A difficult quarter

After a first and second quarter with record sales and record income, sales growth decelerated much more rapidly than expected during the third quarter, as visible in the reported earnings. The downturn in the economy has been significantly exacerbated by the global financial crisis. The important European market has declined significantly, while North America and Japan continue to show weak demand. In addition, we are seeing indications that the economic climate is also weakening in other parts of the world. Because of the deceleration being so rapid, we haven’t been able to reduce our costs at the same pace, but currently hard work is being performed around the Group in order to adjust operations to the present market situation and to counter the effects of increases in the cost of materials.

In Europe, customers are continuing to adopt a wait-and-see attitude to the ordering of new vehicles and equipment. Moreover, they have increasingly opted to cancel already placed orders. For our part, we have made sure to diligently go through and cleanse out orders in order to secure the quality in our order books. The same number of orders that have been received in Europe during the quarter have been removed from the order books, which contributed to a virtual standstill in net order bookings. Due to this situation, it has become necessary for us to adapt our production rates and costs to the lower demand trends prevailing in our markets. Although the personnel cutbacks that we have decided on are painful, they are essential because the economic climate has become much harsher.

In North America, demand for trucks remains weak, at the same time as the markets for construction equipment and boat engines have declined additionally. To enhance the efficiency of our North American truck operations, we are planning to relocate Mack’s Head Office, including such functions as product planning, product development and purchasing, to Greensboro, North Carolina, where most of the Group’s truck operations in North America are already located. We are also concentrating production of Mack trucks to one plant.

To enhance competitiveness and profitability within road machinery in North America, we will close the factory in Goderich, Canada and concentrate manufacturing to the plant in Shippensburg.

Sharp deceleration – lower profitability
During the quarter, the Volvo Group’s sales totaled SEK 69.6 billion. Sales declined in Western Europe and North America but increased in Eastern Europe, Asia and South America.

Operating profit declined 37% to SEK 3.2 billion. Cost inflation pertaining to raw materials and components had a sharply adverse impact on earnings. The upward pressure on prices that we started to note during the second quarter had a full impact in the third quarter. Earnings were also charged with costs for the restructuring of road machinery in North America and increased costs for research and development in preparation for new emission legislation scheduled for introduction in several markets in the next few years. We are also investing resources in the development of new generations of hybrid vehicles. These are key initiatives in efforts to boost our future competitiveness.

Cash flow was negative during the quarter, mainly as a consequence of decreased trade payables, but also because of lower operating income and excessive inventory build-up. Work to reduce inventories is a very highly prioritized area.

Adaptation to lower demand
Deliveries from the Group’s truck operations decreased by 5% for comparable units during the quarter, order bookings declined sharply and operating profit declined to SEK 2.7 billion. We are currently implementing structural measures and adapting production rates in an effort to reduce costs and increase efficiency. In view of the weakened business trend in Europe, we expect the truck market to grow by 0-5% in 2008. In North America, the market is expected to decline by about 10% this year, compared with 2007.

On August 1, 50% of the joint venture with Eicher Motor in India was consolidated in the Volvo Group. As a result of this partnership, new opportunities will be opened in the Indian trucks market, which is highly attractive from a long-term perspective. We also see opportunities to eventually export trucks from India to other markets in Asia and Africa, among other regions.

Of the Group’s business areas, Construction Equipment, for which steel is an important input material, was affected most severely by the increase in raw material prices, which resulted in reduced profitability. In North America demand weakened further and in Europe the downturn rapidly spread from the compact machines to the larger machines.

Buses reports weak earnings, but is implementing important measures within the framework of its global profitability program, in which restructuring of the European manufacturing system is a key feature. At Volvo Penta, the market for marine motors for leisure boats continued to decline, while industrial motors experienced a better trend. Volvo Aero’s earnings improved compared with the second quarter, as an effect of healthy development within its components business.

Our customer financing operation within Volvo Financial Services showed healthy profitability in the third quarter. We have a conservative approach to customer financing, and our credit losses remained low during the third quarter.

Strong finances
The Volvo Group’s financial position is strong. The need for refinancing of industrial operations is very limited in the next few years. In our customer financing business, we need to turn to the credit market to finance customers who choose to raise loans for purchasing new products. We haven’t had to reject loan applications from credit-worthy customers. We have secured financing to cover the lending that we expect to grant to customers during the remainder of 2008.

We are in a situation in which demand is declining in an increasing number of our markets. In times of recession, we face increasingly tougher demands. To ensure that the Volvo Group will emerge from the imminent recession with a stronger market position, we will have to quickly adapt our production even though it’s painful and affects many co-workers. We must lower our overhead costs, increase our cash flow and, not least, continue to work hard and in a determined manner.

Leif Johansson
President and CEO