grow, but you keep them at a stable level. So we are convinced that it will be a very, very good support if and -- or when the market turns down.

[Martin Lundstedt]

And referring to your point that also in '15 and '16 and the downturn, one important point where we -- why we continue to stay in black in North America was thanks to the increased penetration and services captive, captive the powertrain but also that we have been working a lot with uptime centers, et cetera. So when we -- I mean, when you look at North America, I mean, we have a market share maybe 20%, 25% due to lack of bay capacity, historically. Our dealers are continuing to invest in new workshops and new bays. And we are more efficient in turning around, so to speak, the vehicles through this uptime, certified uptime bay concept, where we actually are decreasing the turnaround time dramatically. So I mean, there is a lot of very specific activities ongoing that makes us taking better market share of our own fleet basically of Volvo Mack.

[Klas Henrik Bergelind, Director]

My final one is on the changeover in Mack. You say a very strong order booked-out for entire next year. So obviously, when the transition is over and Anthem starts to deliver, the market share in theory should jump quite a bit there. When do you think you can see more normalized situation? Is it on this side of the year? Or do we have to wait until the first quarter '19?

[Martin Lundstedt]

First of all, maybe you overread it. What I said of that order book is the whole next year, but it's a considerable part of next year, I should say. And that is good enough, I should say. I should be even more worried if it was the whole year, actually, given, I mean, quality in the order book. But having said that, this is, as I said, for Weissburg and the team over there, the main priority right now. And as I said, reception of the vehicle's great, high demand and not at least on highway executions where we previously, with the pinnacle, we have had a pretty weak offering, actually. So a full focus on that, there you -- I mean, we are continuously -- let's see, I mean, an improvement. I mean, if you see year-over-year, we have increased also for Mack. So I mean, we are improving, but it is a tough situation right now with the competition and moving everyone want to get the attention in the full supply chain here. So -- But I can promise that this is a full focus. Hampus?

[Hampus Engellau, Automotive Analyst]

Hampus Engellau, Handelsbanken. I have 2 questions. Starting off on the European orders second quarter, there was a big difference between the OEMs in terms of order growth. You have Scania and Volvo reporting negative orders. And Daimler and man was up quite a lot. And as I understood, it was a couple of large orders in Poland and Germany. So I was wondering if you could share some light on the order activity third quarter, given that you report a 5% growth in heavy. Then a bit on coming back to Europe. If you could talk also a little bit about current situation regionally, Central versus Northern and also Southern Europe. Because there's a big difference in aging there if you look at some replacement cycle in the southern part of Europe.

[Martin Lundstedt]

Yes. If we start with, I mean, the difference between second and third quarter, when we look at -- when we look upon it. And here, we have been working, I mean, for a couple of years now to have a good quality in the order book and really see what is happening, et cetera. And as you know, we have a big captive portal at least on the Volvo trucks side also, so we have good control of that. And I should say that, when we look at quarter 3, and I can also include the regions, we have a relatively good spread both when it comes to segments, customer sizes and also geographies. And so -- and also, when we look at the used situation actually in Europe, stable and solid. So generally speaking, we feel that the good activity level continues and not specifically only for certain regions or customer segments.

[Kina Wileke]

All right. Let's move back to our callers.

[Operator]

Our next question comes from the line of Graham Phillips of Jefferies.

[Graham Phillips]

A couple questions, please. First of all, just back on the NOx issue. Can you just give us a little bit of idea, Martin, please? You said you're implementing solutions. Is it via software or a hardware fix? Has this got some similarities with what Cummins had to deal with back in August? And when you do have to account for this from a financial perspective, will it be something that will be in terms of higher warranty charge? Will it be a one-off number in the quarter, a charge against Trucks? How should we think about that?

[Martin Lundstedt]

Yes. When it comes to -- again as we said, I mean, this is a component that is originally designed to last over the complete life cycle or life length of any vehicle or machine. In some specific cases, we see that there is a risk of not doing so. And in that case, it's not about software. It is about hardware. And we need to upgrade that and replace that in that case. And there are different types of solutions of doing so, depending of segment. And I think, again what is important for all of you trying to understand, it's an isolated problem that we understand. We have solutions to put in place. And thereby, I think you should more think about that as a one-off rather than going concern.

[Graham Phillips]

Okay. And so, I mean, yes, again, so did you look at the Cummins situation and where they had to make a similar fix, I think, on their engines in the U.S.?

[Martin Lundstedt]

We did look at the Cummins situation. Obviously, we look at all competitors in all different matters, but I have no specific comments to Cummins. We are working on our issues. What we are, so to speak, proud about is that we have been very transparent. We detected this internally. We have disclosed it. We have had the right context. We are taking actions. And we are taking our responsibility when it comes to our customers. And we have a good view on both the problem and the solution, and that is what we are focused on.

[Graham Phillips]

Okay. So my other question was on the drop-through margin in Trucks. Can you give us some idea on pretty much the R&D capitalization? How much, Jan, was the R&D capitalization to Trucks? Is it pretty much all of that? And given that the numbers coming out quite healthily looks like about 27%, and there's more to go for was your comment a couple of times about the leverage, that means on flat volumes, in fact, we could be looking into next year maybe at a higher drop-through margin?

[Jan Gurander]

Starting with the capitalization, the majority of the capitalization, that comes obviously for Trucks actually. So I think it's more or less virtually everything that is related to Trucks. I think what I said was that -- I mean, we still have disturbances and increased or elevated cost levels due to the fact that the supply chain is -- and it's both internally and externally. It's not working as it should do in normal circumstances. So maybe there also with a little bit more of a stable situation, not as high, high growth rates. I think that there's room for improvement from an efficiency point of view if you look ahead. So I think all other things being equal, that could actually be healthy for our margins and what you could call the drop-through.

[Graham Phillips]

And could there be more capitalization in 2019 compared to '18?

[Jan Gurander]

We -- always we guide for the next year in terms of capitalization, when we come to Q4 actually. So I will not go into that today as well as we don't do that for currencies either.

[Graham Phillips]

Okay. And just finally, looking at the Volvo book-to-bill situation in North America, very high, 2.3x. Again, you made the comment about the quality of the order book. I mean, are customers prepared to wait that long for a truck when they're ordering, and they can see that it could be maybe even into 2020 before they'll get a vehicle if you're not willing to add capacity?

[Martin Lundstedt]

Not all that. But I think Graham, to your point, and that's the reason why I also said that, I mean, you have a mix in the order book of, I mean, firm orders, and then you have certain placeholders. I mean, some of the big fleets, for example, we're working with, they want also to make sure. We know that they have a certain need over the year. That can vary a little bit, but I mean, the basic need and the baseline is already there. And then we are working with them on that, so we can distribute that over the year. Then what we are doing is that when we are rolling the order book ahead of us, we are also going through that month by month, both for Volvo and Mack, and not only in North America. By the way, this has have been one of the prime focuses of the last years to really get the relation between the order book, deliveries, production and the value chain much tighter than we have had historically in the group. And that is giving results, but I mean, I think you should think about it as a reflection of confidence also into the market, both from dealers but also primarily from customers that know that they need capacity.

[Björn Enarson, Head of Equity Research of Sweden]

Björn, Danske Bank. Sorry coming back to this, but on the NOx situation, you keep telling us that there is a -- that you identified a risk at least to some components. So are you telling us that you have not have trucks out on the streets being on the wrong side on what the regulation says?

[Martin Lundstedt]

What we're saying is that this is a degradation issue that can happen over time. And in certain issues, we have already changed the box. And now we are much more in-depth analyzing why did that happen. There is no big end numbers of that, but why did it happen because there can be a number of different causes. You've got everything from mechanical failures and to this type of degradation. And again what we are saying is that if that is happening, we are changing, obviously, because we need to comply with the limits that exists on the market. But when it comes to the disclosure and the discussion about the figures, again we would like to be certain about the magnitude, so we have a serious response to the market instead of guessing. And that is what we're doing right now.

[Jan Gurander]

Yes.

[Björn Enarson, Head of Equity Research of Sweden]

And on coming back to a potential slowdown in the market, apart from the service side, what other big changes from last time it went south? What kind of actions can you implement, or are you looking at to...

[Martin Lundstedt]

I think several -- a number of things here. Reaction time is the key here. Now I'm talking more, Jan, so don't take this as we have the sign of this going down, which is also always difficult to say. But I mean, if the sales organization is saying minus 12 -- 10, then triple it when you plan for the production. I mean, that is how it works. You need to be bold when it starts, and the reaction time is number one. And number two is that you have the flexibility in the system as such. And that, we have when it comes to temps and fixed contracts and also the flexibility in our value chain together with our suppliers.

[Björn Enarson, Head of Equity Research of Sweden]

How does that differ from last time on the...?

[Martin Lundstedt]

No, I should say that not only in figures because that is not differing so much but also the preparation where you have the flexibility so you really can take it out. One thing is that you have, I mean, a mix between fixed and temps. But another thing is that the consultants or the variable costs in manning can really be taking out from the system. That, we are now working with a lot. And again, I think that both Brazil, the downturn and North American also, the Volvo Construction Equipment case have shown that we are capable -- that we are humble and we are looking at this all the time, so we have a good preparation level. I don't know if you want to add something, or ...

[Jan Gurander]

No, but as I said before now, I mean, this is obviously some cost increases in some areas. And what we try to do all the time now make sure that what we add on now is really flexible when the downturn comes. And we are also mapping that quite carefully. So coming back to your point, from experience, I can say reaction time is actually a pretty big thing. Because if you wait too long, you don't have the right signal, that is old. So if you're prepared and know what to do, act in the right time, and also if you see things starting to happen a little bit bigger, take a pretty abrupt thing. Because it's usually -- it's the best thing because people are always a little bit more optimistic rather than what you think.

[Martin Lundstedt]

And another thing, I -- to the point to Jan said, I think also the cultural shift, I mean, decentralization gives also power. I mean, that is automatically giving closer signs to the organization that you really take the decision out in the regions or in the brands and really act quicker. Because I mean, the accountability's there to do so. And so yes, the only proof in the pudding will be when, one day, that happens and we can show that we can do it.

[Jan Gurander]

We are prepared.

[Martin Lundstedt]

We are prepared.

[Kina Wileke]

Operator, please go ahead.

[Operator]

And our next question comes from José Asumendi of JPMorgan.

[José Maria Asumendi, Head of the European Automotive Team]

José, JPMorgan, just want to come back to Europe. As you prepare for a downturn next year, can you just give us a sense of the proportion of temporary workers you have, one? Two, how many do you plan to lay off by the end of the year, if that is going to happen or not? And then three, can you just give us a figure on the reduction of fixed costs that you've done in the European business in this cycle versus the previous cycle? The second element would be please around your product mix. It looks like on orders, heavy trucks are definitely suggesting about a 3% to 5% improvement in product mix going on to the next quarters. How sustainable is that share of heavy trucks in your business model, if you could just give some color maybe across regions? Obviously, you haven't seen yet the impact of market in the U.S. long-haul.

[Martin Lundstedt]

Okay. On the first, José, there, I think it's a little bit exaggerated to call it a downturn. What we are saying is that we believe now we are guiding up from 310 to 315 for this year. And that is really the fine-tuning when you're coming at the end of the year to see where it will end. And it might be some smaller correction or that for 2018. And then, what we are saying is that, next year, likely to be on a stable and good level of 300,000, that is I mean, if you calculate it in an Excel sheet at minus 5%. But in reality, that is what you're taking with the flexibility you have in your production system, as it is with banking hours and also the flex. And given that type of stabilization to minus 5% and beyond, that obviously we have the flexibility needed and beyond that as well, absolutely. And then I was not really sure about the second question, José, if you can just repeat what you meant there about ...

[José Maria Asumendi, Head of the European Automotive Team]

What I meant, any way you look at orders and deliveries and you look at the share of heavy trucks within your business, it looks like it is suggesting that the share of heavy-duty within your business, both on deliveries and on invoicing going forward, will take an additional bigger share within the Truck division. And this obviously, I think, is an element that could be a surprise for investors as you continue to deliver record truck margins over the coming quarters. And in other words, I think there's a product mix element also coming through for you on the Truck front. Is this a level that you think it is sustainable? And obviously, we have not seen yet the impact of long-haul Mack yet.

[Martin Lundstedt]

Yes. Okay, thank you. Now I understand. Thank you, José. Yes, if anything, you can say obviously 2 elements for that. Historically, it has been a drag for us, if I'm very clear, to have the mix into North America, regardless if it has been heavy duty. The good news is that we have constantly been improving that situation for North America. So the first answer to that is that an increased share in North America is not necessarily bad to us. That has been historically but a good situation. The second part is that when North America is increasing, by definition, that is heavy duty because we are only into heavy duty when it comes to North America. So if you look at the full cost, the share of heavy duty in relation to others will increase.

[Kina Wileke]

Right. Let's take one more from the room.

[Mats Liss, Equity Research Analyst]

Mats Liss, Kepler Cheuvreux. Coming back to the emission issue there. Could you say something about geographical mix in those properties? Is it more a U.S., or is it similar to -- in Europe as well?

[Martin Lundstedt]

What we have said is that it is segments and applications both affecting North America then and Europe. But again also, that is what we are working now to really understand the different patterns we see, since again, this is the wear and tear over a pretty long time period, since we have -- with good reasons also, by the way, those demand that it should withstand through a longer period of the life cycle. So that is exactly what we're investigating.

[Mats Liss, Equity Research Analyst]

And do you use the same supplier for all your engines?

[Martin Lundstedt]

Yes. I mean, at that -- for the time being, we are not commenting on, so to speak, how the supply chain looks. Because what we feel is very important now is that everyone that is part of this, really take the full focus of working together to have a good grip on the situation, make sure that we are, so to speak, solving or understanding better the population. As I said, the root cause and the solutions, we understand together. But now we need continue to understand the pattern, so we proactively can -- and make sure that the customers can run their operation in good mood, so to speak.

[Mats Liss, Equity Research Analyst]

And then a quick one on China, I guess for -- on trucks there, there are some emission -- tougher emissions standards coming up in 2020. Do you see any prebuy impact already?

[Martin Lundstedt]

It could be. There are 2 elements there, Mats. First of all, 2020 CN6 or equal to Euro VI is coming into play in China. But what is interesting is that the bigger cities are not waiting for that because they have so high demands on complying with air quality. So many of the bigger cities actually are demanding that already from mid-2019, which means that we foresee certain type of prebuy order in 2019 for the bigger cities.

[Kina Wileke]

We have room for one more caller. So operator, please go ahead.

[Operator]

And our last question from the phones then comes from Alok Katre of Societe Generale.

[Alok Katre, Equity Analyst]

I just had a couple really. One is on the U.S. now. Just wondering if you could elaborate a little bit more in terms of how, let's say, your thinking there has developed for 2019. Because I was just looking at how strong the ordering rates are, and even if we sort of adjust for some speculative orders and with more normalization of the order rates, 310,000, or let's say a bit more than that still seems a bit, let's say, soft than what the orders would suggest. So just wondering what is it that's driving your thinking around the 310,000 or let's say even if it's 320,000 or whatever it is for 2019. So that's the first, and then I have a follow-up on the R&D.

[Martin Lundstedt]

Yes. If anything, I mean as we said, of course, we have a very strong both order book to your point and also continued strong order intake. And I agree, even if that could be, I mean, some placeholders as we have said, I mean, we foresee with activity levels we have, now a strong 2019. And as I already said also in the presentation, if anything, if we have 310,000 could be on the lower side. We think a little bit will be restricted also about how we'll, so to speak, the supply chain generally speaking, keep up with this high activity level. So yes, we certainly agree there. And we have discussed that where we should put the forecast here. But we wanted to guide that it's a continuous good market that will move north. And then the fine-tuning is still to be seen here.

[Alok Katre, Equity Analyst]

Right. So the supply chain supports then -- I just wondered again just on supply chain side, I mean clearly, if the supply chain is geared up for 300,000, then 310,000 seems like a smaller jump. Or even 320,000, 325,000 seems like a relatively smaller jump. So what's really -- I mean, is it just visibility that you have at the moment, that you want to be a bit more cautious going in? Or really...

[Martin Lundstedt]

I think the main message there is really, as we said, a strong, solid market right now. We are not seeing any signs that, that should soften off. When we told the customers' activity levels, when we look at the connected activities, when we looked at the order book, et cetera up, and when we look at the changes in the market driven, for example by e-commerce, there is a lot of signs, but -- so we have guided for 310,000. It might that be on a little bit lower side, it might be so. But that is the figure we are guiding for, for the time being.

[Alok Katre, Equity Analyst]

Okay, fair enough. And just on the R&D, and sorry, and I appreciate you wouldn't want to guide on FY '19 overall. But just wondered, just conceptually how should we think about the R&D capitalization versus amortization cycle as we look into the next 12, 15 months or thereabouts? Because obviously, for this year, it's probably looking more like a 1.5 billion tailwind. That's 40 basis points roughly on the margin. So just wonder how we should think about where we stand in terms of the capitalization versus amortization cycle, so to speak?

[Jan Gurander]

I think I'll -- after careful consideration, I think I give the same answer as before. We do not yet guide for 2019, so I will not do that too today. We always do that when we come to the first quarter actually.

[Alok Katre, Equity Analyst]

Okay, fair enough.

[Kina Wileke]

All right. That's a wrap-up. Thank you so much for coming today, and see you in 3 months' time.