AB SKF (publ)

Thank you and good morning everyone. Welcome to the conference call on the second quarter results for SKF.

Today's speakers are our President and CEO, Alrik Danielson and our Senior Vice President and CFO, Niclas Rosenlew. Carina Bergfelt, 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 will leave the word to Alrik, please.

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 SEK2.5 billion, including costs for restructuring and impairments of SEK317 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 SEK22.5 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% last year and organic growth of 0.5%.

The underlying operating margin was higher than last year, with restructuring and impairments impacting reported result negatively. Sales in Europe, 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% and the organic growth was negative 6.8% compared to 5.2% growth last year with significantly lower sales 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 can 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 deployed.

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 and 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 is still a lot of work to do but as we continue with our restructuring of our manufacturing and upgrading of our plants and our integrated planning and other activities, we will gradually be improving this figure [indiscernible]. If we turn to the next page and talk a little bit about the regions.

Well, we saw revenues coming in line with guidance. We saw relatively stable revenues in the quarter.

In Europe, organic sales were 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 volumes for trucks and higher volumes for the vehicle aftermarket.

In North America, sales were 3% lower than last year. We saw relatively unchanged industrial demand.

Sales to the energy industry, 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' cost and improve their efficiency but also be able to significantly improve the environmental impact of industrial operations.

And around here, 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 you reusing bearings for the benefit of both SKF and the customer and of course, the new logistics setups that we are working on with integrated 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 a 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 startup at this moment but with a ready technology 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 see here on the page a picture, a industrial oil on the left side and after being treated by our double separation technology where we are both using a chemical separation method and the 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 third quarter of this year and onwards. If we by that go to the next page, I wanted to just talk a little bit about and our latest announced investments.

You know, last quarter, I talked about our new factory for tapered roller bearings in Changshan in China, bringing our three 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 SSEK450 million investment within deep groove ball bearings. It is an investment in our existing factory in Bari, in Italy, where we 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 purpose pronunciation, in China, where we will have a state-of-the-art 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 strive that we have in SKF and now we are taking this 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 wants, the world's best deep groove ball factory in China and you are hotly welcome.

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

Thank you Alrik and good morning everyone. So I am Niclas and before moving on with the presentation, 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.

During my working life, I have worked in Europe, North America and spent a fair amount of time in the fast moving Asian market. I am truly impressed, having just a few [indiscernible] with SKF, I am truly impressed about SKF's global reach in multiple industries.

You will 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 is 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 than automotive declined by 6.8%.

Currency effect 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 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 on to operating profit.

Operating profit in the quarter have shown a positive trend during the period, covered by this slide. So 2016 onwards, we have seen a positive trend.

The operating profit in the second quarter was SEK2,539 million which includes restructuring and impairment costs of SEK317 million. The underlying operating profit was SEK2,856 million in the quarter and this represents a 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 SEK68 million and this related to the disposal of the L&AT business.

The currency impact in the quarter was a positive SEK112 million compared to last year. And then let's spend a bit more time on the operational performance.

So the operational performance decreased by SEK430 million year-over-year. Contributions from organic sales and manufacturing volumes was SEK60 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 SEK20 million in the quarter. In terms of cost development, costs were SEK370 million higher than last year.

And note that this includes the higher costs for restructuring and impairments of SEK296 million. So in absolute terms, we had SEK317 million this year versus SEK21 million last year, which is clearly higher than what was discussed at the last conference call.

Excluding this, cost improvements where significant compared to last year, which we are very pleased with. The restructuring costs relates 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, relates primarily to us upgrading to the latest SAP platform S/4HANA. The negative material cost impacts 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.

Let me take the opportunity here to comment a bit on the third quarter guidance to the bridge and I will 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 loss kind of results from divested companies, so essentially L&AT of about SEK70 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 SEK30 million in Q3 2019.

In terms of cost development, in Q3 we expect to see an underlying cost inflation of about SEK225 million and this would be partially offset by cost savings of about SEK100 million. In terms of material costs, we expect it to impact negatively by around SEK100 million compared to Q3 2018 and we expect to have similar restructuring costs as last year and last year it was about SEK86 million.

In Q3 last year, we also had a positive effect from land sale amounting to about SEK185 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 reported results negatively. Price mix contributed positively to the result 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 continue 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 volume and increased material costs was actually partially offset by pricing, so higher pricing. What comes to the income statement for the group in the quarter, we reported a solid Q2 results with an operating margin of 11.3%.

And note that this includes the restructuring and impairment costs for SEK317 million. And as mentioned, the comparable number was SEK21 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 SEK278 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 SEK40 million. Taxes in the quarter were SEK682 million and this resulted in effective tax rate of 30.1%.

Our earnings per share was SEK3.32 and the 12 months trend for EPS was SEK15.07 versus the year ago when we were at SEK14.43. Moving on to cash flow.

As Alrik already commented, quite a strong cash flow in the quarter. Cash flow excluding acquisitions and divestments was SEK1,849 million compared to SEK2,182 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 that 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 of SEK5.1 billion last year to SEK6.2 billion.

Net working capital was 30.1% of sales at the end of the second quarter, which is one 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, SEK2,976 million impact.

And the net debt to equity ratio excluding leasing was actually unchanged on the total while we saw an increase in provisions for post-employment benefits, so pensions. Net debt excluding pensions and leasing was 17% of equity by the end of the quarter.

Finally, some guidance, additional guidance. For the third quarter, we expect finance net to be about SEK245 million negative, including IFRS 16 effects and industrial exchange rates based on June 30 exchange rates, the currency impact on the operating profit is expected to be positive by about SEK130 million compared to the third quarter of last year.

Based on exchange rates at July 15, the currency effect in the third quarter would be about SEK190 million positive. For the full year, we expect a 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 SEK2.8 billion. And with that, I will hand the floor back to Alrik.

Thank you Niclas. Thank you.

Well, just to summarize, if we go to the next slide. The second quarter was a strong 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 continue to see positive pricing and our efforts to reduce our cost base are 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.

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.

Thank you. 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 start of 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 that's coming given that you have capitalized quite a bit over a number of years?

I will start with those two. Thank you.

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 segment that are a little bit weaker. And I think there is no mystery in that.

The big question, of course, is that we have seen for long time now in China lower automotive market. And what we have seen is, it's interesting you know how uncertainty actually drives of course a 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 have 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 many of our big Chinese car customers, this is how they see it too.

I mean it's not that, in other regions the weakness in the automotive business is coming now recently, as you may recall in China it's been going on for quite a while. So what we are saying is that we see for the first time now a flattening out of the Chinese automotive market and then maybe cautious sort of understanding that maybe we have reached a trough and we will be able to see some improvements compared to what we have seen in the last year.

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

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.

Thank you.

Thank you.

Yes. Hi Alrik and Niclas.

It's Klas from Citi. Can I come back, Alrik, to Asia and China.

Could you talk a little bit on the industrial side? Distribution versus heavy?

And how we moved through the quarter? You talked about automotive.

I would be interested to hear what happened through the quarter also on the industrial side. I will start here.

No. I can tell you, what we see here in the quarter is what we have said.

We see some of the segments for smaller drives and smaller electrical motors weakening and that we saw through the quarter and businesses like wind. We must understand, right now there is a legislation that says that if you get your windmills ready by the end of next year, you will get a certain feeding tariff.

If you understand, the price for electricity, beyond that point, it's unknown. So you can imagine how everybody currently are pushing for getting their windmills ready for that date, that year-and-a-half time frame.

It may continue. 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 as we see, we see that continuing.

But otherwise, you know, we have been quite good at seeing one quarter ahead. And I think if you recall, if you look at how we have been sort of guiding, we have been quite successful so far.

I hope that streak will continue. I cannot promise because of course, we are always talking about the future.

But this is how we see it, you know what we guide. And this is the flavor I can give you, so to speak.

Yes. No, I am aware of wind.

I was just, the pure industrial bit, but it seems like smaller drives, et cetera, weakening a bit. And my second one is on price increases on spot.

I think you were planning to pursue there on distribution in Europe last quarter. I was wondering how effective these increases were?

And if you are planning to increase yet again now in the second half? Obviously, very solid cost control yet again, but it could mean that increasing prices is a bit more difficult.

Price hikes often works but if there is a lot of cost inflation, obviously it's the other way round now. So I was wondering how the distribution pricing happened?

Yes. I think that as far as what we have done in distribution, it's been doing well and working well.

And you know, we are very disciplined in this and there is absolutely, we are pushing this through and it's holding. And as far as pricing in general, of course we are always taking for the opportunity.

There is more always work to do and I think there is 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 the 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. There is a tendency of course, that we will see that maybe steel prices, et cetera will be different going forward.

But right now, I think in many markets, what we have seen so far, there is quite a resilience in this. So there is no increase.

No, there is 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 still are not in that kind of territory, I would argue.

My final one is for, it's for you, Niclas, on the bridge. Just to confirm, your guidance for SEK225 million in cost inflation into the quarter and this was I think a little bit more than SEK70 million here in the second quarter.

If that's correct, the reason for asking is that the last couple of quarters on SKF have been better on cost. It was more on IT, logistics, R&D where cost came down, but the plus SEK200 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 SEK74 million versus SEK225 million guided?

And now it seems like you are guiding for SEK100 million cost inflation off the savings into the third, so again the low level. Just to understand how you can cut back here and what to expect ahead?

Yes. Let me, actually, I mean Patrik, not to make sure that I don't say anything stupid which we have to regret, misguide you.

So on the exact details, I mean Patrik, feel free to comment here.

Yes. The accounting on the performance in the current quarter, I would say we performed really strong on cost.

As we discussed in the bridge, we were able to almost offset raw material cost inflation, which was about negative SEK90 million in the quarter and the underlying inflation which is about SEK235 million in the quarter by reducing our underlying cost. We have 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 have been successfully doing that.

Going forward guidance for Q3, yes, underlying cost inflation is still about SEK225 million. Raw material cost inflation on a similar level compared to what we saw now in Q2, about SEK100 million in Q3.

And we expect to offset some of that with continuing cost reductions of about SEK100 million in Q3. That's the pure cost side.

But Patrik, the SEK225 million, are you talking about SEK100 million savings? And typically you don't split out SEK100 million savings.

So is the SEK225 million less SEK100 million, that is your cost inflation that should be compared with the SEK74 million you did this quarter?

You are correct, yes.

Yes. All right.

Thank you.

Hi. Good morning everyone.

I sort of had a 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.

Well, I think 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 are 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 gives us 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 they 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 something light in the tunnel there.

And I would only say, if you look at China, you understand that the downturn has been going on for quite a while, but maybe then it's not so strange actually.

Thanks. If I can just ask a follow-up, just on some of the cost savings which you have 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 are seeing in auto market? Or is this just a more general sort of structural improvement of the business?

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

It's also automotive but it's across the business.

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

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 have had initiatives ongoing.

I mean the footprint related to factories is only one area but that's pretty clear and we will of course continue with these initiatives. There is no kind of end date to them.

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

That's perfect. Thank you.

Good morning. Thanks so much for taking my questions.

I am sorry but I would like 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 have got minus SEK100 million for raw materials. I have got minus SEK225 million normal inflation, minus SEK74 million delta restructuring, minus SEK175 million one-off reversal and plus SEK100 million cost improvement.

Do I get these right? And am I missing anything in that line in terms of the guidance you have given?

Hi Andre, it's Patrik. No, 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 is no restructuring delta.

Right. So zero on the bridge and it's at the SEK&0 million level, it's the same, okay.

So we sum up to minus SEK400 million, great. Thank you very much for this.

Can I just also ask on price mix, you clearly indicated that you have been successful in raising prices and that it was positive in Q2, the guidance for Q3 for that to be positive. Can you calibrate at all compared to Q2, do you expect it to be as positive, more positive, less positive in Q3?

You know, as we have 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.

Thank you. And lastly, just a much broader question on the circular economy and selling bearings per rotation.

I 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? Is this a higher margin business?

What is it growing at?

So there are two effects of this. One is, I can tell you, right now as we have said, apart from Latin America, actually this is not yet seen by saying that where we had sort of fee-based arrangements where everything is included, the bearings, the services and everything and we take a sort of a fee-based arrangements 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 for both increase market share and profitability both for us and also for our customers.

And the key here, of course, you understand, there is so much weight still to be eliminated and when you have a fee-based contract, the interest of the supplier and the customers are completely aligned. There is no conflict of interest.

And this is why I am so absolutely convinced that all of our customers, if there is 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 that even if in the beginning we don't actually manage to have a fee-based arrangement from day one, the customer sees us as a completely different kind of supplier.

We have become sort of straight into their strategic development, how they are going to run their factories in the future, how they are going to improve their efficiency and how they are going to lower their environmental impact. And you know I suggest there is a video on YouTube about River Steel and SKF and if you want to see the perception of a customer that we just signed up on this kind of agreement, you know it's not a bad thing to have a look on that YouTube, River Steel and SKF.

I will definitely look it up. Thank you.

Can I just follow-up on this? In LatAm, can you give an idea of how big it is in LatAm?

And is that contributed to the faster growth that you are seeing there?

Yes. Well, the short term growth that we see in Latin America is of course basically based on how we are working with our customers where this is already sort of a main way of working with out customer on industrial side, but also because we are coming in with a lot of new interesting localizations of production for the automotive space.

So as you see, in Latin America, we are actually growing from an automotive perspective and there is a lot of really interesting initiatives that has enabled us to grow also our automotive business in Latin America.

Got it. Thank you very much for you time.

Thanks very much. Good morning everyone.

I just had a sort of slight pedantic question, I suppose. If I compare the wedding 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 then the presentation, it says lower. So I am 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?

It should be slightly lower.

Slightly lower, okay. So it's not a reflection that we are kind of on the border and it's a bit difficult to call invisibility as low?

It's just a, my guess, it's just a [indiscernible]?

I haven't seen this. I apologize for this.

If this is true, I didn't see this. But you know, you hear what we are saying.

This is how we see it. So I apologize for that.

I apologize.

That's great. Thank you.

I hope no harm done.

I just wanted to clarify that.

Alexander, thank you.

And then just on as a follow-up. I am slightly surprised at how weak the VSM is in auto.

Are you not surprised to see a little bit more resilience in that part of the market? Maybe can you talk a little bit about the regional development in terms of guidance as well, that would be helpful?

Yes. I mean there are two things that you have to see in this respect.

And one of the areas where we are actually doing a good development is in China, for instance, where we see this development better. If you look at the amount of cars that, you know VSM really comes, kicks in after about seven years.

So 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 seven to 15 years ago. And that's how you are going to go to see the market develop.

And if you see it all around, you know, seven to 12 years ago, it was not a great sort of amount of cars entering the market and that of course having a dampening effect. On the other hand, we are doing, I think we are 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.

Got you. Okay.

So it's more of a phasing thing or a temporary thing. It's not something that we need to --?

Yes. Well, no.

Well, there is also dynamics in the marketplace, more OES channels, more the car manufacturer is taking over some spare parts dealing. There is more e-channels coming up.

There is a change in the VSM dynamics coming with new technologies as well, the new channels to market. But I argue that we are going to be part of that as well.

This is what I am talking about.

Okay. Thank you.

And then just a quick follow-up on industrial. We have 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 are behaving, would be very helpful?

Yes. Well, you know, from our point of view, if you are 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 development. And you know, 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.

Okay. That's helpful.

Thanks Alrik.

Good morning and thank you for taking the question. I had a couple.

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 are going to being 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.

Well, you know, the logic I am trying to sort of portray on China is the fact that the downturn, if you recall, came much earlier in China and been going on for quite a while. And when something has been going on for quite a while and you understand that both government 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 is a logic to actually believing that there could be actually truly a change.

And I think that is more what I am alluding to. In other markets like in Europe, for instance, where the downturn has not been going on for as long and there is still 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, you know, the way you look at it.

Understood. Thank you.

And second question and I hope I am 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. 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 pre-buy effect or an inventory effect in the distribution channel?

Is that something that you seen? Or am I reading too much into it?

No. That's not what we see, no.

There is no industrial dynamics in this thinking from our side. But you have to understand, if you look at the market as such, there is some South Asian market 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.

Understood. Thank you.

And final question for Niclas is, we are now guiding to about SEK2.8 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 this type of level? Do we think the 2019 is an unusual year?

Or is this going to be the cost of doing business going forward?

It's not an unusual year. Whether the exact amount is SEK2.8 billion or plus or minus something, it has been a different thing.

But we have a major initiative, you know, 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.

But I resent your comment of saying cost of doing business. I can tell you, all of these investments, all of these investments 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.

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.

And it is fair for me to say that the restructuring cost, 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?

Well, what happens is, when you take individual actions, so there are two kinds of investment, you understand. One is when you are taking an existing factory and you are 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 put them in China.

Well, you know, when we do these kind of things you will get a small or one-offs when those activities happen. But they are also with a good return.

They are also with a fantastic return.

Okay. That's really helpful.

Thank you very much.

Thanks. Hi.

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

Understood. I will keep it short and sweet, Patrik.

Thanks. Hi Alrik, Niclas, Patrik.

Hi.

Hi. A quick one on automotive in North America, Alrik.

I am struggling a little bit with the performance, particularly with the car and light vehicle 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?

Well, you know I think that if you look at the kind of models that are really holding up in the U.S., as I think I have 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.

And finally, Alrik --

As I said before, we are 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 our strongest platforms are maybe not where the American market is performing the best at this moment.

Clear. Can I clarify just the raw material guidance for Q3, the negative SEK100 million?

Is that net of the savings in the quarter? And I am struggling a little bit with a negative SEK100 million.

We have seen obviously a rebound in scrap in July but still down materially year-over-year. Could you help me understand what you are baking in from a raw material standpoint and what's being baked in from a tariff headwind standpoint to the extent there is any?

Hi Lars, it's Patrik. On the negative guidance on the raw materials, it's not primary price.

It's primarily driven by our consumption. We have some of the industries, some of the products that we expect to perform best, consume a relatively higher proportion of raw materials than others.

So it's mainly a manufacturing mix issue than actual price.

And it's then offsetting to extent?

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

Thanks.

With that, 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.

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.

Thank you.