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Edited Transcript of SAND.ST earnings conference call or presentation 17-Jul-19 12:00pm GMT

Q2 2019 Sandvik AB Earnings Call

Sandviken Jul 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Sandvik AB earnings conference call or presentation Wednesday, July 17, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ann-Sofie Nordh

Sandvik AB - VP of IR

* Björn Klas Otto Rosengren

Sandvik AB - President, CEO & Director

* Tomas Eliasson

Sandvik AB - Executive VP & CFO

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Conference Call Participants

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* Alexander Stuart Virgo

BofA Merrill Lynch, Research Division - Director

* Gael de-Bray

Deutsche Bank AG, Research Division - Head of European Capital Goods Research

* Graham Phillips

Jefferies LLC, Research Division - SVP Industrials, Capital Goods Research

* Guillermo Peigneux-Lojo

UBS Investment Bank, Research Division - Executive Director and Industrials Analyst

* Klas Henrik Bergelind

Citigroup Inc, Research Division - Director

* Lars Wauvert Brorson

Barclays Bank PLC, Research Division - Director

* Markus A. Almerud

Kepler Cheuvreux, Research Division - Senior Research Analyst

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Presentation

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Ann-Sofie Nordh, Sandvik AB - VP of IR [1]

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Greetings everyone, and welcome to this presentation where we will run through the results for Sandvik's second quarter results. As usual, we have our CEO, Björn Rosengren; and our CFO, Tomas Eliasson here with us who will run through the slides. And after that, we'll open up for your questions.

And without further ado, Björn, please go ahead.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [2]

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Thank you, Ann-Sofie. And also, I like to welcome you to this second quarter interim report presentation.

Starting up with a summary of the quarter and it can be seen as 2 sides on the coin. On the first one, we still see historically high demand levels. We do our second best result in the history, and we see a strong performance within SMT as well as in the mining business area. On the other hand, we see a weakening of the demand in the end of the quarter, driven by the automotive and general engineering market. And we have a weaker result in the SMS business, driven of lower volumes. And based on this, we then have kicked in a number of efficiency measures that will be implemented during the half year, and that's driven by our divisions in the way we do in a decentralized organization.

Also, if we look at the quarter, we have also taken an important decision, is to start separation within Sandvik of the SMT business area, but also to investigate the opportunities for a separate listing. We have also presented and also actually closed 2 acquisitions, Newtrax as well as OSK. Come back to that a little bit later.

So just to the cost program that we have initiated. And this is, as you know, a decentralized-driven structure, which means that based on the lower volumes that we saw in the end of the quarter, a number of these continuous measures have been kicked in by the divisions. And if we summarize these activities, it's about reduction of approximately 2,000 people, with a estimate saving of approximately SEK 1.4 billion, and the cost for this program around SEK 1.2 billion. And these savings will kick in later on during the second half of the year.

So to the demand picture. So we -- first we can say that we can see weakening in all 3 major segments there or, first, let's say, the market. Europe is down 10%, North America minus 8% and Asia 6%. If we dig into these numbers a little bit more in detail, which I think is important, we can see Europe, it has different flavors here. If you at look SMS, which is important as a good indicator of the demand, we see in the whole EU about minus 5%, but in Germany, we see minus 13%. So that's more severe. In North America, we see -- that is including of course, the whole North America, we look at U.S., which is an important indicator here, we see a plus 3%, if you actually exclude large order for SMT and that is both for the whole Sandvik as well as for the SMS. Actually, SMS is plus 4%, so somewhat better.

And then we're looking to China or the Asian region, we can see that China by itself is about minus 2%. But if we look at SMS, which I think is a better indicator here, it is actually minus 9% in that part. What's sticking out here is also Australia, which is then related to large orders within SMRT, within our mining business, and that's our big contractors in Australia who's placed orders, where these equipment will be used all over the world, so a very positive development there.

If we're looking at the segment, I think we see a similar pattern both year-over-year as well as sequentially. It is 2 segments that are developing negatively and that is the automotive and the general engineering, while the other segments are pretty flat.

So if we look at the order intake, and overall, it's minus 5%. But I think you can say that we saw a pretty good start of the quarter. So if we look at both April and May, we think it's a pretty stable numbers and then we saw a weakening in the June -- month of June, which have resulted in minus 5% order intake.

On the revenue side, yes, it's pretty much in line with last year.

On the EBIT level and the profit level, as I mentioned for the beginning, this is actually the second highest profit that we have had, and this is the third highest profit margin of 18.8%. Yes, but I'm still not 100% happy with this number because I think on the SMS side, it was somewhat weaker than expected. All right, we can say, it's about 2% down compared to last year quarter.

Then if we go into each of the business areas, so starting up with SMS. Yes, what I said before is that the quarter actually started pretty good with a strong April and a reasonable good May and then we saw a softening in the third quarter. And -- sorry, in the third -- in June, which is the last month in the quarter. And that is driven by weaker markets, but also that month is somewhat shorter, I think, it's about 2 days shorter than previous year.

Yes, we're seeing then that the margin, the EBIT margin, had declined to 23.3% and that is lower than that I expected from SMS. And that is probably coming because of the lower volumes in the end of the quarter and not having time to take the right measures. And this is of course why the divisions now have decided to take these actions to adjust the cost structure in line with the rest of the demand.

One -- we also have in SMS one acquisition, that is the OSK, it's around 2 -- it's a Chinese, around 2 company that was also closed during the quarter. Volumes is down 4%, but it was more during June than we saw in the beginning of the quarter.

On the mining side, I think we're seeing good execution here. On the one hand, we saw weaker June in SMS or in the short-cycle business. We had a record order intake in June in mining. That was actually the highest we have had in a very, very long time, which was driven by Australia and strong contractor orders during this period.

On the other hand, I think we can say that if you look at the growth here is about 0. But if you dig into that a little bit, you have approximately minus 8% on equipment and then if you're looking at the aftermarket, which include both the service as well as the consumables, it's about 5% up. And that ends up at about 0. I think also 18% EBIT margin is an improvement from last year. I think it's moving in the right direction, and sometimes I also presented without the Varel business, as you know, is on the sales list, it is as high as 18.9%. So quite good execution from the mining business.

Then looking at SMT. I think Göran and his team doing a great job in improving the efficiency in the business to reach 10% for the full year. We saw during this quarter 14.6% that includes, of course, also the metal price effect. If we look at the underlying margin, it's 11.3% in the quarter, which is in line with the expectations that we have to be able to reach the 10% for the full year.

Worrying side here is the short-cycle part of the business, SMT, what we sometimes call core and standard where we saw orders drop down there, resulting in 20% lower than previous year on the full quarter. If you take away large orders now relating to the umbilical business because we got 1 big order for umbilicals about SEK 260 million, but last year that was over SEK 500 million. So if you exclude that part, it's about 17%. So still that is quite a severe down in order for SMT. And that is also why SMT like some of the other divisions need to make sure that we have the right cost structure moving forward.

So Tomas, maybe you can dig in a little bit in the financials. Thank you.

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Tomas Eliasson, Sandvik AB - Executive VP & CFO [3]

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Thank you very much, Björn. I'll do my very best. So let's take a little bit of a dive into the numbers, and we'll start with the financial summary. And if we go to the upper hand right corner and start with the top line, you can -- you see the minus 5% in orders and flat on revenues, 0. Currencies was plus 4%, both for orders and for revenues; and structure was minus 3%, both for orders and for revenues. And structure is, of course, net of both acquisitions as well as divestments. The big divestment that we had last year was Hyperion. The buyer consumed -- consummated the acquisition on July 2, so this is the last time we have Hyperion as a negative in the numbers. Total, minus 4% for orders and plus 1% for revenues.

If we then move to the earnings. Earnings was down in numbers, 2% in the quarter, plus 2% for the 6 months and the margin was 18.8% compared to 19.4% a year ago. But as Björn mentioned here, this is one of the highest earnings numbers we've had in the history of the company and one of the highest margins we've had in the history of the company, but that's history now. Now we have to take actions to continue to deliver strong earnings going forward.

The finance net will dip a little bit deeper into this time, but it was minus SEK 387 million in the quarter, driven by a repayment -- a premature repayment of some facilities. More about that in a second.

The tax rate underlying was 26%. You can see that the reported tax rate was 23.2%, but that's impacted by a Coromant operation within Varel Oil and Gas where we had a capital gain on a Coromant, which was offset against tax laws. So a capital gain without tax effect that pushed down reported tax rate. But if you take that out, it's 26% straight in the middle of the guidance of 25% to 27%.

Working capital was up to 25.9%, and we have a slide on that as well. Cash flow, basically the same as a year ago, and plus 28% for the 6-month period. Returns, 22%, and earnings per share flattish compared to last year.

So if we move a slide then and go to the bridge, you see the -- on the organic side, the top line was flattish or black 0 plus SEK 28 million and leverage of close to -- or an EBIT effect of minus SEK 300 million. This is all from SMS. SMRT and SMT had both growth and improved earnings and improved margins. This minus SEK 300 million also we should bear in mind that around SEK 100 million in the bridge is because we had overproduction a year ago, and now we have reduced production volumes. So it's just a mathematical effect out of that. So minus 1.1% in margin dilution organically, plus 0.8% from currency, and minus 0.3% from structure and one-off. So that's the journey from 19.4% to 18.8%.

On the next slide, we have the finance net. And the most important line in the finance net is the interest net, first one, it's gone down from minus SEK 174 million to minus SEK 148 million just as it should as the debt is reducing. Then on the next line, you have the one-off, minus SEK 200 million. This is a redemption or a premature repayment of 3 loan facilities during the quarter totaling little bit more than SEK 5 billion. This were not traded bonds, this was bilateral bonds. So it was up to us to decide whether we want to repay it or not, and we did so.

The real interest compensation was SEK 300 million, but then we had a positive swap of SEK 100 million that we could release back into the income statement. So the net-net is minus SEK 200 million. This corresponds to about 20% of the gross debt and about 40% of the interest net. So we'll have a nice reduction of the interest rate going forward. And as you can see in the table here, this SEK 200 million will repay itself over the next 2 quarters. So it really doesn't affect the guidance on the finance net for the full year.

On the next slide, we have working capital. If we move over then to the balance sheet, and of course, working capital was up in the second quarter. Three factors really: the first one, as it says here on the chart, seasonal stock build up, as we always had; the second one is that we had heavy deliveries at the end of the quarter, giving us a lot of receivables that will sort itself up within 60 days, it would just become cash flow before the end of August; the third factor here of course, which has an impact on the working capital is the drop in volumes in June, which of course had an impact on the inventories, which actually increased. So you can see that on the right-hand side especially on the SMS side, you can see here how inventories are going up at the end of the quarter.

Cash flow, same this quarter compared to the same quarter a year ago. And of course, if you look at the chart now you can see that Q1 and Q2 seasonally in Sandvik in all these years is always on the low side. It's somewhere between SEK 4 billion and SEK 6 billion, that's what it is. The third and the fourth quarter is always much, much better in terms of cash flow. And we will have a cash flow during the second half of the year, which is similar to what we had last year and in 2017. Our ambition is to actually be a little bit better on the cash flow for the second half of this year compared to 2018.

Finally, net debt. The financial net debt ended at SEK 10 billion, of course impacted, as always, by the dividend payout in May of SEK 5.3 billion. The total net debt, of course, is also impacted by an increase of the pension debt as the discount rates has gone down. So it's SEK 6 billion now, that's SEK 1 billion up sequentially and SEK 2 billion year-over-year. And the gearing is 0.32. Given the cash flow ambitions we have, we still expect the financial net debt to melt down to basically nothing before the end of the year given that we don't do anything else.

Now let's finish off with the guidance. First looking at the Q2 guidance. We guided SEK 300 million in positive currency effects, underlying currency effects, transaction and translation it ended at plus SEK 455 million and the driver of that is, of course, the -- even weaker Swedish krona compared to the U.S. dollar. Total currency effect minus SEK 390 million. Metal price effects, SEK 131 million; we guided SEK 100 million, so basically in line.

For the third quarter, we guide SEK 300 million in currency effects underlying still the U.S. dollar, and metal price is basically on par, so minus SEK 20 million. And the full year guidance, cash CapEx around SEK 4 billion or below SEK 4 billion as we have said before. Net financial items around SEK 1 billion and the tax rate, we keep the guidance of 25% to 27%. We had 25% flat in the first quarter. We had 26% in the second quarter. The 6-month tax rate is 25.6%, so we are well in range, actually in the lower half of the guidance.

And with that, Björn, I'll hand over to you again for summary and conclusions.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [4]

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Thank you, Tomas. So if we sum up this quarter, we can say that, yes, we've seen a quarter with good demands, but slowing down in the end of the cycle driven by the short-cycle business that we have. We have based on that and that is the way we work, our divisions have taken the actions that they need to do to adopt cost level in line with the demand and with the measures have been taken and we are planning to during the second half of the year to reduce our manning with about 2,000 people, that is an important.

We have also during this quarter, as you all know, taken the important decision to start the separation within -- of SMT within Sandvik. And during the quarter, we have also presented our financial targets as well as our sustainability targets, and these were presented during the Capital Markets Day in Tampere, Finland.

And as a last part, I'll say that we are of course as always committed to these targets that we recently presented.

By that I think we end the presentation and go over to question and answers. Ann-Sofie, please.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [5]

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Yes. Let's do that. And we'll start with a question from the conference call, please. Operator, would you put through the first question, please?

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Questions and Answers

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Operator [1]

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And our first question is from Klas Bergelind from Citi.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [2]

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Björn and Tomas, it's Klas Bergelind. The first one is on the cost savings. Could you talk more about the split between the divisions, the weak spot business in SMS where we see the incremental volume weakness and also looking at the weaker margin? But on the slide there you say that you want to take out costs in all divisions. I would have thought that all the actions would be in SMS as we had the weaker drop through. Were you not focusing on entirely on SMS? Are you effectively saying that you are still confident there that you are going to trough at the higher level and the under absorption is bigger this quarter, lot of questions on the under absorption and drop through versus your confidence in the higher trough margin during the Capital Markets Day. So why not all the cost savings gear to SMS? Is that the confidence level still very much being there?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [3]

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Sure. Little bit first on the cost savings. You know the structure we work each of the division are taking the actions that are being needed and then we from central (inaudible) we just follow-up that things are being taken. And we have our continuous plans and that is what the divisions are delivering on to. These cost savings are in all divisions and -- or all business areas, not all divisions, but all business areas. It's correct that SMS is taking the biggest part of this. They have already during this year taken out over 500 people, which would be start kicking in during the coming quarters. So that has been done during the part and that has just been running on. Now they need of course to continue to initiate these actions to be able to deliver the numbers which they have committed to.

But at the same time, we've seen on SMT side, on the short-cycle business there that the orders were in, they need to take actions there. On the mining side, yes, they're seen in certain areas that is being done a little bit on the equipment. So they have also felt that they need to take these actions. But this is the important thing that in this decentralized part, the divisions are making these decisions. They are closest to the customers, they are feeling what they need to do.

And we are in, of course, an early stage of a so-called decentralized organization and as more these divisions learn how to act, I think, they will be quicker also in taking decisions going forward. But I'm happy with the numbers that we have presented and we've gone through it, and I feel that this will have a good impact both of the performance of SMS, but also for the total Sandvik performance.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [4]

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Because you said that you were surprised by the margin shortfall, but -- was that more the June turning out much weaker? Or is the drop through weaker in general than you thought? Because we are getting lots of questions on this.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [5]

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Yes, sure. I can say that after 2 months, we were pretty -- I was pretty satisfied with where we were and -- on the volume side and then June became much weaker than we thought, then the drop through was there. On the other hand, we ran last year the business in full speed upwards, and as you know, we had a gearing, which was around 65%, 70% last year, so there was a lot of on cost that came from powder business, which was record high and high performance, and we never had this high profit margins. We are comparing to extremely high numbers.

But sure, I'm not happy with the 23.3%. I had expected a little bit higher, not much higher, but I had expected a little bit higher in that some of those measures that have been taken would have kicked in, and that's why also they are accelerating these actions going forward. But it is a -- I mean, it is a vertically integrated business. And when you're coming and the volumes are slowing down, yes, it drops out, you had to adopt your cost structure. And they were also taken by surprise a little bit in June that June was that weak.

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Tomas Eliasson, Sandvik AB - Executive VP & CFO [6]

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Maybe I can comment a little bit on the drop through, Klas. We're talking about June here. We're talking about the end of the quarter here. And I mean, we are fully committed to deliver what we said on the Capital Markets Day. But the structure of the SMS income statement is that their material content is pretty small compared to the other businesses and the value add is very high, which means that in a single month, all costs become fixed, both what we normally call variable and what we call fixed cost. That's why you have a pretty tough negative drop through from that, but this will sort itself out not by itself, but through actions over the quarters to come.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [7]

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Yes.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [8]

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No. I totally get it. And my second one is on mining. So I want to confirm here on the aftermarket if the year-over-year slow down versus last quarter is just a comp effect year-over-year that were effectively flat quarter-on-quarter on volumes? And then on equipment, as you said, June was very strong. Underground, however, is down year-over-year. Is this effectively the replacement cycle in underground now coming off and that you still then see solid development in brownfield and maybe even in greenfield?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [9]

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I think there's not too many greenfield project and hasn't been doing this upturn to be honest. I mean there are extension of mines, which are kicking through in some parts. But to give you a little bit of a flavor of the quarter for the mining industry, we are comparing to the highest quarter during last year, it was very, very high on that part. If we're looking at equipment side now overall, we are actually 8% down, and if you're looking at the aftermarket, which of course, is much more resilient to weaker markets, it is up 5%, and so -- and that is a combination of consumables as well as on the service business. And that totally is about 0. But you know that it's SEK 4.5 billion. So from my -- if you're looking at these numbers, these are extremely high numbers that we are comparing. So how does the market look like? Yes, it varies a little bit between different areas, and yes, you can say that in certain places, decision-making is taking a little bit longer time. On the other hand, we don't see any downturn, and there are no mines really not making money on these levels.

The gold prices saw the highest in a very long time. Copper prices, I looked at today is about $6,000. And then we should know that also the copper is not producing a dollar currency, that means that the dollar is extremely high. So still making good money. We see iron ore on record levels and so on. So we don't really see a slowdown. On the other hand, we are down on equipment compared to that, so it's more probably leveling off in a more normal level that we see. And some actions, I think, is adequate also for the mining business to adopt to this situation. But definitely no slowdown yet.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [10]

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Thank you very much, Klas. And we have some questions put through online here. We'll -- here's one from Henrik Moberg at Danske Bank. He wants to know more about production levels in SMS in the third quarter. Are you going to lower them in order not to build inventories?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [11]

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Yes. Of course I think that is pretty clear. The production levels are -- I mean it's -- we deliver our products in 24 hours, so we -- if volumes are lower, you feel it immediately. And yes, we are not going to see any inventory buildup, that's been promised. I hope that will be executed in the right way. So they will run their production levels. Normally now summer period, they don't run as much anyway because we have built inventory during the previous quarter. So it is normally a pretty low quarter for SMS, and then it normally kicks back a little bit in September and possibly we'll see on what levels that will be. But sure, they are adopting and they are going to -- not going to overproduce and so on. So volume levels are down.

And if you look at July, I mean, we normally give you a little bit an indication how is July developing compared to the previous quarter that has been and it's only 2 weeks, so it's a little bit early yet. But we don't see there's big drops as we see in June, but we see about the same level as average we're seeing down. So around 5%, 6%, around there is the levels that the orders are popping in during July. So not as dramatic as June, but of course, it's lower than last year, and that's what we need to take actions for.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [12]

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Thank you. And just a follow-up from Henrik regarding, you mentioned Varel, how -- no news release this quarter, how is that progressing?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [13]

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Yes. Maybe I should have mentioned that in my presentation. I think the project is running according to plan, and we have -- we are now in the ending phase where some of our interests are looking closer into the company, and we do expect and hope that we can do -- close it here during Q3, and I think that sounds a reasonable timing.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [14]

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Thank you. And then we'll go back to the conference call. Operator, would you put through the next question, please?

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Operator [15]

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And our next question is from Graham Phillips from Jefferies.

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Graham Phillips, Jefferies LLC, Research Division - SVP Industrials, Capital Goods Research [16]

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Björn and Tomas, my question first on mining and rock. If you look at the 5% organic growth in service aftermarket, do you expect that to sort of continue now into the sort of remaining period? Because obviously we got some tough comps, you'd expect it to be more in line with underlying levels of production. And sort of related to that, why has the drop-through margin come down since the first quarter? Is there a higher mix of service in aftermarket, which is on higher margin? I would have thought instead of sort of the mid-20s, it could have been something more in the mid-30s we had been seeing.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [17]

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No. I think the drop through is positive during the quarters. I mean I don't really get what you are referring to. If you look at the mining part, we have improved our performance compared to previous year, but also compared to previous quarter, so I think that is going through. We have a leverage actually of 26% and that might be somewhat lower than we said around 30% is normally what we say, but I don't think that is on any worry level there. So I think, they are getting this through. So I think, it's moving in a good way.

There is always some mixes between what kind of equipment is going out to the customer, what has been invoicing, and so on. The aftermarket is, if I don't recall -- if I could recall right, about 62% of the total sales, so still a lot of equipment is being invoiced and a lot of equipment being invoiced, it has of course a lower margin than our aftermarket. So I think, for me, I'm quite happy with this development, have no complaints to the mining business.

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Tomas Eliasson, Sandvik AB - Executive VP & CFO [18]

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26% is quite okay. We shouldn't draw too many conclusions, so I don't know...

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [19]

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Yes. No, I think it's -- from my perspective, I'm -- I think we are moving quite good. And we have -- of course, it's very competitive quarter that we are competing with last year.

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Graham Phillips, Jefferies LLC, Research Division - SVP Industrials, Capital Goods Research [20]

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Okay. And so the underlying level of service in aftermarket growth, is that the normal sort of level, mid-single digit, 5%?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [21]

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We have had during many years now over 10%, which is much higher than the mining market is growing. And then if you recall what I've said before, the output from the mines is normally growing 1% to 2% per year, also in downturn. So I mean, if you can have double as high as that I think it's quite good levels. So I think 5% for service and consumables is quite a good level from my perspective.

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Graham Phillips, Jefferies LLC, Research Division - SVP Industrials, Capital Goods Research [22]

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Okay. And just on machining, the comment about minus 2% in cutting tools, so when you strip out the other effects in there, again what's sort of happening with sort of pricing mix on round tools versus inserts and holders? Is there anything we can draw there about an impact to margins? And what's likely to be happening in the second half?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [23]

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No. I don't think it's correct that -- I think, round tools has been somewhat better than inserts during the period, but I don't think it's any party. The volumes is down, and I think the effect on the margin was what we have seen in June and not before because as I said, I felt pretty comfortable after 2 months and was expecting a walk-through in the June and was taken a little bit from surprise there. And -- but I'm also happy that they have been quite quick within divisions to kick in these actions that needs to be done sooner not later.

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Graham Phillips, Jefferies LLC, Research Division - SVP Industrials, Capital Goods Research [24]

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And just finally, the Materials Technology business, that's still on track. There was, obviously, a report out last night that there was dissension amongst the Board about whether that would be -- would still be spun-out?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [25]

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No, no. From my perspective, we don't see any disagreement in the Board. We have all -- the whole Board is in line with the decisions that we have been taking and that is to separate SMT within Sandvik and that to explore the opportunities for SMT for a separate listing. But the final decision of that will be taken later on, of course, when we feel comfortable about SMT performance and that they will be able to stand on their own legs. But we don't have any disagreement that I know in the Board. But I read it also this morning.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [26]

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Thank you, Graham, for asking that question. We could at least kill 1 elephant in the room.

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Operator [27]

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And the next question is from Lars Brorson from Barclays.

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Lars Wauvert Brorson, Barclays Bank PLC, Research Division - Director [28]

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Björn, Tomas, Ann-Sofie. Bjorn, just on SMS, you didn't take material cost out in 2018. Just last quarter, we heard you say you're in growth mode. That's obviously in contrast to most leading indicators, at least that I follow, has been slowing down for over a year. You've had tough 3-ish quarters in automotive. I'm struggling a little bit with why this cost program is coming now? Appreciate June was weak, but there's also some volatility from fewer working days. I wonder what is it that you are seeing underlying that makes you believe you have to take more meaningful cost out now into 2020?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [29]

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I think this is decided by the people who are close to our customers and looking at demands and looking at performances and what they need to deliver, and that's the beauty of a decentralized organization. So I think, that is what is based on. But as I mentioned to you, we were pretty happy in -- during the first 2 months during the quarter, but we saw -- at the same time, we have seen quite weakening or very flat market during Q4 and Q1 especially in China and in Germany and that of course accelerated during the last quarter.

We've seen stronger U.S. in both fourth quarter and first quarter and now U.S. was down to, I think, for SMS 4% up, which is smaller than double-digit that we have seen before. So yes, I think we feel that this is the correct decision. I mean -- to be honest, I mean, we are putting it together here centrally, but the initiatives is of course coming from the divisions and where they feel it is necessary. And in the end that's -- we need to protect our margin, we need to make sure that we don't get a negative leverage on SMT that could destroy our targets.

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Lars Wauvert Brorson, Barclays Bank PLC, Research Division - Director [30]

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Just on your U.S. business, if I can be allowed a follow-up? I mean we have heard some of your U.S. distributors talk about also weaker June, more destocking and now having to clawback some of the tariff-induced gross margin pressure they have seen of late. What are you doing there from a price-action standpoint?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [31]

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I think on the prices side, I'm pretty happy. If you look at the businesses, we are keeping the pricing up for the group. We are close to 2%, which I think is good. And that has not deteriorated in our businesses, which I think is important and that needs to continue. Yes, I mean, U.S., I think the automotive was down there also now, and I think automotive has been down, and I can agree with you, we've been a little bit surprised that we've been spared from losing volumes at an earlier stage, but on the other hand, we saw strength in other segments part, which were maybe flattened out a little bit during this period.

We also saw a little bit of down in the end of the months when it comes to general engineering. So yes, if you look at it, it's not much that is looking extremely bright going forward. So I think we have to fight at these levels going forward and that means running the productions a little bit less and keeping our cost under control and making sure that we are lean and mean.

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Operator [32]

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And our next question is from Gael de-Bray from Deutsche Bank.

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Gael de-Bray, Deutsche Bank AG, Research Division - Head of European Capital Goods Research [33]

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Can I have 3 questions, please? The first one is on the automotive side of SMS. I mean one of your peers mentioned this morning that his automotive business was actually pretty flat in June and there was now some hope at the end of the tunnel there. So I'd like to get your thoughts on this because it seems to be pretty much at odds with what you've suggested it was. And then still talking about SMS, I think you mentioned to the press that SMS growth in July was comparable to that of Q2. So what does that mean exactly? Does that mean that the underlying cutting tools business is now down around 4% or is it still around minus 2%? Just to get a sense of the direction here. Is July actually better than June or not for SMS underlying business?

And the final question I have is on the timing of the SEK 1.4 billion savings. It seems that you intend to deliver the full run rate of these savings by the end of 2020, which seems to be fairly quick in terms of the payback. So can you perhaps try to explain to us why the process is going to be so quick perhaps by detailing in which kind of functions you intend to take out these cost and people? And I guess and that would be great if you confirm or not but that there's not going to be really any structural changes to the manufacturing footprint?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [34]

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Very good questions. Let's start with the automotive part. I think I read also what you said and that was related to some improvement in China. We have not seen any of those improvements, but I would be very happy if that is true. We are -- I mean, as you know, we work with everyday customers and we supply in a very quick mode. So we get the indications there. So I mean in the end, we see China continue to be on a weak level. I think I mentioned China levels before and China was down for SMS, minus 9%. So that's the premier.

I am not saying that it had worsened during the quarter, but it's still on a very low level. To be honest, from our perspective, we maybe saw in April an improvement in China. We came first quarter -- we had a good in April and then it went down again in May and it continued on a low-level in June. So we were a little bit optimistic there in April, but unfortunately that did not follow through the coming months. So I think for our viewpoint, I would be very glad if the automotive would pick up, but we don't see that yet in our businesses.

SMS deviate a little bit on the July and June situation. And what I actually said is that we don't see that huge drop that we saw in June coming through in July. We are more seeing a level on the average around 4%, 5% down compared to last year in July. And I think that was important for us that we didn't see because June was, as you know, much more severe during June in the drop. So for us it's only 2 weeks yet, but I think that's for us a little bit a comforting sign that, that is not totally collapsed there.

When we come to the savings, SEK 1.4 billion, yes, that will start kicking in by the end of the year and then we will see much more during the first quarter during the part and fully implemented by the end of 2020 when you see the full year on that part. I don't think that this is too quick. I would probably like to see a little bit quicker, but this is -- we follow the rules and the regulations in the way we do these kind of adoptions. What you probably will see also during the fall is that we will initiate a number of structured programs that has been little bit on the waiting list, that meaning closing number of smaller factories, some factories and doing that program that we have been working now on for more than 4 years. We've been closing more than 25 factories and that work will probably be intensified a little bit here during the second half of the year.

So there are measures, but all of this is driven by the divisions and that's the beauty of a decentralized structure that we have 30 business leaders that are driving efficiency going forward. Yes. Tomas, yes.

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Tomas Eliasson, Sandvik AB - Executive VP & CFO [35]

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Thanks. I mean just as a -- some just complements on that one. The -- of course, the 2,000 people we talk about, that's not really structural, that's adjusting the cost base really. It's tough, sad, of course, but it's fairly quick, you have a quick payback on it. There's no shutdowns, et cetera, in that number that -- but that will come as Björn mentioned here, and that is more complicated and takes more time and is more costly, et cetera, et cetera.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [36]

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Right.

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Operator [37]

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And the next question is from Markus Almerud from Kepler Cheuvreux.

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Markus A. Almerud, Kepler Cheuvreux, Research Division - Senior Research Analyst [38]

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Markus from Kepler Cheuvreux. My first question is on SMS and the margin there. So I think you said on an interview, which was -- which had on your website that you're not happy with the delivery, and I'm just wondering what you mean by that? Would you have wanted to see the divisional business -- divisions acting faster? Do you think they could have and are you working in that case to get them to do that? Or is it simply -- are you simply referring to the margin level?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [39]

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Yes. I think one day you connect a little bit, I think, from my perspective. Now what I said is that I had expected a little bit better margin. Now I think June drop through was more negative than I expected, and I was, as I mentioned before, pretty happy with the SMS performance until end of April -- end of May. And then a weaker June, there was a bigger drop-through which actually pulled down the margin a couple points, which was negative, not a lot, but it affected negatively and that was not what we had hoped.

Yes. I mean, in the end, all the divisions according to our continuous plan, they have committed themself to deliver certain numbers with certain weakness in the demand, and I do expect that, that is what we're going to fulfill going forward, and that's what we will make sure that the division implement these kind of actions. So it is what it is but -- and that's a little bit why we're speeding up the actions a little bit going forward.

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Markus A. Almerud, Kepler Cheuvreux, Research Division - Senior Research Analyst [40]

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Okay. And then if I can just ask about the end markets, which were weakening. Am I correct to assume that it was mainly talking about general engineering, which weakened in June? Or was it also an acceleration in automotive? If you can talk a little bit about the difference in different geographies in just June particularly in general engineering?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [41]

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Yes. I mean I think where we saw weakening during the part is that U.S. was much stronger during the previous quarter, and it went down somewhat. We also saw Germany weakening during the end of the quarter. I think the whole quarter if you look at SMS, in Germany, we're minus 13% with -- this is pretty big numbers for SMS, so that's definitely weakening. And then there are some parts of the general engineering that went weaker and pulling down some of these numbers. Some of these general engineering that can be a lot of different, it can be related to oil and gas, it can be related to the automotive industry because it could be sub-suppliers selling to distributors and so on. It can be actually related to the automotive in one way or another. But anyway we saw this change from previous quarter, and that's what we need to act on.

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Markus A. Almerud, Kepler Cheuvreux, Research Division - Senior Research Analyst [42]

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Okay. And then if I can just finally ask about automation in mining, you said that portfolio keeps growing quite nicely. How big is -- how big are those sales roughly?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [43]

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Of?

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Tomas Eliasson, Sandvik AB - Executive VP & CFO [44]

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Automation.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [45]

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Automation.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [46]

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Oh, the automation. Yes, yes, yes, of course. Now you're coming closer to my heart. Yes, this is an exciting part of the mining business. As I said so many times, this is -- this differs from previous upturns and the situation, the technology is there. Sandvik has a good offering there with AutoMine, OptiMine and My Sandvik and so on. We did lot of presentation on this during the Capital Markets Day. But we have approximately 45 mines today that have autonomous loaders and trucks operating, but also drill rigs. And we have numerous of installation on the OptiMine, which is a operation system to run mines more efficient. This is accelerating and growing in a very high pace. That of course also drives equipment deliveries because you need to have the latest equipment, which is what we call intelligent products, which is what we call automation adopted equipment for this. But this is exciting, and we will see a lot of growth in this coming forward, absolutely.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [47]

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Thank you, Markus. And we have one question from the online questioner, where we have Sebastian at RBC who is sticking to the automotive tune here and wants to know if the downturn that you are seeing is at all related to the growth of electrical vehicle fleets? And how much cutting tools does an electrical vehicle require compared to a normal combustion engine car?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [48]

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Yes. No, I still think that the electrical vehicle part it's a very small part of this change. I think this is more -- we've had very high automotive production during many, many years now. I think the world has been producing close to 100 million cars per year, very high in China. Of course when it comes to electric vehicles, it might be that people are hesitating buying something now because of expecting -- seeing what's happening in political decisions and so, but it could also be trade problems between the China and U.S., it can be a lot of stuff. But we've seen weakening of the automotive industry during quite a long time, and I'm -- we don't think it's related only to the -- absolutely, not only to the electric vehicle side. It's correct that on electric vehicles you need less inserts for -- especially for the combustion engine, which is a big off taker of this inserts. So yes, it will be -- if you only have electric cars, it will be less inserts, that's pretty clear.

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Operator [49]

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And the next question is from Alexander Virgo from Bank of America.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [50]

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Björn, Ann-Sofie, Tomas. Quick one on SMS, again, I'm afraid. I just wanted to clarify if Asia was down 8%, China down 9%, obviously non-Asia up a little bit, just wanted to clarify that that's fair? And if so, any particular end markets that you can call out there? And then on SMS, I think, you also mentioned that you noted customers reducing inventory, I'm wondering if that is something you see as temporary or that's more to go? And whether that is both gen eng and auto or one more than the other?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [51]

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Yes. I'll start with the last one when it comes to inventory side. What we are referring to and we've been discussing this a little bit, yes, I mean, customers during the summer if demand in the automotive sector is lower, yes, then it is that they might have too much components, they may be closing factories a little bit longer time and holding -- producing at a little bit lower level during the summer period. So that is probably -- I mean, it need to be verified fully, but we definitely believe that the customers are pulling down some inventory, which affected in June, that's pretty clear. But at the same time we think we'll see this during the summer period. So if a factory -- if there is less demand out there as we've heard, then you might close another week or you might run at a lower during the summer period and that might be effective part.

I think it'll be very important to see when the demand -- the higher demands are coming back in September on what levels these would become and then it will be easier to make a conclusion, is this temporary or is that going to kick up back again. So that we need to see. But in meantime we just need to face the situation where it is and take these necessary actions. I think that's important. If things change too much better, then we might have to reconsider things, but the actions is based on lower volume going forward.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [52]

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Okay. And non-China or Asia?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [53]

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No. I think both of them are down.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [54]

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Both down. Okay. And just to clarify, you answered one of the questions earlier on with respect to demand in the U.S. saying somewhat down. I'm just checking that when you say that, you mean it's lower growth or was it actually down in June as well?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [55]

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No, no. Lower growth.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [56]

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Lower growth. Okay.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [57]

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Still -- just underline, it's still very good numbers in U.S. because we've seen growth there for a long time. So we are not down in low numbers there, it's still growth numbers.

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Operator [58]

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And the next question is from Guillermo Peigneux from UBS.

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Guillermo Peigneux-Lojo, UBS Investment Bank, Research Division - Executive Director and Industrials Analyst [59]

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It's Guillermo Peigneux, and it's a pleasure to have the last question. Can I ask about 2 things? I think, first, with regards to the different brands in SMS, Walter, Seco, Coromant, is there any discrepancy other than end market related? Is there any discrepancy in the performance of the different brands that you see? Or in other words, for example, is round tools still outperforming premium cemented carbide inserts? That'll be the first question and I have follow-up afterwards.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [60]

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Yes. I think the brands are falling pretty much in line and that's of course a good way to see how things indicate. It varies a little bit between the brands, someone -- or maybe doing a little bit better. Some of them have a bigger focus in North America, some have a little bit bigger focus in automotive, some is more distributor sales, and so it varies a little bit. But I think the main trends are pretty much the same. Also on the round tools side, yes, round tools has gone stronger than we've seen on the insert side, that is correct.

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Guillermo Peigneux-Lojo, UBS Investment Bank, Research Division - Executive Director and Industrials Analyst [61]

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Okay. And then the second one is on the cost savings. I guess, looking at SMS mostly, over the course of the last 4 years, I guess you became leaner and meaner, at the same time obviously you highlighted the need of R&D on the division. So I wonder whether you could explain us which actions in terms of cost savings can you implement and which -- those actions would it be the focus of [May], is it manufacturing only, will it be sales and general and administrative expenses or are we also talking about lower R&D expenditure as well?

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [62]

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I think there's other divisions that are taking, but it is both blue collar/white collar in all different areas. It will it be -- it's correct that we're doing a lot in R&D, and we have extended these costs during the last 3 years. In addition to these, SMS, these tooling divisions, we have 2 new divisions, 1 related to software development where we are investing a lot of money and also to additive manufacturing parts. So totally there we are spending approximately SEK 300 million without any profit side, which is just on a cost that we have increased during these 3 years, which is of course part of the profit levels. We will continue to invest in these areas to secure future revenue streams going forward. But I think SMS has grown a lot during the last years and we are a lot of people within, we're close to 20,000 people, so it's a huge organization and they need to make sure that we adopt those where we need to do and take out cost at same time. They've been very successful. I mean maybe you remember when we go back to 2014, '15 and '16 there, I think they did a fantastic job in adjusting the cost structure where we had big volumes down at that time. Then they were not coming really from these huge growth areas, so there were more on a softer way at that time, but they really managed low volumes at that time with over 20% EBIT margins. So they are very efficient when they take on different actions. So I feel very comfortable about their performance moving forward.

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Ann-Sofie Nordh, Sandvik AB - VP of IR [63]

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Thank you. And I think we'll all just repeat what Björn just said. Have a nice summer, and we'll see you in about in a quarter's time.

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Björn Klas Otto Rosengren, Sandvik AB - President, CEO & Director [64]

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Yes. Thank you, very much. Bye-bye. Thank you.

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Tomas Eliasson, Sandvik AB - Executive VP & CFO [65]

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Thank you. Bye.