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Edited Transcript of SKF B.ST earnings conference call or presentation 22-Oct-19 12:00pm GMT

Nine Months 2019 AB SKF Earnings Call

50 Goteborg Oct 23, 2019 (Thomson StreetEvents) -- Edited Transcript of AB SKF earnings conference call or presentation Tuesday, October 22, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alrik Danielson

AB SKF (publ) - President, CEO & Director

* 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

* Gael de-Bray

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

* Jack O'Brien

Goldman Sachs Group Inc., Research Division - Equity Analyst

* James Moore

Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research

* Klas Henrik Bergelind

Citigroup Inc, Research Division - Director

* Olof Cederholm

ABG Sundal Collier Holding ASA, Research Division - Analyst

* Sebastian Kuenne

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to today's Q3 report 2019 conference call. (Operator Instructions) I must advise you, the conference is being recorded today, and that's Tuesday, the 22nd of October 2019.

I'd now like to hand the conference over to your speaker today, Patrik Stenberg. Please go ahead, sir. Thank you.

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

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Thank you so much, and welcome to this conference call on the third quarter results. Today's speaker is, as usual, our President and CEO, Mr. Alrik Danielson; and also our Senior Vice President and CFO, Niclas Rosenlew.

As usual, we will start by presenting the results. And after that, we will have a Q&A session. Results presentation will probably take some 25, 30 minutes. And after that, we hope we should be able to answer all your questions.

So with that brief introduction, I leave the word to Alrik, please.

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

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Thank you, Patrik. And good afternoon, everyone, and welcome and thank you for joining in and listening to our third quarter results presentation. Those of you who follow us will know that we have been working hard in the last 12 to 18 months to prepare for the economic downturn, which is paying off. As you can see in our results today, a stable underlying margin despite a decline in volumes with a solid cash flow.

We focused on our region-for-region manufacturing footprint, increased investments in manufacturing technology as well as maintained the focus on costs, so much so that for the first time during my tenure as CEO, cost inflation has been offset by cost-cutting activities. There's still a lot of uncertainty out there, macro and political, but the best thing we can do is to keep on doing what we have been doing, focusing on keeping costs under control, strengthening our competitiveness through innovation and investing in our factories and keeping the customer's need in focus.

If we turn to the next page and look more in detail on the Q3 results. We've seen third quarter with stable margins on lower volumes and a strong cash flow. We have managed the business well in a weak economic environment. And our efforts to reduce costs are contributing to a strong and stable operating margin in the quarter with an underlying margin of 11.3%. We had higher realized cost savings than cost increases, as I mentioned, resulting in a positive net contrition to operating profit in the quarter.

As expected, we saw a decline in organic sales of 3% compared to last year, with net sales amounting to SEK 21 billion. Sales were relatively unchanged in Asia, slightly lower in Europe, significantly lower in North America and slightly higher in Latin America. Cash flow was SEK 2.1 billion compared to SEK 1.6 billion of last year, a strong performance, highlighting our ability to generate a strong cash flow even in periods of weaker demand.

If we turn to the next page and talk a little bit about our Industrial business, that had yet another strong quarter with an underlying operating margin of 14.1% with a negative organic growth of 1.4% compared to last year when sales grew by 9%. Sales in Europe and Asia were relatively unchanged, significantly lower in North America, but increased in Latin America. The reported operating margin of 14.7% was impacted negatively by restructuring costs and positively by a VAT credit.

If we turn to the next page and talk a little bit about the Automotive. Well, Automotive business had an underlying operating margin of 4.3%. On an organic growth, that was negative with 7%, with significantly lower sales volume in North America and Asia, lower sales volumes in Europe and significantly higher sales in Latin America. The reported operating margin of 1.1% was impacted negatively by costs related to customer settlements and restructuring.

If we go to the next page and quickly look at our different performance parameter, we see that last year was a very strong year for SKF, as we know. We had a record sales, record operating profit and record cash flow. In 2019, we're seeing a moderation in growth rates, but we are continuing to deliver solid performance with good operating margins and return on capital employed.

The net debt ratio has increased somewhat due to the implementation of IFRS 16 methodology on leasing. But we are still well below the target of around below 80%. We continue to work on reducing our net working capital. And at the end of the quarter, we were at 30%, still above the target of 25%. So as we've said, there is still more to do. But as we implement our strategy on manufacturing and sales, I am sure that over time, we will reach our targets.

If we go to the next slide and look at the different regions. We can see that, as expected, we saw a decline in organic sales that we guided for of around 3% compared to last year with net sales amounting to SEK 21 billion. Sales were relatively unchanged in Asia, slightly lower in Europe, significantly lower in North America and slightly higher in Latin America.

In Europe, organic sales were 3% lower than last year with relatively unchanged Industrial demand, while Automotive volumes were lower compared to last year. The negative development in Europe is mainly due to tougher market conditions in Germany and Italy. On the other hand, for example, Eastern Europe and the Nordic countries have performed well. The fact that we do relatively well in Europe despite the large market Germany and Italy struggling is something that we see as a strength.

Sales in Asia were relatively unchanged. Organic sales in Asia were 1% higher than last year, and we saw good development in China.

Sales in North America were 11% lower driven by a broad-based underlying decline in Industrial activity. This was accentuated by destocking at the main distributor and the impact on certain OEMs which have SKF as a significant supplier and, therefore, also an exposure for us.

In Latin America, sales grew organically by 4% compared to last year. We saw relatively unchanged volumes within Industrial and significantly higher volumes in Automotive.

If we turn to the next page and talk about one extremely interesting acquisition that we have done. We have just recently signed a deal to acquire Presenso and it's a developer of AI-driven industrial analytics, to further strengthen our Rotating Equipment Performance offer. We continue to focus on developing our fee- and performance-based business with customer wins in a number of markets. As reminder, we also acquired RecondOil a quarter ago. We are very excited about continuing to strengthen our REP service business offer to our customers.

And by that, if we turn to the next page and look at -- I cannot have a quarter without sort of celebrating that we had -- yet we have had many contracts, but one specific Nordic Paper in Säffle in Sweden, where we have signed an agreement for 5 years to -- in a fee-based and a bonus-based relationship, together work to reduce costs, reduce environmental impact and improve machine availability and productivity. And you know how passionate I am about this. I know that these REP agreements are good both for the supplier but most of all for the customer. And I can just encourage you all of there -- out there, when you meet customers, tell them about SKF REP offers.

If we turn to the next page, I can just say that now I will leave the word to Niclas.

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

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Thank you, Alrik, and good afternoon, everyone. If we turn to the next page, I'll take you through the details of our financials in the quarter, starting with sales. So net sales decreased by 1.4% in the third quarter. Organic sales were 3% lower than last year, as Alrik mentioned. For Industrial, we saw a decline in organic sales by 1.4%, and Automotive declined by 7% in the quarter.

The currency effect on sales was positive in the quarter by 4.2% with the largest effect, as usual, coming from dollar, euro and renminbi. The structure component, i.e., the divestment of L&AT last year was negative 2.6%.

We turn to the next page, please. Operating profit by quarter has shown a positive trend during the period covered on this slide. The operating profit in the third quarter was SEK 2.3 billion, which includes restructuring and settlement costs of SEK 272 million as well as a capital gain of SEK 180 million. The underlying operating profit was SEK 2.4 billion in the quarter, and this represented a margin of 11.3%.

Moving to next page, please. We go through the operating profit bridge for the quarter. Firstly, we had a negative effect from the divested companies of SEK 72 million. As mentioned, this related to the L&AT divestment last year. We had a currency impact, which was positive SEK 106 million compared to last year. And in terms of operational performance, we had a decrease of SEK 343 million year-over-year.

And if I comment on this SEK 343 million a bit more in detail, the organic sales and manufacturing volumes was SEK 218 million lower, we had a positive effect from price/mix, and we had a negative effect from lower sales and production volumes. The cost development was good, and we had a higher realized cost savings than cost increases, which we are very pleased with. And this resulted in a positive net contribution to operating profit in the quarter of SEK 60 million compared to last year.

Note that this figure includes higher restructuring and customer settlement costs than last year, so SEK 272 million, as mentioned, versus SEK 86 million last year. And it was offset by a positive VAT credit, which was the SEK 180 million, as I mentioned. We also highlight that we had a capital gain from land sale of SEK 185 million in the third quarter last year.

And a short comment on material costs. So we had a negative material cost impact, but this was slightly less negative than what we guided for. And we do see good cost flexibility in production and more cost reductions -- or more cost-reduction effects than we forecasted.

So summarizing the bridge from an underlying operating profit perspective, in simple terms, we had a negative SEK 70 million from divestment, we had a positive SEK 100 million from FX and then we had a negative SEK 150 million from operational performance. And if you wonder what this SEK 150 million is, it's simply the SEK 343 million adjusted for the land sale, SEK 185 million that we had last year.

Let me take the opportunity to provide a couple of comments or perspective on the bridge for Q4, so Q4 2019. So in terms of M&A, in Q4 last year, we had a positive effect from the divestment of L&AT, the L&AT business of SEK 1.3 billion, SEK 1,261 million to be exact, that we will not have this year. In terms of price/mix, we expect to see a continued positive effect from price/mix in Q4. And in terms of cost development in Q4, we do expect to offset the cost inflation with cost savings. So in rough terms, cost inflation of SEK 225 million, so that's a negative material kind of cost, negative SEK 50 million, offset by savings of roughly the same, so SEK 275 million. Lastly, Q4 last year, we also had costs for restructuring and impairment and settlements amounting to SEK 556 million, so this was negative.

If you turn to the next page, please, performance by customer group in the quarter. In terms of Industrial, as mentioned, organic net sales in Industrial decreased by 1.4%, so relatively unchanged. Sales in Europe and Asia were relatively unchanged. We had lower sales -- significantly lower sales in North America, but we saw an increase in sales in Latin America.

The reported operating margin for Industrial was 14.7% compared to 14.3% last year. Price/mix contributed positively, while then higher material costs and lower production volumes had a negative effect in the quarter. Operating income was also negatively impacted by restructuring costs and positively impacted by the VAT credit that I mentioned. The underlying operating margin was 14.1%.

In terms of Automotive, our organic sales in Automotive declined by 7% in the third quarter. We had a significantly lower sales volumes in North America and Asia, we had lower sales volumes in Europe and significantly higher sales in Latin America. The Automotive business had an underlying operating margin of 4.3%. The result was negatively impacted by lower volumes and increased material costs. And the reported operating margin was 1.1%, and this was impacted negatively by customer settlements and restructurings.

Move to the next page, please. Cash flow was strong in the quarter, I think we are very happy with. Cash flow, excluding acquisitions and divestments, was SEK 2.1 billion in the quarter, as Alrik mentioned, compared to SEK 1.6 billion last year. The increase is mainly due to lower working capital, which is then partly offset by lower operating income and higher investments. The cash flow, excluding acquisitions and divestments for the last 12 months, has actually increased from SEK 5.8 billion last year to SEK 6.7 billion this year.

Turn to the next page, please. Net working capital was 29.9% of sales at the end of the third quarter, which was 0.9 percentage points higher than in the third quarter last year. The increase is mainly explained by exchange rate development.

Next page, please. Our net debt/equity ratio was 67% at the end of the quarter. The net debt/equity ratio, excluding leasing, was largely unchanged, while we saw an increase in provisions for post-employment benefits, i.e., pensions. And the net debt, excluding pensions and excluding leasing, was 12% of equity by the end of the quarter.

Finally, some additional guidance on quarter 4 2019. We expect the finance net to be about SEK 250 million negative, including IFRS 16 effects. And based on the exchange rates at September 30, the currency impact of the operating profit is expected to be positive by about SEK 250 million compared to the third quarter last year.

For the full year, we expect the tax rate of about 29%, and note that our previous guidance was 28%. Over the last 3 years, we've consistently increased our investment, which is something that has been very much part of the strategy and will add to our competitiveness. We are actually accelerating our investment in property, plant and equipment. And in 2019, we expect to see additions to plant and property of SEK 3.1 billion, and this can be compared to our previous guidance of SEK 2.8 billion.

And with that, I give the word back to you, Alrik.

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

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Thank you, Niclas. Well done. Can we -- if we turn to the next page, I give a short summary then. And like I said in the start of the presentation, the team has done a fantastic job, I think, preparing for and managing the business during the start of this downturn. Cost-cutting is, of course, one important aspect here, but we should not forget that we're also accelerating our investments and, for instance, moving more production capacity to Asia.

We're also investing in innovation. And this, in combination with our property, plant and equipment investments, is further strengthening our competitiveness. Looking into Q4, we expect to see lower volumes, but we also expect to continue to offset cost inflation by cost savings.

Thank you. And by this, I go back over to the next page. Sorry, we should -- no, it's to you, Patrik. Sorry, sorry.

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

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Thank you, Alrik. And I think with that, we have concluded the presentation part, and we are more than happy to take your questions. So operator, please.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Klas Bergelind.

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

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Alrik and Niclas, it's Klas from Citi. So first, Alrik, on the organic growth, it trended like we thought, but you had more savings than guided, almost 3x more, and the net effect on one-off was not that different versus my assumption. So obviously, a job well done on savings, but it signals a little bit that price/mix is a bit slower. Can we get some guidance on how mix and pricing trended in the quarter? I think about price/mix in the second quarter to be around 1%. Is it much lower? Or is it roughly around the same level? Some indication there would be useful.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [3]

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Klas, Niclas here. I'll steal the answer from Alrik here. So price/mix, as said, was positive. To give you a bit of a sense, it was less than the figure you just mentioned. And if we look at the 2 components, we actually had a positive price, but we had a somewhat negative mix. And again, the net of these were kind of the -- still a positive price/mix, if that helps?

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

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Okay. And then my second one is on the cost savings. It seems like underlying cost inflation came in line with the guide of SEK 225 million, better raw mats by SEK 50 million. So it's the savings line that were better. Can we break down these savings a bit more, Niclas? How much is it from the factory upgrades and the previous restructuring charges versus more new variable cost savings? And how should we think about this line going forward? I mean is it less travel, less focus in the front end? Just so we understand a little bit about how to think about the cost line.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [5]

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Yes. I think on a -- and I'll let Patrik here comment. He might have additional comments as well. But I think the way to think about it is that, I mean the effect of this was due to the actions that we've taken earlier. And you can say that, by and large, it's related to kind of manufacturing where we saw a positive kind of price development -- or not price, but cost development. What comes to other costs, I mean we have -- it's ongoing actions essentially and it's something that we work on, and we do see more potential out there. But in Q3 specifically was mostly related to manufacturing.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [6]

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And for me, it was definitely not that we focused on sales full speed, that we will never stop.

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Klas Henrik Bergelind, Citigroup Inc, Research Division - Director [7]

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That's good. That's good, Alrik.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [8]

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We'll take, Klas, your needs on travel. I don't really done this.

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

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I always travel alone. I always travel alone.

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

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My final one is on Asia on the Industrial side. You obviously benefit from being big towards wind and rail, but I was surprised to see that heavy drive distribution are developing better this quarter obviously always have comp effect. But is this linked to more domestic growth infrastructure that is holding up in China at the moment with the export side of the economy being weaker? I was a little bit surprised to see that some of the outside of rail and wind developed better. If you could comment on that, Alrik?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [11]

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Yes. Well, you remember, we actually foresaw this already in the initial of this quarter, the past quarter that Asia was going to be a little bit stronger for us. And I remember some people say, are you sure? And we saw that time how -- actually, even though we're looking at lower growth rates in Asia, in China, it's actually growing. And our position is good. And I think with all the investments and all the activities we're doing in China, we have a strong position. And so in a way, Asia actually developed as I thought it was going to be.

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Operator [12]

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And your next question comes from the line of Alexander Virgo.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [13]

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I wondered if you could just develop the pricing comment a little bit more. I mean thinking about it on a slightly longer-term view, you've talked historically about your pricing developing from tight supply/demand dynamics and obviously commodity prices as well. And I think relatively speaking, both of those are probably reversing now in terms of trend. So I'm just wondering if you could talk a little bit about how we should think about the pricing dynamics over the next 12 to 18 months and I guess, in particular, how you think that plays into your sort of annual contract negotiations for 2020. That will be my first question.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [14]

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Well, in general, if you have a good differentiated product, you can always have -- providing value to your customers, you can always -- even in not so good times actually make good money and defend your value with the customer through a good price development. However, you are absolutely right, of course, they're part of the portfolio that when demand is slowing, there will be an increased tendency of competitors actually wanting maybe to give away some price. And that's like we've said before, that's nothing new. But we haven't seen it yet. As we say, we believe that still in Q4, we will have actually a positive development on this side.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [15]

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Okay. And then as a follow-up, just on North America and your comments around truck markets in particular, I think, are quite interesting given the dynamics around orders and production that we've seen developed over the last couple of quarters. I wondered if you could talk a little bit about what's driven the guidance in auto beyond just the auto exposure.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [16]

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Well, if you look at the U.S., we see in some markets a softening coming, and this is what we are sort of alluding to when we -- when you look at our guidance. Then we also have, as we have said, we have a few distributors which is naturally in a downturn who are now, when availability is good from the market -- from the suppliers, actually looking over their inventories, and so there are some industrial demand dynamics also in this. But what we see is that there are certain sort of pockets of industry where we see weakening. But that the underlying business, once this industrial dynamic is sort of taken out, will, we hope, improve.

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Alexander Stuart Virgo, BofA Merrill Lynch, Research Division - Director [17]

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Okay. But I mean I guess, how do you see your development in truck in particular, I guess, both here and...

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [18]

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In truck, in particular, yes, well, honestly, we see that when production is changed and when, of course, there was a situation where there were some uncertainty with the strike and so forth that impacted some of our customers, but that was really very short, but of course, as we see the order book going down and eventually when that hits real output, it will be seen. That's absolutely clear.

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Operator [19]

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And your next question, it comes from the line of Gael de-Bray.

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Gael de-Bray, Deutsche Bank AG, Research Division - Head of European Capital Goods Research [20]

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I have 2 questions, please. The first one is on the Automotive business. How do you explain that your performance is actually looking a bit light compared to the global auto production? I mean I think your top line dropped 7%, while I think it was down 3% for global auto production. So is this a question of mix or a question of selectivity perhaps, a question of product offering? I mean any color on that would be great.

The second question is on the restructuring costs you've booked so far this year. I think if my maths are right, it's probably up to EUR 670 million for the first 9 months of the year, so that's a significantly higher number than usual. So maybe could you give us an update on the planned restructuring for the full year and help us quantify the corresponding savings you expect to generate perhaps going into next year?

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

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Well, if I start with the first question and then Niclas, you can take the second. Basically, you put the finger on the different components that is in there. You can understand that on the -- in the OEM side of Automotive, you don't lose market share between one quarter to another. And I argue even that lately, long term, we've actually had quite good order intake in our Automotive business at large. So the effects are what you said. It depends on where you are, what products you're on, what platforms, what geographies, et cetera. But you can also note that on the vehicle service market, actually, we've seen sort of a breakthrough and we're strengthening.

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

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Yes. And on the restructuring, I'm sure I immediately recognize the 650 number, but anyway, I guess the point taken that it's a substantial number. I mean obviously, these are very difficult to guide for because they are kind of one-off occurrences. Some of them relate to our manufacturing work. So moving production, for instance, to Asia and then running down some current production in other places. That means, for instance, head count impact. And then now in Q3, as mentioned, we had some specific customer settlements in the SEK 270 million number. So again, while we would love to kind of provide guidance on this, it's just, by definition, a bit difficult.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [23]

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But maybe if we comment on that. I mean we will, of course -- I mean we have a multiyear program related to world-class manufacturing, as you probably know. And also footprint, for instance, increasing our manufacturing kind of capabilities and volumes in Asia. And this will, over time, result in some restructuring costs.

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Operator [24]

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And your next question, it comes from the line of Andrew Wilson.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [25]

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Can I just start on just a question around the working capital and just some of the inventory moves. I don't know if I missed it when you were talking about the Q3 bridge, but in terms of inventory moves kind of year-on-year, did you quantify whether there was an impact in the Q3? And also if there was expecting to be an impact from inventory moves in the Q4, please?

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [26]

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Yes. So inventory is obviously something, as Alrik also mentioned, is well known. I mean we have a target of working capital, and it's working capital of 25% net sales, and we are now hovering around 30% plus/minus something small. It will take time to take it down because it very much relates to our footprint and world-class manufacturing kind of programs, but definitely ongoing work. Specifically in kind of Q3, we actually took down inventories a bit, but not as much as last year. And there are some specific reasons for this, for instance, Brexit, safety stock and then building manufacturing capacity in China. And yes, in terms of Q4, I mean this will be ongoing work. So we will continue to work on taking down inventories, but we should not expect any kind of big one-off kind of step-downs.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [27]

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So would we expect a bridge impact in terms of the manufacturing levels in the Q4?

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Patrik Stenberg, AB SKF (publ) - Head of IR [28]

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Patrik here. Yes, for this way, we reduced inventories quite significantly sequentially during the fourth quarter of last year. We do expect to continue to reduce inventories even this year in the fourth quarter, but slightly less so due to a couple of reasons: one being Brexit; the other one being us preparing for moving production into our newly built plant in China. So 2 good reasons, I would argue. So we'll probably have a slight -- slightly lower reduction of inventories in the fourth quarter than last year.

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Andrew J. Wilson, JP Morgan Chase & Co, Research Division - Analyst [29]

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Perfect. And if I can just ask one follow-up, and apologies if this is just my misunderstanding. But in terms of the customer settlements, clearly, without necessarily identifying individual customers, can you just perhaps provide a bit more detail on kind of where that comes from and sort of why that results? And if it's something that we should sort of expect to be, I guess, a feature of the business or whether this is sort of a genuine one-off in this quarter?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [30]

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No. This is something that has originated way back. And sometimes, in order to be able to continue relationships, you just have to sort of agree, and this is what we've done.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [31]

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And maybe to add to that, so we had the SEK 270 million, including both restructurings and settlements. So you can say that maybe roughly half of -- a bit more than half of that was settlements and a bit less than half of that was restructurings.

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Operator [32]

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Your 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 [33]

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It's Andre from Crédit Suisse. Firstly, can I just follow up on the cash question and on inventory and working capital moves. Could you quantify how much you took the inventory down by, on an underlying basis, in Q3 2019 because on balance sheet, obviously, it's gone up sequentially?

And then looking at receivables, I don't know if my numbers are right, but they appear to have gone down by nearly SEK 5 billion in Q3 '19 versus Q2 '19, SEK 19.9 billion going to just over SEK 15 billion. So just wanted to check what kind of drove that, how you achieved it and whether we should treat that whole sort of SEK 5 billion of cash from that as sustainable going forward?

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Patrik Stenberg, AB SKF (publ) - Head of IR [34]

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Patrik here. If you look at the inventories sequentially where there's a slight reduction, less than we have last year, still a reduction, but a small one in volumes if you adjust for the FX, which is quite significant in the quarter given the weak Swedish krona.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [35]

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And on AR, maybe that's something that we need to come back to separately. But just to again provide you a bit of a kind of longer-term perspective on this, I mean we've worked on AR kind of over time. And we've seen a kind of a positive development there again over a longer period. Obviously, when the economy goes down, that's an area which -- where you probably can expect less positive, less kind of low-hanging fruits available going forward. So I don't know whether that helps. I don't want to provide a specific number for Q4 per se, but we should be a bit cautious in terms of how much more we can financially improve it.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [36]

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Okay. Got it. Got it. I'll double check my numbers as well. Maybe we're just quick to update it then. And then other couple of questions I have. Firstly, on the negative mix that you mentioned, could you give a bit more detail on that because, I guess, into divisional mix should be positive given that Industrial is outgrowing Automotive? So just wondered what kind of product or other mix is there that's driving...

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [37]

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Yes. Well, I mean just to give you an example. I mean it's -- you think about industrials and look through the kind of list in the reports of various industries, there are -- I mean there's -- industrials is, goes without saying, is more than just industries -- multiple industries. And as an example, one thing which can affect the mix is if we have more wind, so large -- very large applications or bearings compared to smaller ones. I mean they consume more steel in simple terms, so that's an example of what can affect the mix.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [38]

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Got it. And finally, just on that cost development line, I wanted to make sure that I've got the components right. So if we look at the SEK 60 million that you provide on the bridge as a positive, taking out the SEK 185 million year-on-year effect of a one-off last year, am I right to hear that you've kind of implied that there was a SEK 50 million negative raw materials inflation within that and around SEK 225 million negative normal inflation?

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [39]

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Yes. Correct.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [40]

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Okay. And if I go through the rest, and please bear with me, so you had the customers settlements of -- I mean I guess it's working out to be somewhere around SEK 150 million, SEK 160 million for what you said?

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [41]

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Yes. I said we don't want to provide the specific number, but again, as mentioned, of that SEK 270 million, you can say that a bit more than half was settlement and a bit less than half was restructuring. But yes, so...

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [42]

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Okay. And then the VAT settlement offsetting that of SEK 180 million and then the restructuring cost was then sort of slightly higher year-on-year than the SEK 90 million last year?

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [43]

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Well, again, so SEK 90 million or SEK 86 million to be specific last year, SEK 272 million this year, and then the SEK 180 million related to VAT positive.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [44]

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Right. So it kind of implies over SEK 300 million of positive cost savings, right, excluding these one-off effects?

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [45]

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Yes. So if you have negative SEK 272 million, then you have adjust for last year's SEK 86 million and then you have a positive SEK 180 million, I mean essentially they equal each other, positives and negatives.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [46]

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Okay. And then you're guiding for SEK 275 million for Q4 against that kind of over SEK 300 million, right, of savings?

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [47]

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Yes.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [48]

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Okay. Can I just -- a final one on this. Your number of employees has gone down kind of from back end of last year. I think I've run some quick math there. And now kind of the savings seems to be catching up, but your number of employees have stabilized now since kind of Q2 level. Are there further actions planned to kind of sustain the savings? Or is this kind of the program and we see the shape of it kind of playing out around SEK 250 million, SEK 300 million savings a quarter?

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

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No. Definitely, I mean this is part of the normal -- the way we treat the business normally to try to increase our efficiency and, of course, adapt ourselves. So this work, it continues.

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Andre Kukhnin, Crédit Suisse AG, Research Division - Mechanical Engineering Capital Goods Analyst [50]

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Okay. So the kind of the stabilization of number of employees now that we've seen since what you reported in Q1 roughly, that's kind of just in phasing of programs and we should see further reductions as we...

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [51]

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Yes. Well, so without commenting specifically on number of employees and how that will evolve in the future, we do kind of continuously, on a continuous basis, work on the cost base, essentially taking it down. It won't be even every quarter because every now and then there are specific activities, for instance, related to factory or so footprint activity. And then we have a number of other kind of initiatives also that we are looking into. So don't assume that it will be exactly the same number every quarter. But directionally, we are working on taking down our costs.

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Operator [52]

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And your next question comes from the line of James Moore.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [53]

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I've got 3. Maybe we could also go one at a time. My first question is about future pricing actions. Have you got any actions that have gone into the distribution channel or planned to go into the distribution channel? Or can we assume stable prices now given the demand environment and the metal price environment?

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

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We are always -- it's interesting how you come back to the same question all the time, and I appreciate it. We are -- continuous in Q4, you will see a positive pricing. We see that. We are always working on how we differentiate ourselves and do good profitability on our business. I think we have taken businesses lately where I see the still improved profitability. As we say, of course, in a general metric, it will be more difficult to increase prices in a less buoyant environment. But for now, we still see a positive price/mix going into the fourth quarter.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [55]

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All right. Secondly, I think it will be fair to say that your Industrial development in North America was worse than you expected. When I look across industries, it looks like aerospace, industrial drives, energy, electrical, industrial distribution were all meaningfully worse than the development of last quarter. So it seems to me quite broad spread. Given that you called Asia very well, what was it that made the U.S. harder to forecast? Are the lead times much shorter or something different? And really, what was it that changed in the quarter?

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [56]

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Yes. I mean of course, you can't be happy with negative 11%, but didn't come as a kind of a total surprise either. So we, of course, on a very generic level, we continue to see kind of a falling industrial activity. And then specifically related to SKF, so the Industrial activity has not come down 11%, it came down a bit more. We have seen destocking, distributor destocking, and then an impact coming from certain OEMs which we have significant exposure to, without going into specific names, but it's essentially a handful of cases. And as Alrik mentioned earlier, this kind of destocking is a very, very kind of obvious or typical one when it's a larger customer of ours who decide to kind of take down inventory levels, and it affects us.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [57]

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Just on distribution inventory levels, they appear to me to be at a 10-year, 20-year high in some cases in the U.S. Do you think the U.S. inventories are particularly high compared to the rest of the world? And do you see a destocking phase continuing?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [58]

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Yes. In this particular case, I think it's more of a new way of working for one of our biggest partners, and they are sort of in a coordinated way doing this now, and it's the second quarter they do it. We hope that in a quarter or so this will be over and they will be back at buying from us according to their -- how they sell. But there's always true is, of course, that there are some -- even though we've been working hard to reduce industrial dynamics, as you know, in worldwide, there is still industrial dynamics, meaning stocking or destocking when that opportunity is there in the value chain.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [59]

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So I think on North America, obviously there's work to do, no question about that. Then to offset that, as we discussed earlier, it's not North America, but China is something we are actually very, very pleased with.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [60]

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Okay. And lastly, just on China, you have a very big wind business relative to the rest of the world. And given the new tariff environment, we're seeing 20%, 30% increases here in onshore and 100% in offshore. Can you remind us whether your Chinese wind businesses skewed disproportionately to offshore versus onshore versus the normal market shipment breakdown?

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

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My friend, we work with the main producers and following them in their quest to supply. And we -- I can't tell you off the bat, onshore and offshore. But of course, you can imagine, we are one of the main suppliers for bearings at large in China. So of course, we are on both these applications.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [62]

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But do you -- are you seeing sort of extreme growth rates in China wind that could comp next year or the year after? Just so we're aware of what's happening...

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [63]

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Yes. Well, there's 2 things with wind, of course. One is capacity, I mean how much capacity for these kind of bearings is there around. And as you can imagine for a while now, due to that there has been quite a renaissance of wind during the last 18 months, a little bit more, you can imagine that there's a lot of capacity utilization already taken in the wind business in Asia.

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Operator [64]

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And your 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 [65]

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I guess the first one is just qualitatively, Alrik, I wanted to understand why you wanted to -- or what was the main driver of the decision to kind of reduce the outlook? Is this really all about North America, i.e., the change that you see in North America during the quarter? And if it wasn't for North America, would you actually be feeling that things were basically quite stable?

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

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Well, what we do is that we see, of course -- as we guide, we took it down a notch. But of course, we're looking at the upper level of that interval that we are foreseeing for the quarter. But of course, we're looking at both North America but also Europe softening.

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Benedict Ernest Uglow, Morgan Stanley, Research Division - MD and Head of European Capital Goods Equity Research [67]

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Understood. And if we come back to North America, if you look at what you've seen in terms of distributors in the channel and customer conversations, is what you're seeing today similar to what happened when industrial production went negative in 2015 and '16 and that was largely due to oil? Or is it fundamentally different? If you had to characterize what's happening in North America now versus then, do you see them as similar or different?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [68]

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Well, what I can say is that there are -- if you take the underlying sort of business from this particular distributor that I've been talking about, the partner we had which has been destocking, they're still -- they see some softening maybe, but they're still selling quite well. There's more that we see certain sectors that are softening clearly, and that's how I see it.

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Benedict Ernest Uglow, Morgan Stanley, Research Division - MD and Head of European Capital Goods Equity Research [69]

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Understood, understood. And then just a final question, just on China. I know your businesses is broad-based, but if you had to characterize China throughout the quarter, did you think things were stable, getting better? Do you see, as we head into the fourth quarter, any green shoots in China?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [70]

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Well, the interesting thing is that we look at China and we see a lower grade, but a lower growth, but the growth is still quite strong. And we didn't perceive that there was a lot of sort of support of the economy from the government during the quarter. So maybe there's even some kind of resilience coming from that point as well in the future because even though we look at lower grades -- growth, we still look at growth.

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Benedict Ernest Uglow, Morgan Stanley, Research Division - MD and Head of European Capital Goods Equity Research [71]

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Understood. And then final, final question. If you look at your mix of businesses and we look at sort of China, maybe stable to better. If we look at auto production rates, which is surely going to ease over the next 3 to 6 months, why would you not be a bit more confident about your outlook? I'm playing devil's advocate here. But what I'm trying to understand is why are things not, ex North America, a little bit better?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [72]

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Well, this is always -- it's interesting when you look at this kind of forecast. If you look at how we have been guiding during the last years since I came in here, we've actually been guiding quite accurately. I made the wrong -- when you look into the future, you can't be proud of how you will look into the future because honestly, we're still looking into the future, right, so you don't really know. But this is what we see. So when we look at the ability of some of our customers also to use the Christmas holidays, et cetera, to adjust their inventories and so forth, it's prudent of us, I think, to look at the guidance the way we've done it.

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Patrik Stenberg, AB SKF (publ) - Head of IR [73]

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Thank you. Being cautious of time, we have 3 people still on the list for putting questions. (Operator Instructions)

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Operator [74]

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And the next question comes from the line of Olof Cederholm.

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Olof Cederholm, ABG Sundal Collier Holding ASA, Research Division - Analyst [75]

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It's Olof Cederholm from ABG Sundal Collier. Just a quick one on...

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [76]

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Olof. Hey.

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Olof Cederholm, ABG Sundal Collier Holding ASA, Research Division - Analyst [77]

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The cost savings, they're quite impressive, and they keep picking up the pace. It continues to gain pace. So how should we see this going forward? I mean not Q4, but if you could offer some insights and maybe on a longer time period, 2020, do you think you'll be able to continue to offset cost inflation with cost savings?

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [78]

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So Niclas here. Olof, the -- as I said earlier, we should not expect an even quarterly development where every quarter is the same that we exactly kind of match the cost inflation. But we do -- I mean maybe different to some of our dear friends out there in the market, we have not announced a program per se, but we have multiple activities internally which we push and follow up on when it comes to costs. And we do expect these to contribute positively going forward, also kind of throughout 2020. But I would caution, again, and I just highlight that don't assume kind of an even distribution every quarter.

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Olof Cederholm, ABG Sundal Collier Holding ASA, Research Division - Analyst [79]

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Okay. Great. Then just very, very quickly, sorry, the raw mats, are they -- the decline in raw material prices, is that picking up pace as well for you?

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Patrik Stenberg, AB SKF (publ) - Head of IR [80]

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Patrik here. Yes, I would say we are seeing a benefit from the price also in this quarter, and we expect that to continue next quarter. But still, in total, a raw material headwind due to the mix. Essentially, we sell more bearings that consume a higher proportion of raw material.

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Operator [81]

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And your next question comes from the line of Sebastian Kuenne.

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Sebastian Kuenne, RBC Capital Markets, LLC, Research Division - Analyst [82]

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Main question for me is your production plants, you now have roughly 94 plants, I think. The auto business is doing very poorly with lower margins. How many of your 94 plants are now significantly below the return on equity or return on capital employed that you have as a target? Out of the 94, how many are really underperforming at the moment? That would be my main question, and I would have a small follow-up.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [83]

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Yes. Sebastian, short answer to that, we don't really have that data or we have that data, but a bit hesitant to comment on individual factories per se.

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [84]

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But what you can say, Sebastian, is you have to understand that for Automotive units that are wheel-related, we have specialized factories. Most of the other components that go to the Automotive are also making Industrial bearings. So the actual effect of the downturn in Automotive is less -- affecting us less on a global basis in those areas where we make the products where we also make Industrial bearings.

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Sebastian Kuenne, RBC Capital Markets, LLC, Research Division - Analyst [85]

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Understood. So it's more a product price that is an issue for the margin. Understood. A quick follow-up, if I may?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [86]

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Yes, you've got the line.

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Sebastian Kuenne, RBC Capital Markets, LLC, Research Division - Analyst [87]

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Electric cars, I think you have a very large market share for the -- for Tesla for the MEP platform of Volkswagen. Are there other like Chinese players where you have a dominating market share for the bearings and the powertrain of electric cars? Or is it...

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [88]

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We work globally. We work globally with customers around electric powertrain. That is my answer to this, if you understand. It's not only -- you've seen us talk about some of our gains that we have done in Europe and so forth, but we work globally on this. We are globally one of the leaders when it comes to working with electrical powertrains in the world.

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Sebastian Kuenne, RBC Capital Markets, LLC, Research Division - Analyst [89]

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And dominating in that segment?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [90]

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Yes. You know -- yes, I mean...

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [91]

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Of course, dominating is a very strong word, which we absolutely want to avoid for different reasons. But we are...

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [92]

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We are a strong player.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [93]

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We are a strong player, yes, definitely.

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Operator [94]

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And your last question comes from the line of Jack O'Brien.

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Jack O'Brien, Goldman Sachs Group Inc., Research Division - Equity Analyst [95]

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It's on the negative mix point again. You've talked about various industries, but is the real question here that you earn higher margin in North America and a lower margin in Asia and, therefore, as growth slows in one and increases in the other, that's really what's driving the negative mix?

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [96]

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No.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [97]

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No, no, no. It's more kind of -- when we talk about mix, we do refer to kind of applications or industry segments rather than industries -- rather than geographies, sorry.

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Jack O'Brien, Goldman Sachs Group Inc., Research Division - Equity Analyst [98]

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So if simplistically, we were to assume that Asia moves from 25% of sales to 35% of sales on a multiyear view, you wouldn't see that as a negative or detrimental to your...

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Alrik Danielson, AB SKF (publ) - President, CEO & Director [99]

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No, no.

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Niclas Rosenlew, AB SKF (publ) - Senior VP & CFO [100]

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No, no, no. We actually have decent or actually quite good margins also in Asia or China.

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Operator [101]

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There are currently no further questions from the phone lines.

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Patrik Stenberg, AB SKF (publ) - Head of IR [102]

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Thank you so much. And now we conclude the presentation and the Q&A session, and we thank you all for listening in. If you have any additional questions, we would be happy to take them by phone. Or if anything else, we will be in Stockholm for meetings tomorrow and in London on Thursday. So with that, bye-bye.

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Operator [103]

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Thank you, sir. That does conclude our conference for today. Thank you all for participating. You may now disconnect.