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Good day, and welcome to today's SKF Q1 2018 Results Conference Call. Today's conference is being recorded.At this time, I would like to turn the conference over to Patrik Stenberg, Head of Investor Relations. Please go ahead.
Thank you and good morning and welcome to this conference call on the first quarter results. The conference call will, as usual, take about an hour. Present today are our President and CEO, Alrik Danielson; our CFO, Christian Johansson, our Director of Group Controlling and Accounting, Carina Karlsson; and Theo Kjellberg, Press and Media Director; and myself, Patrik Stenberg. We will start as usual by presenting the results, will probably last about 30 minutes and then after that we are open to take your questions. So -- and one quick reminder about the questions. It is good if we can limit it to one or two questions, so that anyone -- everyone gets the opportunity to pose their questions at the end of the call.With that introduction, I'll leave the word to Alrik. Please.
Thank you very much, Patrik. Welcome. And if we go to the next slide, it is a record start for SKF, it's a record quarter, a historical quarter, with a record high sales of almost SEK 20.6 billion with organic growth of 7.5% and an operating margin of -- just short of 13% and a cash flow that, of course, could have been stronger, but was definitely much better than last year.If we go to the next slide, we have, as you know, targets. We have 5 key targets and we are now delivering on 3 of them and we are doing very good progress on return on capital employed. And the other one that we still have some work to do is net working capital, which is in a way absolutely normal. In times of high volume growth, there will be a increase of net working capital, but I'm sure that you will see good progress also on that going forward .If you take the next slide, we look a little bit more on sales growth in the different regions. And as you see, we are growing in all regions and I am really happy to see how Europe is coming along, Asia-Pacific, Middle East and Africa, all important segments are growing. And in Europe it's really good to see that industrial distribution is developing so well. In North America and Latin America, growth is also there, the underlying growth is there. The little bit weaker figures in Latin America is, in my mind, entirely dependent on wind. Our large-size bearing factory, dedicated to wind applications, has basically been standing still, due to the fact that there has been no deployments of windmills in Latin America, basically, during the quarter. We see, however, that we are now starting up the factory again.The same in North America. Heavy trucks is going well. We are selling strong into industrial applications. And here it's basically the wind as well. There are some businesses in wind that we have decided not to pursue. And that's the reason for a little bit lower absolute comparison figures than the underlying figures.And we'll talk a little bit about pricing. We've talked about how we are increasing prices and you see now clearly that what we have been telling is coming through and the industrial distribution [indiscernible] price increases are there and we're working on further enhancing that. I mean, there are industrial OEMs, wherever there has been a contract change, price increases have been implemented. And in automotive, of course, with the slower pace, due to the dynamics of that industry, but still also prices are coming through and being adjusted also there.If we take the next slide, and I'll talk a little bit about things that I see, I am really happy about. The rotating equipment performance is one of our key strategic initiatives and I see how our product and services application know-how and customer focus on new technologies starting to really give good results. And we have the suite of both products and services and knowledge to enhance our customers' performance and I see now how this is truly starting to have effect.And if you take the next slide, we all know that unplanned production stops cost the industry billions. And every time a machine is stopped and opened, because there is no need, drives cost and we are now absolutely in the position to support industry like never before in giving them these benefits from the technology available. And there is a very good development in this going forward.If you look at the next slide, we have -- we'll talk a little bit about products. We have been chosen as the main development partner for Volkswagen on the all-electric MEB vehicle platform, which is their future platform for their new electric vehicles. That's fantastic.If you take the next slide, we talk about another good initiative. The LEAP engine, this is the new GE engine for aircraft that is being ramped up and our hard work to get the lion's share of that program is now paying off and we are growing strong in this business.With those words as a short introduction to this very good initial quarter, I hand over to Christian for more details around the results.
Thank you, Alrik. Good morning to all of you. So some more details, starting with -- on the next page. Thank you. Sales development.Net sales increased with 4.9% in the first quarter and we still, as you've heard, experienced a healthy growth in the quarter in most of our markets and across most customer industries within industrial and automotive with few exceptionals, like wind. Organic sales increased 7.5%. Currency effect was negative 1.9% and the structure component, as we've had previously as well, was this quarter 0.7%, related to our divestment transaction that we closed second quarter last year.So if you turn page. Organic sales growth. Last year, we, as you know , we grew organically 8.2% on full year, which was equally distributed over the quarters. So the 7.5% organic sales growth this quarter mean that we remain at around 8% year-over-year growth, which is very pleasing, knowing that we now grow from significantly higher comparison values. The working day effects was negative in the first quarter with about 1 day versus last year.So turning the page. So operating profit, and as you might have seen in the press release and I would like to mention it as well, since it's a change, we will from this first quarter onwards only report operating profit including items affecting comparability. So I will come back to reporting changes in the end of the presentation. But if you look at the graph, the reported operating profit in the quarter was SEK 2,625,000,000, or some SEK 330 million higher than in the first quarter last year, and it was as you heard from Alrik, the highest operating profit yet as reported in a single quarter in history. The 12 months trend on operating profit was SEK 8.9 billion.So if you turn page, and we come to the profit bridge. I am taking you through this. For the quarter, from left to right, we had a negative effect from the divestment that contributed with SEK 32 million in profit last year that we don't have this year. Currency impact was negative SEK 287 million compared to last year. If we go to the operating performance, this was for this quarter very strong and increased year-over-year by SEK 649 million with a good leverage. So contributions from organic sales and manufacturing volumes increased by SEK 939 million. We saw positive effects from sales volume, from price mix and from fixed cost contribution from the increased production volumes.Price mix, clearly positive compared to last year. The improvement [ to annual ] pricing that we have seen in the previous quarters have continued and gave a clear positive contribution in the profit bridge. Mix was also positive in the quarter, both related to industrial automotive mix and to the distribution OEM mix.The manufacturing contribution included the positive profit effect of about SEK 30 million from increased finished goods, inventories. The inventories increased slightly more than in the first quarter last year.Cost development in the quarter gave a negative effect of SEK 290 million. Repo changed here as a consequence of what I told earlier. The year-over-year effect now includes restructuring costs, which previous year was then reported as items affecting comparability, and this is now part of the operational performance and part of the cost development. It was relatively unchanged in this quarter versus last year. We are also, from this quarter, including the year-over-year effect from Unite in the cost development. So no separate bar for Unite in the profit bridge. And Unite was in the first quarter positive SEK 65 million compared to the guidance we gave with a positive effect of [ SEK 50 million ]. And the full year forecast for Unite is still positive SEK 100 million. So it's a minor item going forward and that's why we feel -- we take it as part of the overall cost development.The material cost was in the first quarter negative with SEK 100 million versus last year. And we continue to manage the -- to compensate the raw material with positive effects from commercial activities, design and specification changes and reduced consumption. For the second quarter, we expect the material cost impact to be somewhat less negative, so about SEK 70 million negative year-over-year.The remaining cost development is then negative SEK 255 million, consisting of ordinary cost inflation, which is around SEK 200 million in the quarter, somewhat higher than previously, and we also had some extra cost related to freight, to manufacturing, due to that we ramp production now on high capacity utilization and to R&D and these make up the difference of SEK 55 million. And for the second quarter, with our positive demand guideline in mind, we expect somewhat higher cost level to remain at negative SEK 250 million, excluding the material that I commented earlier. So in total SEK 320 million. So that was a lot of the comments for the profit bridge.If we turn page, performance by customer group. Industrial, organic net sales increased by 8.5%, significantly higher in both Europe and Asia and relatively unchanged in North America. Operating margin 15% compared to 14% last year. Contribution from increased sales and manufacturing volumes was positive, together with a clearly positive effect from price mix.Automotive organic sales grew 5.5% in the quarter. Good sales growth for both light vehicles as well as trucks. Strongest automotive markets continue to be Asia, but demand was also good in North America and Europe. Operating performance continues to strengthen and reported operating margin 7.7% compared to 6.8% last year.If we turn page, income statement for the quarter. If we turn page please. Gross margin was almost flat compared to last year. Positive contributions from organic sales and manufacturing contribution, offset by negative currency, higher material costs and the general inflation manufacturing costs and freight, as I already commented.Selling and administrative expenses as a percentage of sales decreased to 13.1% from 13.7%. General inflation offset by positive -- by productivity, positive currency effect, as well as lower Unite costs. Financial net negative SEK 200 million compared to SEK 170 million last year. Exchange rate fluctuations had a negative impact versus a positive impact last year.If we go to taxes, in the quarter, we had a effective tax rate of 26.3%, so clearly lower than last year same quarter and this is due to that we have higher profits taxed in Sweden, so lower tax rate and to the U.S. tax reform, as well as, [indiscernible] to last year, which was impacted by tax cost in the first quarter 2017 that related to prior years. Earnings per share in the quarter increased by more than 20% and was SEK 3.77.So next page, cash flow. After investment, before financing, excluding M&A activities, positive SEK 254 million versus SEK 64 million last year, mainly due to higher operating profit, offset by increased working capital, while investments were just slightly higher than last year. And 12 months trailing was SEK 4.3 billion.So on next page please. Net working capital, 31.7% of sales at the end of the quarter, 0.8% higher than the same quarter last year. Ratio was negatively impacted by currency. However, also adjusted it was somewhat an increase in the quarter. We see good progress when it comes to trade payables. Receivables ratio improved somewhat versus last year, 19.1%. However, if you compare it to end of last year it increased a bit. I would say that's due to the Easter weekend that was in the end of March was impacted the day of payment from some of our customers.Inventory ratio increased to 23.4% and we have continued to have good availability. In order to keep the service levels up, we've increased customer demand and as you've seen in the P&L, we do see positive effects from us being able to meet both the OEM and the aftermarket demand in our profitability.So if we turn page. Net debt/equity ratio continued to improve. End of the quarter we were at 66%. Then excluding pension we are down to 29%.Next page, guidance for the '18. For the second quarter, finance net is unchanged, about SEK 200 million negative. And then we have the currency impact, where we have 2 references. End of March, as you have in the slide, we expect SEK 160 million negative in the second quarter. And if we take the exchange rate of April 24, it's improved a bit, so it's negative SEK 100 million for the second quarter. We still believe tax rate will be 29% and no change to the investment level, additions to plant and property, SEK 2.4 billion.As I said, coming back to reporting changes. And the first one was already mentioned that we now have one operating profit line including IAC. So that will not be separately reported, it will be reported part of cost developments or where it belong in the profit bridge. And we will not report an adjusted operating profit. From this quarter, we will not give any sequential demand guideline, only year-over-year demand guideline and I will soon come back to that for the second quarter.And finally, we have also done a slight adjustment to the segment definition in our sales reporting and this in order to align it with the general industry standards, and you have the segment changes on the right side of the slide. And I will not go through it, but please call us if you have any questions on this.So with that, I'll leave the word back to you Alrik.
Thank you very much. And just to summarize, continued growth in Q1, record quarter, both as far as sales and operating profit. And that we are expecting to see this continue into Q2 with higher volumes year-over-year. So a really good quarter and I'm proud of SKF today, I must say, it feels good.If you look then on our demand outlook, I'll read it to you for the sake of good order. Demand compared to the second quarter 2017. The demand for SKF's products and services is expected to be higher for the group, including industrial and automotive. Demand is expected to be higher in Europe, significantly higher in Asia and relatively unchanged in North America and Latin America.So with those words, I hand over again to you, Patrik. Thank you.
Thank you, Alrik. Operator, please now we move to the last slide and we move into Q&A. So please go ahead, operator. Please.
[Operator Instructions] And we'll take our first question from the queue, Gael de-Bray from Deutsche Bank.
I have actually 2 questions, please. The first one is about the Chinese market trend. How do you see your market share actually trending in China? You've again delivered pretty strong growth there and I was curious to see if you were actually outperforming the market. And if yes, in which areas. The second question is about the automotive business. I think the turnaround of this business has now been largely completed with the margins getting closer to the 8% target. But the growth momentum is apparently fading a little bit, so what's next here? I mean do you still expect the division to be able to contribute positively to the group's earnings growth momentum in the next few years? Thank you.
Well, this is Alrik here. If you start with the Chinese question, it's at this point just 1 quarter hindsight to be truthful of knowing exactly how much market we are gaining and in what segments, I tell you, it is difficult to me to be precise about it . In general terms, our assessment is that SKF is now gaining position in the markets. And when you look at the key markets we are in, we are doing fine. We have a relatively good delivery performance and I think our customers are happy with us. As far as the automotive, yes, I think -- I am really proud of the team, they have done an excellent job to actually get to what we -- what were our expectations. Now we are looking, of course, at many, many new interesting initiatives. And the automotive business, if you have the right technology and the right offerings, will, of course, be able to good contribution to the SKF group going forward. I see no reason why not. We talk about electrification. We talk about new powertrain solutions, et cetera. This is a positive environment for us, because rest assured, the traditional powertrain will stay for quite a while, at the same time as we have the new powertrains coming in and look at it -- if you look at the cars that are now being launched, they are mostly hybrids. And yes, there are some fewer electrical vehicles, but the bid volumes for the years to come will still be with the traditional powertrain. So we are, as you have seen with the Volkswagen nomination, for instance, a key player in the electrification, as well as a key player in wheel bearings and chassis bearings and in the powertrain and there is no reason why that will not continue.
Okay. Can I just have a follow up on the Chinese situation? Have you seen your Chinese competitors following on the your price rises?
If you recall, they were actually the first ones to start compensating themselves already 2 years ago when -- or 1.5 years ago when we clearly saw the turnaround in the second half of 2016. So definitely.
And now we take our next question from the queue, Klas Bergelind from Citi.
I will start with the favorite topic, which is price mix. It seems like price mix is the key driver behind the improved profit, manufacturing only impacting the bridge by SEK 30 million. Depending on the pure volume drop through, I get price mix to between 1.5% and 1.8%, which is obviously a big improvement quarter-on-quarter. First, if you can confirm if that's the right ballpark figure. And then if you can try and break down the price mix a bit, am I right that mix and distribution pricing was perhaps 50 basis points each, and then 50 basis points to 100 basis points from the OEM on the annual contract started to kick in?
Klas, it's Christian here. And as we have commented and you're right, in that we have a clear positive step-up here, sequentially here. I mean we don't -- I don't want to comment your absolute judgment there on what you gave. But it's clearly going in the right direction when it comes to pricing. And as I said also when it comes to mix, I mean the important factors in the mix is on one hand, as you know from the margin, industrial versus automotive, it was positive and you have the distribution versus OEM, which was also positive, by us being able to serve the industrial distribution of the market in a very good way.
And the OEM side, is it around 1/3 that this annual contracts kicking in from January or...
I mean, as we used to discuss, we have so many customers and so -- and I mean this is [ no ] customer by customer setup. I mean, what date you have further changed. But, as we have said, we are on this [ board ], we have been on it for a while, and the longer this positive business climate remains, obviously the more OEM contracts are expiring and pricing is on the table and eventually adjusted in the contract to come. So for sure, some of this came in 1st Jan, and some of it comes in at other points in time. But I mean the trend is positive.
I think the key -- we have been talking about this now for so many -- and I think that we are now proving that what we've been saying all along is true in a way that there is pricing power and that SKF is on the move.
My follow-up was on raw materials. Did you say SEK 70 million negative year-over-year in the second quarter, Christian? And should that stay at that level for the rest of the year per quarter, given that the year-over-year comp in the bridge is similar from here, or are the increased steel prices in the quarter going to drive a bigger impact year-over-year into the second half?
No, I don't think so, since we have -- but I mean, to be honest, I haven't looked into the quarter report. We follow, obviously, the raw material price trends carefully and then already -- and that's why we are minus [ SEK 70 million ]. We had the cost increases that creeped on us already in the second quarter last year, and that continued. So -- but I mean, I would say that the steel price as such has been quite -- [ surcharges and so on ] -- it's on a quite stable level now. So I cannot comment on the second half of the year, but I would not expect it to increase in the second half of the year, for sure.
Now we take our next question from the queue. Peder Frölén from Handelsbanken Capital Markets.
Christian, thanks for the clarification on the operating profit waterfall there. Could you -- you mentioned that the sort of production helped the profit by SEK 30 million, which I appreciate. Could you please explain how that works, since the inventory build was quite significant. It was I think at [ SEK 1.3 billion ] or so quarter-by-quarter and last year it was maybe half of that level. So is there less finished goods, or could you please help me to understand that?
I'll try. And I mean what your consider in the -- let's say, the inventory contribution in the bridge is the sequential basis, because obviously the increase from last year that has been happening gradually during the 12 months, let's say. But if you take the sequential increase, and we always have a seasonality in Q1, because we have, for example, in automotive, plant shutdowns over Christmas and so, and then they are ramping up again. So if you take the Q1 sequential inventory this last year and you take the same this year, we have been slightly more, not much, slightly more finished goods inventories this year and that's what I'm saying corresponds to SEK 30 million profit contribution in the bridge from inventories. Then, obviously, we have contributions from the overall, the sold volumes in production as well. But the inventory build, which you usually ask for, is SEK 30 million.
Now we take our next question from the queue, Markus Almerud from Kepler Cheuvreux.
My first question is on pricing. So I know it's difficult to quantify, but if you set kind of the beginning when you raised prices last year to distributors and you look at your entire customer base, how far in are you? Are you 70% in, so 70% of your customers have since -- have been impacted by price increases, if you could help us a little bit on that. And then I just want ask about potential bottlenecks in the supply chain. You talked about last quarter that you had most of the bottlenecks behind you. Is that unchanged or have you encountered new bottlenecks in supply chain?
Yes, on the pricing, you started on distribution. And, I mean, obviously we have implemented price increases in distribution, which means that, that has impacted the total chain of distribution network. I mean, I cannot quantify the percentage on the OEM that has implemented price changes in the contracts. But I mean -- again, we are pushing on this, we are on the ball. I think you clearly recognize that this is happening, [indiscernible] it's had a slow steady -- because our ambitions has been higher last year, quarter-by-quarter. Now we have a somewhat bigger step in the first quarter and we expect to continue to have a clear positive bridge effect from price mix also in the second quarter. So that's what I can give you on this. You had a second question also, or no?
Yes.
Yes, bottleneck. So I mean, what we have and you refer eventually to the extra costs that we have. Imagine, when you run on higher utilization, both in our factories and in the supply chain with suppliers, you have to take costs for rush transports, because simply you don't get what you need in your plants on time and you take this extra cost in this type of markets in order to serve the customers. I mean that's what you do, and that's natural that it comes on extra. And there could be bottlenecks on transports also and you have to take another route or you have to fly things and so on. So this happens. And also in the plants as such, you have to take on sometimes an extra shift, night shift, more expensive and so on. So this is nothing strange at this part of the business cycle.
Now we take our next question from the queue, Andre Kukhnin from Credit Suisse.
I will start on the outlook. You guided for higher year-on-year, which I think in your definition is the range of 4% to 8% growth. You've just done 7.5% in Q1 against a negative days effect, which is at least -- well a couple points of growth, maybe 1.5 points. So just wanted to check that firstly, your outlook is still on an all-in basis, so it's not days adjusted, and if it is then what is behind that sort of implied slower run rate even at the top of that guidance range of 8%. Compared to what you've just done in Q1, is there anything in there that you expect to grow at a slow pace or is it just conservatism?
Again, I mean, we don't -- we don't -- I mean it's a demand guideline we have, it's a demand guideline. Our organic sales include price mix. So back to that. Demand guideline, we take it as it is on the calendar. We don't do any kind of seasonal adjustments and day adjustments and so on. And what you said, at least when we calculate, 1 day in a quarter is below 1% -- oh sorry, 1 day in a quarter is slightly more than 1%. I don't know what I said there, but you're right.
Okay. So it's clear that the price mix could be making difference. Thank you. And just because you report now all in, can I double-check if there was anything in Q1 of a one-off nature, whether operational or not, whether positive or negative?
No. If you talk restructuring cost year-over-year, it's not in quarter 1.
Okay. And no revaluations of inventory or anything like that?
I mean, not that -- if you talk about whether our guidance and so -- is an underlying stable performance, I say yes to that. We don't have any special things in the quarter that makes it -- the performance that you see now unique.
Okay, great. It was just to double-check and obviously the move to all-in reporting is a move towards high quality.
Now we take our next question, James Moore from Redburn.
I have a couple of questions. I'll go one at a time if I could. Just on the price mix, you've always been quite clear in the last 40 years about that number, even in the last couple of years has been relatively clear. You seem to have abandon any transparency on it this quarter. Maybe I could try a little harder. Is it closer to [ 2 or 1 ] for the quarter? That's my first question.
As we said, we don't comment on the number.
Okay. And just secondly, to follow up on Andre's question, are you saying that adjusted EBIT how do you report is identical to reported EBIT, so the non-recurring item is 0 in the quarter?
No, sorry, I mean the bridge effect is 0, but you have -- in absolute terms, you have in the same range as you had last year, which were around SEK 60 million. Sorry, if I misunderstood the question. We have -- I mean, honestly, we have discussed this. We don't have bid programs, but certainly we shave up some costs, we are working on our footprint products, which have some restructuring costs. So you have that on a same level as -- roughly same level as we had last year.
Okay. And earlier, finally, on cost development. I think you mentioned SEK 250 million, excluding the raw material for the second quarter. Am I correct in saying that includes your Unite positive?
For second quarter, if you have a full year Unite effect, which still remains as we guided last quarter of [ plus SEK 100 million ] and we have positive [ SEK 65 million ] in the first, you don't have much of Unite in the second quarter. But yes, it includes -- the SEK 250 million includes Unite.
Maybe finally I could just -- another second final question. On China, could you help us with the pace of growth of China versus the rest of Asia-Pac? Is there big difference between the two?
China is doing -- is of course -- China is still the major economy in that regions. You can imagine, with that kind of growth figures, China is doing very well.
We take our next question from the queue, Ben Uglow from Morgan Stanley.
I guess this is a question for Christian. It's a big-picture question around how we should think about the cadence of your margins in any given year. When I look at the last 2 years, the first quarter margin has actually been the kind of high watermark for the year and obviously I think there are inventory and other effects in there. But when I go back further, I look all the way back to 2011, you've actually seen quite big step-ups between your first quarter and your second quarter margin and into the remainder of the year. I fully realize that there are some inventory, FX, all kinds of different things going on here. But in your mind, as the CFO, is there any normal seasonality or is there any normal pattern that we should think here in terms of margin?
So your question is, if seasonality has changed from previously in history and if we have a certain seasonal pattern on the margins. I mean, spontaneously -- I mean, obviously, volumes are somewhat different in the quarters, they are not 25%, even though you don't have a dramatic difference between the quarter, but that certainly to some extent impacts the margins. But there is nothing else in our business in terms of -- that you have segments that are buying more or less on a big picture that influences the margins in the quarter. So at least as far as -- I mean, obviously, it could have -- I mean the industrial-automotive mix could be different. But I mean I have to come back and look to that.
There is one -- this is Alrik here saying -- there is one thing that we have been working diligently with, if you know, that this is try to avoid the pre-buys in the end of the years. Previously many distributors were buying to reach a bonus in the end of the year, et cetera, and we have diligently, during the last 3 years, worked to get over to COGS, meaning they are getting whatever incentives from SKF, based on what they sell with a transparency as opposed to what they buy. So we don't get these industrial dynamics that we used to have, you remember. That is a change.
And then just one final question. Just on the price increases, and I realize that you're looking at lots of different moving parts. Geographically, where did you see the strongest reception and where has it been toughest?
It's interesting. This is not a geographical thing actually. It's interesting to see that some parts of the bearing market is not global, meaning you are more -- it's more difficult to sell the bearings, because of their size or whatever, outside of your region, but basically the bearing market is global. So there is actually a global trend and here in a situation like we are right now, I think there is pricing opportunity everywhere, but of course there will be certain segments where you as a company you are stronger and in other segments where there is more a contested market, there are customers where you more differentiated in than in others. And this is like it's always been. And I think that this is what I've been trying to tell that it's like it's always been, it's not a new dynamic now than it used to be before.
Now we take our next question from the queue, Markus Mittermaier from UBS.
Two questions from my side please. One, let me ask the OEM contract question in a different way, if I may. So if you look at the last 4 quarters in aggregate over that, is it 20%. 80%, 50% of contracts that has been renewed at the new price level, so where would you put that number roughly? And then secondly on inventory, I'm slightly confused. I think if we go back to the discussion 3 months ago last quarter, the estimate was SEK 300 million finished goods build in the quarter. So it sounds like now of the [ 1.3 ] that we bid overall, maybe sort of like a smaller than the SEK 300 million figure was in finished goods. But what happened in the quarter, just in terms of the incremental inventory build there and what does that tell us for, I think momentum demand into Q2, right, because I understand you are no longer giving sequential guidance, but I'm just trying to understand the relative moves within inventory a bit better here.
If we start with the pricing question. I just can tell you, there is pricing power in the marketplace and we are exercising our ability to compensate costs and improve our margins. And the kind of details, how many contracts or whatever, it is not relevant for me to even speak about that. The truth is -- but you rest assured that there is a positive dynamics in the marketplace and there is pricing power.
If I try -- come back to your inventory question. I mean, if you look in the balance sheet, then [ know ] what happens to the currency situation, as we have talked about. You have a lot of currency in the balance sheet with the weaker Swedish krona. So it's a lot of currency in the overall. Then if you look at the cost of and that there is, we used to talk about 2 things. The manufacturing stock or the channel stock, which includes raw material, it includes components and so on, and it includes work in progress and so on in the factories, and then you have finished goods inventories. And you're absolutely right, I mean, when you talk about the EBIT effect, the value add that you get that you only get when -- on the finished goods side. You don't have any value add by having steel bars in your inventories. So what we guided for in the previous quarter was that we expected the finished goods to increase with SEK 300 million and what I'm saying now is that it has increased slightly more and it was SEK 300 million last year as well. So we said that we will build -- in the guidance, we said we will build the same amount this year as last year. Now it will be slightly more, slightly more [ is SEK 30 million ] in EBIT effect.
We take our next question from the queue, Andreas Koski from Deutsche Bank.
So I am a bit surprised to see the gross margin being unchanged year-over-year when you are able to increase your prices and you get support from your inventory build. I thought we should see higher gross margins coming through from higher prices. So just if you can explain why we are not seeing higher gross margins and also what to expect going forward.
I would say the main thing that -- change what you say, I mean I don't want to go into details, so that we have divestments as part of [indiscernible] the big thing that changed it, correcting thing that you -- assumptions you have is the currency effect. And we have had a -- if you look in our currency composition, it's a lot of transactional effect and the transactional effect is fully coming in to the gross profit. And then we have also negative effects from the translation effects. So I would say it is largely currency, but except for that, we are increasing our gross margins. So the positive effects from price mix, from manufacturing volumes is more than offsetting the cost increases that I have commented.
Yes, okay, so underlying gross margins are actually up?
Yes.
Yes, excluding currency impacts. And then secondly on the cost inflation, the general cost inflation. I think you have previously guided for some SEK 600 million per year. Should we now expect that to be closer to SEK 1 billion this year and next, or how to think about this more than next quarter?
No, I mean, I don't expect it to be SEK 1 billion and it's obviously -- i try to estimate, since we have used that language what is underlying cost inflation and what is extra cost to that, we run very high on the overall operations. So we should not expect it to be that high, but slightly higher. I mean, we had and we talked about that before, I believe, a slightly higher salary increase, for example, in the Central Europe and Germany that we had previous year. So some of this is -- it is some of an increase. So -- but I have to come back to that -- on the overall full year basis. I don't have an answer.
And then lastly, it sounds like you have built finished goods in constant currencies of around SEK 400 million during the quarter, implying that you have increased raw material inventories quite significantly. So I guess that will be turned into finished goods in the next couple of quarters. So what to expect in inventory built finished goods, constant currencies in Q2, Q3?
If you first conclusion on -- but, I mean, if your question is what will happen to our finished goods inventories in Q2, I mean we have, as you've seen in our demand guidance, we do have a high demand also. So things are going out as well. So we presently don't expect to build a lot a finished goods inventory in Q2. We don't expect that. So I would say relatively unchanged.
And in Q2 last your you built [ about SEK 400 million ]?
Correct.
And we'll take our next question [indiscernible].
I had a couple of questions. Starting off with the comments you made, Alrik, on the volumes in the quarter you are trying to hold back on attempts to pre-buy it. Could you say something around that?
No, I didn't say that. What I was trying to explain was, when you look at the seasonality going back, we used to have a phenomenal net cash prior to 2015, where to reach the end year sort of bonus schemes, many distributors bought a lot of their goods by the end of the year. That we have diligently changed during the last years and that is changing somewhat maybe the seasonality. As far distributors, we don't think that there is an excess inventory in the distributor network at this point.
Okay, great, thanks so much for clarifying that. Also I know you don't like to talk about the future, what you're going to achieve in the future, but rather what you have achieved in the past year. But could you say something about the prices for Q2? I hear from other distributors that there is a second price increase to distributors right now pending, can you confirm that?
yes.
Good. And that should with a typical delay -- [ OM ] contract should have an impact upon OEM contracts during the second half and or supposedly the first half of 2019, if you look at history, right?
Well, as you know, it's always a situation with all contracts that when they come due there is a discussion about what is the reasonable price level and right now, of course, it is the sellers market, and there is an opportunity to improve your price also going forward.
And also, talking a little bit about your manufacturing footprint, what you are doing right now, I mean you have earlier highlighted that also, you highlighted in your annual report on closing down facilities. How is that activity level doing right now, considering the strong demand? Is that on hold, or you're waiting for kind of slowdown maybe in volumes before you start to re-initiate those initiatives?
The initiatives are never on hold and they can of course never be publicized before they are actually about to happen. But there is a certain truth in what you're saying. As you are running, even if you want to -- you have a new setup and you want to change a line or a consolidated footprint, it is very difficult to do when you are at the same time struggling and working full-time to serve the marketplace. So you are right, there is a certain slowdown of course in our ability to do these projects currently.
And in addition to that, maybe the ones that you have seen in terms of press releases, a couple of plant closures and plant moves in the U.S., obviously they are communicated and they are implemented. Could be some quarter of delay and so on, due to the demand situation, but they are not stopped. And that's one of the reasons why we have still some restructuring cost in the quarter here related to these footprint changes.
Okay, got you. My final question, when you talk about prices, are you mainly referring to bearing or are you referring to your whole product --
Everything, of course, everything, everything. The reason is that there has been some doubts about this with your peers and we have been trying to tell you this is not correct. And I think now we are proving that our standpoint that there is a pricing power with SKF is true and I hope everybody puts this question behind them now and start believing us for real.
Thank you. Ladies and gentlemen, with that we conclude our question and answer session for today. I would like to hand the call back to Patrik Stenberg for any additional or closing remarks.
Thank you so much. Thank you for your questions. If you have any additional questions, you are more than happy to give me a call. And on the last slide in the back here, you will see some of the upcoming events, when we will be able to meet you in person and also through video conferences and so forth.
And I want thank you for attending today's conference. And it is a record quarter for SKF. We are performing well and I'm looking forward to continue to have a good dialog next quarter. Thank you very much.
Thank you. Ladies and gentlemen, with that we conclude today's SKF Q1 2018 results conference call . Thank you for your participation. You may now disconnect.