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Edited Transcript of SKF B.ST earnings conference call or presentation 17-Jul-19 7:00am GMT

Half Year 2019 AB SKF Earnings Call

50 Goteborg Jul 26, 2019 (Thomson StreetEvents) -- Edited Transcript of AB SKF earnings conference call or presentation Wednesday, July 17, 2019 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Alrik Danielson

AB SKF (publ) - President, CEO & Director

* Carina van den Berg

AB SKF (publ) - Director of Group Controlling & Accounting

* Niclas Rosenlew

AB SKF (publ) - Senior VP & CFO

* Patrik Stenberg

AB SKF (publ) - Head of IR

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Conference Call Participants

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* Alexander Stuart Virgo

BofA Merrill Lynch, Research Division - Director

* Andre Kukhnin

Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst

* Andrew J. Wilson

JP Morgan Chase & Co, Research Division - Analyst

* Benedict Ernest Uglow

Morgan Stanley, Research Division - MD and Head of European Capital Goods Equity Research

* Erik Golrang

Skandinaviska Enskilda Banken AB (publ.) - Analyst

* Klas Henrik Bergelind

Citigroup Inc, Research Division - Director

* Lars Wauvert Brorson

Barclays Bank PLC, Research Division - Director

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the Q2 report 2019 conference call. (Operator Instructions) I must advise you the conference is being recorded today, Wednesday, the 17th of July 2019.

I would now like to hand the call over to your first speaker today, Patrik Stenberg. Please go ahead.

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Patrik Stenberg, AB SKF (publ) - Head of IR [2]

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Thank you, and good morning, everyone. Welcome to the conference call on the second quarter results for SKF. Today's speakers are President and CEO, Alrik Danielson; and our Senior Vice President and CFO, Niclas Rosenlew. Carina van den Berg, Theo Kjellberg and myself, Patrik Stenberg, are also present here in the room representing Group Controlling, Media Relations and IR.

As usual, we will start by presenting the results. It will probably take about 20 to 30 minutes. And we will follow that up by a Q&A session.

So with that, welcome once again, and I leave the world -- the word to Alrik. Please?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [3]

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Thank you. Thank you. Welcome to what I see as yet another strong quarter from SKF.

We have seen in the second quarter a strong operating performance on lower volumes. Our efforts to keep costs under control are showing good results in a market with lower demand.

Operating profit for the second quarter was SEK 2.5 billion, including costs for restructuring and impairments of SEK 317 million.

The underlying operating margin was 12.7%, the sixth straight quarter above 12% in a row. Our operating performance was positively impacted by cost reductions and price. Restructuring and impairment costs, on the other hand, had a negative impact.

Net sales were SEK 22.5 billion, a drop in organic sales of 1.6% compared to last year. Sales were relatively unchanged in Europe, slightly lower in Asia and North America and significantly higher in Latin America. And cash flow from operations, which is always one of our fortes, was in line with last year.

If we turn to the next page. A few comments about the industrial business. The industrial business had yet another strong quarter with operating margins of almost 14%, it was 14.6% (sic) [14.7%] last year, and organic growth of 0.5% (sic) [0.6%].

The underlying net operating margin was higher than last year, with restructuring costs and impairment impacting reported result negatively. Sales in Europe and Asia and North America were relatively unchanged but increased in Latin America.

If we take and turn to the next page. We talk a little bit about the Automotive. And the Automotive business contributed with an operating margin of 5% (sic) [4.8%]. And the organic growth was negative with 6.8% compared to a 5.2% growth last year with significantly lower volumes in North America and Asia, lower sales volumes in Europe and significantly higher sales in Latin America.

If we take and turn to the next page. We talk a little bit about our goals. And we could see that last year was a very strong year for SKF. We had record sales, record operating profit and record cash flows. In 2019, we are seeing a moderation in growth rates, but we are delivering a solid performance in both Q1 and Q2 with good operating margins and return on capital employed.

The net debt ratio has increased somewhat due to the implementation of IFRS 16 on leasing, but it's still well below the target of 80%, and we will see it going down in the future.

We continue to work on reduction, our net working capital. At the end of the first quarter, we were at 30%, which is an improvement compared to last year, but still above the target of 25%. So there's still a lot of work to do. But as we continue with our restructuring of our manufacturing and upgrading of our plans and our integrated planning and other activities, we will gradually be improving this figure in time, I'm absolutely convinced.

If we turn to the next page and talk a little bit about the regions. Well, we saw revenues coming in, in line with guidance. We saw relatively stable revenues in the quarter. In Europe, organic sales was 2% lower than last year. We saw relatively unchanged in Europe Industrial demand with increased demand in aerospace, energy and railway industries and relatively unchanged demand in distribution and heavy industries. Automotive volumes were lower in Q2 compared to last year for both trucks and light vehicles as well as for the vehicle aftermarket.

Organic sales in Asia was 2% lower than last year. With the Industrial sales, we saw a relatively unchanged demand. Looking at our different industries, sales to energy, railway and the agriculture sectors, food and beverage industries were significantly higher, and sales to electrical and industrial distribution were relatively unchanged, while sales declined to heavy industries, marine, industrial drives, aerospace and off-highway compared to last year.

In the Automotive, volumes were lower than last year with significantly lower volumes for cars, relatively unchanged volume for truck and higher volumes for the vehicle aftermarket.

In North America, sales were 3% lower than last year. We saw a relatively unchanged Industrial demand. Sales to the energy industry, to the industrial distribution and sales to heavy industries increased, while sales to aerospace and industrial drives were relatively unchanged. Sales to the electrical segment, railway, off-highway and marine declined compared to last year. And Automotive volumes were significantly lower in North America.

In Latin America, sales grew organically by 9% compared to last year. We saw higher volumes with Industrial and significantly higher volumes to the Automotive as we are ramping up with more and more items made in Latin America for the automotive industry.

If we then turn to the next page and talk a little bit about circular economy, which is one of my absolute favorite topics. How -- I see now how we, SKF, around the rotating shaft are gearing up for not only substantially reduce our customers' costs and improve their efficiency, but also be able to significantly improve the environmental impacts of industrial operations.

And around here -- and you see the different ingredients: You have the assets. You have the remote monitoring. You have the data analytics. You have the application knowledge, where we can go in and help our customers to reengineer their machines and their applications. We have the remanufacturing opportunity that we have talked about, where we can really become circular, not talk about scrapping bearings but actually reusing bearings for the benefit of both SKF and the customer. And of course, the new logistics setups that we are working on with integrating and planning and Supply Chain 4.0.

And lubrication management. And this time, I would like to highlight this lubrication management, how important it is. You can imagine how central lubrication is and how important it is to always have clean lubricants in the machine to extend the life and reduce downtime.

So what have we done during the quarter? We have -- if we change to the next page, we have acquired a company called RecondOil. And RecondOil is a small start-up at this moment, but with a ready technology to clean lubricants to an extent that you can prolong the life of the machine and you can reduce the usage of oil significantly.

And you can -- you see here on the page a picture, industrial oil on the left side; and after being treated by our double separation technology, where we're both using a chemical separation method and a normal filtering, constantly can provide into the machine a clean oil and a clean environment and also extend the life of these oils considerably. And I am actually absolutely convinced that this is a perfect addition to our ability to improve the working conditions of bearings and machines at our customers. And you will see and hear much more about this going forward as we roll this technology out during the second quarter -- third quarter of this year and onwards.

If we by that go to the next page. I want to just talk a little bit about our latest announced investment. Last year -- last quarter, I talked about our new factory for tapered roller bearings in Changshan in China, bringing our 3 brands, SKF, PEER and GBC together in a state-of-the-art manufacturing facility.

Well, during the second quarter, we continued this path and we announced the regionalization and automating of our manufacturing footprint. We have announced a SEK 450 million investment within deep-groove ball bearings. It is an investment in our existing facility in Bari in Italy, where we will upgrade our facility there to be competitive and have absolutely the right cost performance ratio for the European markets; and create a factory in Xinchang, I apologize for my Chinese pronunciation, in China, where we will have a state-of-the-art and competitive and customer service-oriented factory already next year.

And this supports our ambition to adopt full value chain approach as we have talked about: Asia for Asia, Europe for Europe, Americas for Americas, this stride that we have in SKF. And now we're taking these to deep-groove ball bearings. And as you can understand, the main market for deep-groove ball bearings in the world is China. So very soon, you will be able to visit, for the ones who want, the world's best deep-groove ball factory in China, and you are heartily welcome.

If we then take to the next page. I, by that, introduce Niclas, our new CFO that joined us also just during Q2. And we're very happy that you are with us, Niclas. Welcome.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [4]

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Thank you, Alrik. And good morning, everyone.

So I'm Niclas. And before moving on with the presentation, let me take a few -- let me take the opportunity to introduce myself briefly.

So extremely pleased to have joined SKF on the day exactly a month ago. I have a background in technology, software and banking. And during my working life, I worked in Europe, North America and spent a fair amount of time in the fast-moving Asian market.

I'm truly impressed -- having just a [few meetings] with SKF, I'm truly impressed about SKF's global reach in multiple industries. You'll get to know me as a team player, for whom business understanding and results matter. And besides many other things, I do look forward to working on IT, on digitalization as well as the new business models related to the circular economy that Alrik just talked about, including REP, where there's actually many similarities to what we see in the software industry.

With that, let's move on with the presentation, starting with sales. In second quarter, net sales decreased by 0.7%. Organic sales were 1.6% lower than last year. Industrial grew organically by 0.6%, while then, Automotive declined by 6.8%.

Currency effects on sales was positive in the quarter by 3.5%, with the largest effect coming from the dollar, the euro and the renminbi. The structure component was a negative 2.6%, and this was related to the divestment of L&AT last year -- the L&AT business. And you could say in sum, we had a stable sales development in the quarter.

Moving onto operating profit. Operating profit in the quarter have shown a positive trend -- or during the period covered by these slides. So 2016 onwards, we've seen a positive trend. The operating profit in the second quarter was SEK 2,539 million, which includes restructuring and impairment costs of SEK 317 million.

The underlying operating profit was [SEK 2,856 million] in the quarter, and this represents a margin of 12 points -- or an underlying margin of 12.7%, the sixth straight quarter above 12%, as Alrik already mentioned.

A few more comments on the operating profit and taking you through the operating profit bridge for the quarter. Firstly, we had a negative effect from divested companies amounting to SEK 68 million, and this related to the disposal of the L&AT business. The currency impact in the quarter was a positive SEK 112 million compared to last year.

And then let's spend a bit more time on the operational performance. So the operational performance decreased by SEK 430 million year-over-year. Contributions from organic sales and manufacturing volumes was SEK 60 million lower. This included positive effects from price/mix as well as negative effects from lower sales volumes. It was also negatively affected by lower production volumes versus last year.

And in terms of finished goods, the year-over-year effect from changes in finished goods inventories was negative SEK 20 million in the quarter.

In terms of cost development. Costs were SEK 317 million higher than last year. And note that this includes the higher costs for restructuring and impairments of SEK 296 million. So in absolute terms, we have SEK 317 million this year versus SEK 21 million last year, which is clearly higher than what was discussed at the last conference call. Excluding this, cost improvements were significant compared to last year, which we are very pleased with.

The restructuring costs relate primarily to our restructuring activities in Bari, Italy, in connection with the announced investments in deep-groove ball bearings. The impairments, on the other hand, relate primarily to us upgrading to the latest SAP platform, S/4HANA.

The negative material cost impact was slightly lower than guided for, and we do see good cost flexibility in production and more cost reduction effects than what we had actually forecasted.

And let me take the opportunity here to comment a bit on the third quarter guidance to the bridge, and I'll do this kind of step-by-step in the same way as we see it in the bridge.

So in terms of M&A, we expect lost kind of results from divested companies, essentially L&AT, of about SEK 70 million.

In terms of price/mix, we expect to see a continued positive effect from price/mix in Q3. In terms of inventories, we expect to see a continued reduction in finished goods inventories in Q3 versus Q2, however, slightly less than the reduction we saw during the third quarter last year, which would translate to a positive year-over-year effect on operating profit of about SEK 30 million in Q3 '19.

In terms of cost development, in Q3, we expect to see an underlying cost inflation of about SEK 225 million. And this would be partially offset by cost savings of about SEK 100 million.

In terms of material costs, we expect it to impact negatively by around SEK 100 million compared to Q3 '18. And we expect to have similar restructuring costs as last year. And last year, it was about SEK 86 million.

In Q3 last year, we also had a positive effect from land sale amounting to about SEK 185 million that we will not have this year.

Moving on. Performance by customer group in the quarter. Industrial, quite happy with the development in Industrial. So organic net sales within Industrial increased by 0.6%. Sales in Europe, Asia and North America were relatively unchanged, and we saw increased sales in Latin America.

The reported operating margin was 13.9% compared to 14.7% last year. The underlying operating margin was higher than last year as the kind of restructuring costs and impairments impacted the reported results negatively.

Price/mix contributed positively to the results in Industrial, while then higher material costs and lower production volumes had a negative effect in the quarter.

In terms of Automotive, our organic sales declined by 6.8% in the second quarter as car sales continued to be weak across Asia, Europe and also North America. The operating margin was 4.8% compared to 8.7% last year. The negative effects from lower price -- from lower volume and increased material cost was actually partially offset by pricing, so higher pricing.

What comes to the income statement for the group in the quarter? We recorded a solid Q2 results with an operating margin of 11.3%. And note that this includes the restructuring and impairment costs of SEK 317 million. And as mentioned, the comparable number was SEK 21 million last year.

The moving 12-months margin trend was at 12.4%. Gross margin was unchanged versus last year at 25.1%. Selling and administrative expenses as a percentage of sales actually increased compared to last year, primarily driven by higher IT costs, restructuring costs and impairments as well as currency effects.

The financial net in the second quarter was negative SEK 278 million. The financial net was negatively impacted by exchange rate fluctuation as well as the kind of IFRS 16 impact, IFRS 16 related to leases, with a negative impact of SEK 40 million.

Taxes in the quarter were SEK 682 million, and this resulted in an effective tax rate of 30.1%. Our earnings per share was SEK 3.32. And the 12-months trend for EPS was SEK 15.07 versus a year ago when we were at SEK 14.43.

Moving onto cash flow. As Alrik already commented, quite strong cash flow in the quarter. Cash flow, excluding acquisitions and divestments, was SEK 1,849 million compared to SEK 2,182 million in the quarter. And the decrease here is mainly due to the lower operating profit, which again is mainly due to the items affecting comparability, so the restructuring and footprint investments and projects that we initiated during Q2.

The cash flow, excluding acquisitions and divestments, for the last 12 months has actually increased from SEK 5.1 billion last year to SEK 6.2 billion.

Net working capital was 30.1% of sales at the end of the second quarter, which is 1 percentage point lower than in the second quarter last year. The decrease is mainly explained by exchange rates, divestments and then lower inventory levels.

What comes to the net debt equity ratio? It was at 68% at the end of the quarter. The main reason behind the increase is again IFRS 16 on leasing, 2,006 -- SEK 976 million impact. And the net debt equity ratio, excluding leasing, was actually unchanged on the total, while we saw an increase in provisions, for postemployment benefits, so pensions. Net debt, excluding pensions and leasing, was 17% of equity by the end of the quarter.

Finally, some guidance, additional guidance. We -- for the third quarter, we expect finance net to be about SEK 245 million negative, including IFRS 16 effects. And in terms of exchange rates, based on the 30th of June exchange rates, the currency impact on the operating profit is expected to be positive by about SEK 130 million compared to the third quarter last year. Based on exchange rates at July 15, the currency effect in the third quarter would be about SEK 190 million positive.

For the full year, we expect the tax rate of about 28%. And very much in line with our strategy, we are increasing our investments in property, plant and equipment. And for 2019, we expect to see additions to plant and property of about SEK 2.8 billion.

And with that, I'll hand the floor back to Alrik.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [5]

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Thank you, Niclas. Thank you. Thank you.

Well, just to summarize, if we go to the next slide. The second quarter was a strong market quarter with solid margins despite lower volumes. Demand developed in line with our expectations, and organic sales were relatively unchanged compared to last year. We continued to see positive pricing in our efforts to reduce our cost base or showing results.

Entering the third quarter, we expect to see slightly lower volumes compared to last year, including relatively unchanged demand for the Industrial and lower demand for the Automotive. Demand is expected to be relatively unchanged in Asia, slightly lower in Europe and North America and slightly higher in Latin America.

With those words, I thank you for listening into us. And I give the floor back to Patrik.

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Patrik Stenberg, AB SKF (publ) - Head of IR [6]

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Thank you, Alrik. Thank you for listening to the presentation. We are now ready to take your questions. So with that, I leave the word back to operator. Please?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Erik Golrang.

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Erik Golrang, Skandinaviska Enskilda Banken AB (publ.) - Analyst [2]

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I have a couple of questions. Starting on the development in Asia and your guidance there for the third quarter. As I understand it, you saw a stronger end to the second quarter than the initial month, which is a bit surprising. Could you give some flavor on the different segments there, perhaps particularly on Automotive side?

And then my second question relates to the SAP impairment. What is the risk that there is more of that coming given that you have capitalized quite a bit over a number of years? I'll start with those 2.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [3]

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Well, let me start by saying that if you take the Industrial business, I think it was clear that there are some very strong segments like wind and railway, and there are other segments that are a little bit weaker. And I think there is no mystery in that. The big question, of course, is that we've seen for a long time now in China a lower automotive market. And what we've seen is -- it's interesting how uncertainty actually drives, of course, more reluctance from consumers, for instance, to buy cars. And what has happened in China is that there has been new emission laws coming. And originally, the idea was that these laws were going to be implemented a year from now. But then to get rid of all the uncertainty, they have actually implemented these laws now. So they are actually in place.

So right now the consumer knows exactly what are the emission regulations and what it means for their purchase. And what we've seen then is that, actually, in the end of the quarter, we saw an improved demand. And in June, as a matter of fact, we were flat. And when we talked there, I was -- myself, I tell you, just in China a little bit more than a week ago, and speaking to our -- many of our big Chinese car customers, this is how they see it, too. I mean it's not that the -- in other regions, the weakness in the Automotive business is coming recently. As you may recall, in China, it's been going on for quite a while.

So what we're saying is that we see, for the first time now, a flattening out of the Chinese automotive market and then maybe a cautious sort of understanding that maybe we have reached a trough and we will be able to see some improvements compared to what we've seen in the last year.

As far as the other question, I give it back to you, Niclas.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [4]

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Yes. Thanks. In terms of the SAP kind of related impairments, essentially what we did was that we signed an agreement to move to S/4HANA, and that made some of the old licensees redundant. And therefore, we wrote down the old licensees. I don't think it's worth speculating on kind of future write-downs or not. I mean the whole point is that we are moving to a new platform.

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Operator [5]

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The next question comes from the line of Klas Bergelind.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [6]

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It's Klas from Citi. Can I come back to you, Alrik, to Asia and China? Could you talk a little bit on the Industrial side, distribution versus heavy and how it moved through the quarter? You talked about Automotive. It would be interesting to hear what happened through the quarter also on the Industrial side. I will start there.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [7]

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So I can tell you, what we see here in the quarter is what we've said. We see some of the segments for smaller drives and electrical -- smaller electrical motors weakening, and that we saw through the quarter. And businesses like wind, there is a -- we must understand, right now there's a legislation that says that if you get your windmill ready by the end of next year, you will get a certain tariff, sort of -- sorry, a feeding tariff, if you understand, a price for your electricity. Beyond that point, it's unknown. So you can imagine now how everybody currently are pushing for getting their windmills ready for that date, that 1.5 years' time frame. It may continue or it may not. So there, you have sort of an induced improvement. And of course, that we see continuing, and that has been accelerating during the quarter.

The same as transport and rail and so forth is strong. And we -- as we see that continuing. But otherwise, it's -- we've been quite good at seeing one quarter ahead. And I think if you recall, if you look at how we've been sort of guiding, we've been quite successful so far. I hope that streak will continue. I cannot promise because, of course, we're always talking about the future. But this is how we see it, what we guide. And this is the flavor I can give you, so to speak.

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

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Yes. No, I'm aware of wind. I was just -- the pure industrial bit, but it seems like smaller drives, et cetera, are weakening a bit.

And my second one is on price increases on spot. I think you were planning to push through there on distribution in Europe last quarter. I was wondering how effective these increases were and if you're planning to increase yet again now in the second half. Obviously, very solid cost control yet again, that could mean that increasing prices is a bit more difficult. Price hikes often works better if there's a lot of cost inflation. Obviously, it's the other way around now. So I was wondering how the distribution pricing happened.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [9]

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Yes. I think that as far as what we've done in distribution, it's been doing well and working well. And we're very disciplined in this. And there is absolutely -- we're pushing this through and it's holding. And as far as pricing in general, of course, we're always seeking the opportunity. There's more -- always work to do, and I think there's a good initiative still on selective pricing going forward. But you are right in the sense that it's easier when the demand is really hot. But it's still possible to work with pricing when you have a good product and a differentiated offering.

And on your last comment there that we now see it the other way around, well, I don't really see that yet. And I don't think our customers see that yet, so to speak, that -- there is tendency, of course, that we will see that maybe steep prices, et cetera, will be different going forward. But right now, I think in many markets, what we've seen so far, there's quite a resilience in this. So there's no increase. No, there's no increase. But we haven't really seen the inflection on this yet. And that is also true for us and for our competitors and for our customers. So we're still not in that kind of territory, I would argue.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [10]

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My final one is for you, Niclas, on the bridge. Just to confirm, you guided for SEK 225 million in cost inflation into the quarter. And this was, I think, a little bit more than SEK 70 million here in the second quarter, if that's correct. A reason for asking is that the last couple of quarters on SKF have been better on costs. It was more on IT, logistics, R&D where costs came down. But the plus SEK 200 million underlying cost inflation, I think, we all thought was more difficult to cut back on.

So first, is the delta correct? I think it is SEK 74 million versus SEK 225 million guided. And now it seems like you're guiding for SEK 100 million cost inflation after savings into the third. So again, a low level, I just want to understand how you can cut back here and what to expect ahead.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [11]

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Yes. Let me actually -- I mean, Patrik, not to make sure that I don't say anything stupid, which we have to regret and misguide you. So on the exact details, I mean, Patrik, feel free to comment here.

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Patrik Stenberg, AB SKF (publ) - Head of IR [12]

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Yes. Accounting on the performance in the current quarter, I would say, we performed really strong on costs. As we discussed in the bridge, we were able to almost offset raw material cost inflation, which was about SEK 90 million negative in the quarter; and the underlying cost inflation, which is about [225%] in the quarter by reducing our underlying costs. We've had very good cost flexibility on our manufacturing operations. We have also released quite a few people during this quarter compared to previously. So I would say we've been successful in doing that.

Going forward, our guidance for Q3, yes, underlying cost inflation, it's still there, about SEK 225 million; raw material cost inflation, on a similar level compared to what we saw now in Q2, of about SEK 100 million in Q3. And we expect to offset some of that with continuing cost reductions of about SEK 100 million in Q3. That's the pure cost side, yes.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [13]

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Yes. But Patrik, the SEK 225 million, are you talking about SEK 100 million savings? And typically, you don't split out the SEK 100 million savings. So if the SEK 225 million less SEK 100 million, that is your cost inflation. It should be compared with the SEK 74 million you did this quarter.

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Patrik Stenberg, AB SKF (publ) - Head of IR [14]

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Correct. Yes.

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Operator [15]

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Your next question comes from the line of Andrew Wilson.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [16]

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Some kind of broader question on the extension, I guess, of what was asked on Asia. But just in terms of Europe and North America, can you talk a little bit about how you saw the industrial markets develop kind of through the quarter? I think there's been some concerns that we saw a slowdown in June, but it sounds like it's been a pretty consistent message. So just interested, I guess, on some color on that, please.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [17]

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Well, I think a bit broadly, you can say that when we started the turnaround, when it started to come in 2016, it was a broad-based, real strong -- geographically broad-based. It came in almost all segments going up. Now we're in this situation where we see some segments actually being positive and growing strongly, as we have commented on, and some segments weakening, as we have also commented on. And that's where we are at.

At the same time then, when we look forward into our next quarter, we see that development continue. There are some strong segments also in Industrial that is developing favorably, and there are some other segments that are a little bit weaker that comes -- that gives this guidance that we have on this general industrial stability.

And then, yes, we are as aware of the reality of the automotive industry around the world as you are. And the only thing maybe where I feel that some people may think that -- are a little bit surprised when we say that we actually see this flattening out of demand in the Automotive in China and where we actually can see maybe some light in the tunnel there. And I would only say, in the -- if you look at China and you understand that the downturn has been going on for quite a while, well, maybe then it's not so strange, actually.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [18]

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If I can just ask a follow-up just on some of the cost savings, which you've mentioned you kind of flagged into Q3. And apologies if this was discussed before. But in terms of what actually these cost savings are, I mean is this a sort of direct reflection of what you're seeing in auto markets? Or is this just a more general sort of structural improvement of the business?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [19]

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I mean it's definitely more of the latter. It's general initiatives across the whole business rather than specific to Automotive. It's also Automotive, but it's across the business.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [20]

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And can we expect to see sort of similar benefits in future quarters, then? It sounds like there's still quite a lot that you guys are targeting in terms of opportunity.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [21]

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Well, again, I mean we don't want to speculate on kind of far into the future, but it's exactly as you say. I mean we've had initiatives ongoing. I mean the footprint related to factories is only one area, but that's pretty clear. And we'll, of course, continue with these initiatives. There's no kind of end date to them.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [22]

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And I think that what pleases me to see -- we've been preparing for this. You know that. We've been sort of saying that we have to prepare, and we've been doing that for a while. And we're ready with activities and we're doing them.

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Operator [23]

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The next question comes from the line of Andre Kukhnin.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [24]

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I'm sorry, but I'll have to come back to the bridge. And can I just build on what was said before and run through what I see as the kind of cost development guidance for Q3? So if we look at just that particular item, excluding the organic sales and manufacturing volumes impact. So I've got minus SEK 100 million for raw materials, I've got minus SEK 225 million normal inflation, minus SEK 70 million for delta of restructuring, minus SEK 175 million one-off reversal and plus SEK 100 million cost improvement. Do I get these right? And am I missing anything in that line and in terms of the guidance you've given?

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Patrik Stenberg, AB SKF (publ) - Head of IR [25]

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Andre, it's Patrik. I think you misunderstood a little bit on the restructuring. There is no delta on that. We expect to be on a similar level in Q3 this year as we were last year. So in the bridge, there's no restructuring delta.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [26]

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Right. So 0 on the bridge and it's SEK 70 million level. It's the same. Okay. So we sum up to minus SEK 400 million. Great.

Can I just also ask? On price/mix, you clearly indicated that you have been successful in raising prices. And it was positive in Q2. The guidance for Q3 for that to be positive, can you calibrate it at all compared to Q2? Do you expect it to be as positive, more positive, less positive in Q3?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [27]

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Yes. As we've said, it's been mostly price and very little mix in this quarter. And we see, probably that's the way it's going to continue, so similar.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [28]

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And lastly, just a much broader question on circular economy and selling kind of bearings per rotation. Just wanted to come back to that. If you could -- could you give us more detail on kind of where are we in terms of level of sales from this new business model? How significant is this for SKF now? And how does that actually impact the economics for you? I mean is this a higher-margin business? What's it growing at?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [29]

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Well, so there are 2 effects of this. One is, I can tell you right now, as we've said, the -- apart from Latin America, actually, this is not yet a very big portion of our sales. And what I mean by saying that, where we have sort of fee-based arrangements where everything is included, the bearings, the services and everything, and we take a sort of a fee-based arrangement with our customer. That's still a relatively small part of our business today. But it's going to grow. It's going to grow, I mean, as I am completely convinced that this is going to be the general way we interact with our customers globally in a few years' time, just that it is a much larger portion, as you can understand, in Latin America, where we have been doing this for a while. And it gives us the possibility to both increase market share and profitability, both for us and also for our customers.

And the key here, of course, you understand, there's so much waste still to be eliminated. And when you have a fee-based contract, the interest of the supplier and the customers are completely aligned. There's no conflict of interest. And this is why I'm so absolutely convinced that all of our customers, if there's any customer listening in, they would love to have a fee-based arrangement with us because it makes it possible for us to together eliminate all the waste.

The other thing that actually happens when we start approaching the customer with these fantastic value propositions then, even if in the beginning, we don't actually manage to have a fee-based arrangement from day 1, the customer sees us as a completely different kind of supplier. We've become sort of straight into their strategic development, how they're going to run their factories in the future, how they're going to improve their efficiency and how they're going to lower their environmental impact. And I suggest, there is a video on YouTube about River Steel and SKF. And if you want to see sort of the perception of a customer that we've just signed up on this kind of agreement, it's not a bad thing to have a look on that YouTube, River Steel and SKF.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [30]

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I'll definitely look it up. Can I just follow up on this? In LatAm, can you give any idea on how big it is in LatAm? And is that a contributor to the faster growth that you've seen there?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [31]

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Yes. Well, the short-term growth that we see in Latin America is, of course, basically based on how we're working with our customers, where this is already sort of a main way of working on our customer on the Industrial side. But also because we're coming in with a lot of new interesting localizations of production for the automotive space. So as you see, in Latin America, we're actually growing from an Automotive perspective, and there's a lot of really interesting initiatives that has enabled us to grow also our Automotive business in Latin America.

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Operator [32]

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Your next question comes from the line of Alexander Virgo.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [33]

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I just had a sort of a slight pedantic question, I suppose. If I compare the wording for the demand outlook for Q3 from the report to the presentation and what you said, Alrik, you described North America in the report, and then what you said is slightly lower. And in the presentation, it said lower. So I'm just wondering, a, can you just clarify which one it is, and whether that reflects a judgment call on exactly how weak the region is?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [34]

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It should be slightly lower.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [35]

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Slightly lower? Okay. So it's not a reflection that we're kind of on the border, and it's a bit difficult to call and visibility is low? It's just a -- I guess just an [intake]?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [36]

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I haven't seen this. I apologize for this if this is true. I didn't see this. But you hear what we're saying. This is how we see it. So I apologize for that. I apologize.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [37]

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Okay. That's great. And then...

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [38]

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And no -- I hope no harm done.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [39]

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I just wanted to clarify, that's all.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [40]

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Thank you for that. Thank you.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [41]

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And then just on -- as a follow-up. I'm slightly surprised at how weak VSM is in Auto. Are you not surprised to see a little bit more resilience in that part of the market? And maybe can you talk a little bit about the regional development in terms of guidance as well? That would be helpful.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [42]

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Yes. Yes. I mean there are 2 things that you have to see in this respect. And one of the areas where we're actually doing a good development is in China, for instance, where we see this developing better.

If you look at the amount of cars that -- VSM really comes -- kicks in after about 7 years. So when you eliminate -- when you look at what -- where you think the VSM is going to go as a market trend, you have to sort of extrapolate what were the cars that were sort of sold into the market, let's say, from 7 to 15 years ago? And that's how you're going to see the market develop. And if you see all around, 7 to 12 years ago, it was not a great sort of amount of cars entering the market. And that's, of course, having a dampening effect. On the other hand, we're doing -- I think we're doing a lot of good things to improve our channels to market and so forth, and we have a lot of activities to mitigate this. So my midterm prediction is that we will improve in VSM.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [43]

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Got you. Okay. So it's not -- it's more of a phasing thing or a temporary thing. It's not something that we need to be worried about [going forward].

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [44]

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Yes. Well, no. Well, there is also dynamics in the marketplace, more OES channels, more -- the car manufacturers taking over some spare part dealing. There's more e-channels coming up there. There's a change in the VSM dynamics coming with new technologies as well and new channels to market. But I argue that we're going to be part of that as well. This is what I'm talking about.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [45]

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Okay. And then just a quick follow-up on Industrial. We've heard a number of companies commenting about a sort of an extension in terms of customer decision-making processes, customer behavior around conversion from inquiry to orders. I appreciate it's probably more of an Industrial thing than an Auto thing. But maybe talk a little bit about what your customers are actually saying and how they're behaving. It would be really helpful.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [46]

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It -- yes. Well, from our point of view, it's -- we have -- with many of -- if you're talking about OEM customers, we have an understanding and a business where we have very good service levels. So it's more of actually seeing sales developments. And as we have guided you on both what happened during the quarter and what we believe is going to happen in next quarter, that's actually how we see behavior as well.

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Operator [47]

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The next question comes from the line of Ben Uglow.

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Benedict Ernest Uglow, Morgan Stanley, Research Division - MD and Head of European Capital Goods Equity Research [48]

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I had a couple. The first one, Alrik, you sounded cautiously optimistic about the China auto outlook. And just from a kind of 10,000-foot view, don't some of the same rules apply in Europe and North America in the sense that you're going to begin to face easy comparables. Do you see any signs? Or are you as optimistic about Europe and North America in auto as you are in China? That was my first question.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [49]

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Well, I -- my -- the logic I'm trying to sort of portray on China is the fact that the downturn, if you recall, came much earlier in China. It's been going on for quite a while. And when something has been going on for quite a while, there -- and you understand that both governments and other forces are trying to mitigate these activities and you see this confidence with the fact that everybody now knows what emission rules are going to prevail in the foreseeable future, there's a logic to actually believing that there could be actually truly a change. And I think that is more what I'm alluding to. In other markets like in Europe, for instance, where the downturn has not been going on for as long and there's been not the same clarity in what's going to be the rules going forward. And that may actually -- and that's what you see in our guidance as well, the way we look at it.

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Benedict Ernest Uglow, Morgan Stanley, Research Division - MD and Head of European Capital Goods Equity Research [50]

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Understood. And second question. And I don't -- I hope I'm not reading too much into it. But in the press release, in Asia-Pacific -- and I think Klas tried to pull this point out earlier, you do seem to make a distinction between what's happening in China in electrical and industrial distribution and what's happening elsewhere. Are you -- do you see any signs? Or do you believe that any of the trends you saw in the quarter in China is due to a prebuy effect or an inventory effect in the distribution channel? Is that something that you've seen? Or am I reading too much into it?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [51]

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No, no, no. That's not what we see. No. There's no Industrial dynamics in this thinking from our side. But you have to understand, if you look at the markets as such, there's some South Asian markets that are very heavy into mining and heavy industry and these kind of segments, while the big electrical motor producers and small gearbox producers and compressor producers, et cetera, they are in China.

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Benedict Ernest Uglow, Morgan Stanley, Research Division - MD and Head of European Capital Goods Equity Research [52]

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Understood. And final question for Niclas is we're now guiding to about SEK 2.8 billion of investments in CapEx, which is around 3% of sales. My question is, is this a one-off in 2019? Or should we expect CapEx to continue to be at this type of level? Do we think that 2019 is an unusual year? Or is this going to be the sort of cost of doing business going forward?

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [53]

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I don't -- it's not an unusual year, whether the exact amount is SEK 2.8 billion or plus-minus something. It's just then a different thing. But I mean, we have a major initiative modernizing, upgrading. We call it world-class manufacturing here, which is a multiyear kind of program. So in that sense, do expect some of that to continue going forward.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [54]

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But I resent your comment of saying cost of doing business. I can tell you, all of these investments are -- have high returns. So as a shareholder, I would be happy to see SKF doing -- investing in the operations with high returns. So it's not about cost of doing business. It's actually something that will improve our competitiveness over time.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [55]

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Yes. I mean that's the whole point. I mean it affects our cost competitiveness. It affects the kind of product competitiveness and so on and so on.

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Benedict Ernest Uglow, Morgan Stanley, Research Division - MD and Head of European Capital Goods Equity Research [56]

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And is it fair for me to say that the restructuring costs, 1 -- over 1% of sales as well, that, that is again -- that's just a one-off? That's not, and I don't want anybody to resent anything, but that's not a cost of doing business?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [57]

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Well, what happens is when you take individual actions -- so there are 2 kinds of investments, you understand. One is when you're taking a existing factory and you're upgrading it, et cetera, then it's a straightforward investment then, like we are doing in the case of Bari, where we took part of the production that was entirely in Italy and we upgrade the part that we keep for Europe and we take out a part of it and restructure that part and moves it -- also with good returns, please understand, with very good returns -- and puts them in China. When we do these kind of things, you will get a small off -- or one-offs when those activities happen. But they are also with a good return. They're also with a fantastic return.

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Operator [58]

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Your last question comes from the line of Lars Brorson.

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Patrik Stenberg, AB SKF (publ) - Head of IR [59]

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And this is the last question, Lars. Thank you.

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Lars Wauvert Brorson, Barclays Bank PLC, Research Division - Director [60]

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Understood. I'll keep it short and sweet, Patrik. A quick one on Automotive in North America, Alrik. I'm struggling a little bit with the performance, particularly for the car and light vehicles segment, down significantly now for the second consecutive quarter. So call it, down high single or low double in a market where car production levels are down, call it, low single. Could you explain to me why that is?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [61]

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Well, I think that if you look at the kind of models that are really holding up in the U.S., as I think I've been saying before, maybe those are not really the ones where SKF has been in the past homologated on. And this is the kind of mix maybe that is a little bit in our disfavor at this point.

As I said before, we're working good. We have good business coming in. We have really good contracts coming in and really good developments coming in for the future. So just as you remember a few years ago, where we had a situation where we had been -- not been homologated on a few platforms, we were back on those platforms, we saw the good development. What we see a little bit now is maybe the -- our strongest platforms are not -- maybe not where the American market is performing the best at this moment.

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Lars Wauvert Brorson, Barclays Bank PLC, Research Division - Director [62]

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Clear. Can I clarify just the raw material guidance for Q3, the negative SEK 100 million, is that net of the savings in the quarter? And I'm struggling a little with the negative SEK 100 million. We've seen obviously a rebound in scrap in July but still down materially year-over-year. Can help me understand what you're baking in from a raw material standpoint? And what's being baked in from a tariff headwind standpoint, to the extent there is any?

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Patrik Stenberg, AB SKF (publ) - Head of IR [63]

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Lars, it's Patrik. On the negative guidance on raw materials, it's not primarily price. It's primarily driven by our consumption. We had some of the industries and some of the products that we expected to perform best to consume a relatively higher proportion of raw material than others. So it's mainly a manufacturing mix issue than actual price.

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Lars Wauvert Brorson, Barclays Bank PLC, Research Division - Director [64]

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And it has led to some [savings]?

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Patrik Stenberg, AB SKF (publ) - Head of IR [65]

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And tariffs also, of course, to some extent, but yes.

With that, I -- we are done with the Q&A session. We have overstayed our hour by a couple of minutes. And I leave the word back to Alrik.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [66]

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Well, thank you very much for listening in, and I hope to have you all back in one quarter. And again, thank you for your very enlightened questions on this, as I see it, yet another strong quarter from SKF. Thank you very much.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [67]

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Thank you.

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Carina van den Berg, AB SKF (publ) - Director of Group Controlling & Accounting [68]

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Thank you.

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Operator [69]

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That concludes the conference for today. Thank you for participating. You may all disconnect.