20-F 1 a5428183.htm AKTIEBOLAGET VOLVO 20-F a5428183.htm
As filed with the Securities and Exchange Commission on June 21, 2007

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549

FORM 20-F

o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
for the fiscal year ended December 31, 2006

OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR
o
SHELL COMPANY PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 0-12828
 
AKTIEBOLAGET VOLVO (publ)
(Exact name of Registrant as specified in its charter)
 
VOLVO CORPORATION
(Translation of Registrant's name into English)
 
Kingdom of Sweden
(Jurisdiction of incorporation or organization)
 
S-405 08
Göteborg, Sweden
(Address of principal executive offices)
 
Securities registered pursuant to Section 12(b) of the Act: None
 
Securities registered pursuant to Section 12(g) of the Act:

Title of class
Name of each exchange on which registered
Class B, common stock
quota value SEK 6,
American Depositary Shares
each representing one Share
of class B common stock
NASDAQ

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None

Indicate the number of outstanding shares of each of the issuer's classes of capital or common stock as of the close of the period covered by the annual report:
 
A shares
131,374,699
B shares
273,088,810

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
Yes x
No o

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
Yes o
No x
 

 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:
 
Yes x
No o
Not Applicable o


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer x
Accelerated Filer o
Non-Accelerated Filer o

Indicate by check mark which financial statement item the Registrant has elected to follow: 

Item 17 o
Item 18 x

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Yes o
No x
 

 
 
1

 
 
 
Unless otherwise indicated, all amounts herein are expressed in Swedish kronor (“krona”, “kronor” or “SEK”) or in United States dollars (“dollars” or “US$”). Merely for the convenience of the reader, this Annual Report presents translations into dollars of certain krona amounts. Unless otherwise stated, such translations have been made at the noon buying rate of dollars in terms of kronor in New York City for cable transfers as certified for customs purposes by the Federal Reserve Bank of New York (the “Noon Buying Rate”) on December 29, 2006, which was 6.8342 kronor per dollar (0.146 U.S. dollars per krona). The Noon Buying Rate on December 29, 2006 differs from certain of the actual rates used in the preparation of the consolidated financial statements of Volvo, which are expressed in kronor, and therefore, dollar amounts appearing herein may differ significantly from actual dollar amounts which were translated into kronor in the preparation of those consolidated financial statements in accordance with accounting principles generally accepted in Sweden. See “Item 3. Key Information - 3.A. Selected Financial Data”. No representation is made that krona amounts have been, could have been or could be converted into dollars at the Noon Buying Rate on December 29, 2006 or on any other date as of which a convenience translation based on the Noon Buying Rate was 6.8342 kronor per dollar (0.146 U.S. dollars per krona).
 
________________________________________________

As used herein, “Volvo”, the “Company” or the “Group” refers to Aktiebolaget Volvo and its consolidated subsidiaries and “AB Volvo” refers to Aktiebolaget Volvo, unless the context indicates otherwise. “Trucks” refers to the combined truck operations of the Volvo Group, consisting of the truck brands Mack, Renault Trucks and Volvo, which are individually referred to as “Mack Trucks”, “Renault Trucks” and “Volvo Trucks”, respectively.
 
________________________________________________
 
From January 1, 2005, AB Volvo prepared its consolidated financial statements in accordance with International Financial Reporting Standards as adopted by the European Union (“IFRS”). IFRS as adopted by the EU differ in certain respects from IFRS as issued by the International Accounting Standards Board (IASB). However, the consolidated financial statements for the periods presented would not be materially different had the Company applied IFRS as issued by the IASB. References to IFRS hereafter should be construed as references to IFRS as adopted by the EU. AB Volvo restated its financial statements from January 1, 2004 to IFRS. See Notes 1 and 3 to the consolidated financial statements. In addition, consolidated net income and stockholders’ equity are reported as reconciled to United States generally accepted accounting principles (“U.S. GAAP”). Unless otherwise indicated, all amounts and percentages presented herein are based on IFRS. IFRS as applied by the Company differs in certain significant respects from U.S. GAAP. For a discussion of the significant differences between IFRS and U.S. GAAP affecting AB Volvo’s consolidated financials statements and reconciliation to U.S. GAAP of consolidated stockholders’ equity and consolidated net income as of and for the years ended December 31, 2006, 2005 and 2004, see Note 38 to the consolidated financial statements.
 
________________________________________________

At times, this annual report presents financial and other information for a specific year that is immediately followed by an amount within (parentheses). This amount within (parentheses) represents the corresponding amount for the previous year.
 
________________________________________________
 
Volvo owns or otherwise has rights (as described under the section “Patents, Trademarks and Licenses” below) to a substantial number of trademarks that it uses in conjunction with its business, including, but not limited to, the following trademarks mentioned in this Annual Report: “Volvo”, “Volvo Penta”, “Renault”, “Mack”, “Duoprop” and “Aquamatic” (see “Item 4. Information on the Company  — 4.B Business Overview — Patents, Trademarks and Licenses”).
 
________________________________________________
 
Certain information presented in this annual report on Form 20-F relating to the markets in which Volvo operates, such as the size of the particular market and the market share of Volvo within such markets, has been obtained by Volvo from market research reports, analysts’ reports and other publicly available information, as well as from internally developed market data. While Volvo has no reason to believe that third-party sourced information is not reliable, such information has not been independently verified. Accordingly, the accuracy or completeness of this information cannot be guaranteed.
3

 
 
This Annual Report on Form 20-F includes “forward-looking statements” within the meaning of Section 27A of the U.S. Securities Act of 1933, as amended, and Section 21E of the U.S. Securities Exchange Act of 1934, as amended. Certain statements included in this Annual Report, including without limitations, those concerning (i) Volvo’s strategies, (ii) the economic outlook for the commercial transport equipment industries, (iii) expectations regarding prices, (iv) the development and commercial introduction of new products, (v) the quantitative and qualitative disclosures about market risk and (vi) Volvo’s liquidity and capital resources and expenditures, contain certain forward-looking statements concerning the Company’s operations, economic performance and financial condition. These statements can often be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “are expected to”, “will”, “will continue”, “should”, “seeks”, or “anticipates”. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurance can be given that such expectations will prove to have been correct. Accordingly, results could differ materially from those set out in the forward-looking statements as a result of, among other factors, (i) changes in economic, market and competitive conditions, (ii) success of business and operating initiatives, (iii) changes in the regulatory environment and other government actions, (iv) fluctuations in exchange rates and (v) risks inherent in business management.
 
Certain of these factors are discussed in more detail elsewhere in this annual report, including under “Item 3.D-Risk Factors” and “Item 5-Operating and Financial Review and Prospects”. Volvo undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law or stock exchange regulation. It is not possible to foresee or identify all factors that could cause future results to differ from expected or historic results. Therefore, investors should not consider the foregoing factors to be an exhaustive statement of all risks, uncertainties or factors that could potentially cause actual results to differ from projections in this annual report.
4

 
 
Not applicable.

 
Not applicable.

 
 
The IFRS selected financial data set forth below as at and for each of the years ended December 31, 2004, 2005 and 2006 has been derived from the consolidated IFRS financial statements of Volvo. See “Item 18 - Financial Statements”. The US GAAP selected financial data set forth below as at and for the years ended December 31, 2002, 2003, 2004, 2005 and 2006 has been derived from the consolidated IFRS financial statements of Volvo. See Item 8 - Financial Statements.
 
This selected financial data should be read in conjunction with, and is qualified in its entirety by reference to, the consolidated financial statements and notes thereto included in Item 18 of this annual report.
 
AMOUNTS IN ACCORDANCE WITH IFRS FROM 2004 1
(In millions, except per share amounts)
   
20043
 
2005
 
2006
 
20064
 
   
SEK
 
SEK
 
SEK
 
USD
 
Net sales
   
211,076
   
240,559
   
258,835
   
37,873
 
                           
Net sales from continuing operations
   
211,076
   
240,559
   
258,835
   
37,873
 
                           
Operating income
   
14,679
   
18,153
   
20,399
   
2,985
 
                           
Net income
   
9,907
   
13,108
   
16,318
   
2,388
 
                           
                           
                           
Net income per share5
   
23.58
   
32.22
   
40,20
   
5.88
 
Diluted income per share
   
23.55
   
32.16
   
40,17
   
5.88
 
                           
                           
                           
Cash dividends per share 6
   
12.50
   
16.75
   
25.00
   
3.66
 
                           
Total assets
   
223,968
   
257,207
   
258,427
   
37,814
 
Shareholders’ equity
   
70,155
   
78,760
   
87,188
   
12,758
 
                           
Share capital
   
2,649
   
2,554
   
2,554
   
374
 
Weighted average number of shares. (in thousands)7
   
418,528
   
405,242
   
404,663
   
404,663
 
                           
 
5

 
AMOUNTS IN ACCORDANCE WITH US GAAP
   
2004
 
2005
 
2006
 
20064
 
   
SEK
 
SEK
 
SEK
 
USD
 
Operating income (loss)
   
19,010
   
16,051
   
20,791
   
3,042
 
                           
Net income (loss)
   
14,416
   
11,398
   
14,309
   
2,094
 
Basic net income  per share 5
   
34.44
   
28.12
   
35.36
   
5.17
 
Diluted net income per share 5
   
34.40
   
28.08
   
35.35
   
5,17
 
                           
                           
Shareholders’ equity
   
73,079
   
79,478
   
84,858
   
12,417
 
 
     
20022
   
2003
 
     
SEK
   
SEK
 
Net sales
    186,198     183,291  
Operating income (loss)
    (5,171 )   5,275  
               
Net income (loss)
    (6,265 )   3,979  
               
Income (loss) from continuing operations
    (6,265 )   3,979  
               
Basic net income (loss) per share 8
    (14.94 )   9.49  
Diluted net income (loss) per share 8
    (14.94 )   9.48  
Income per share from discontinued operations 8
    -     -  
Income (loss) per share from continuing operations 8
    (14.94 )   9.49  
               
Total assets
    232,126     232,180  
               
Shareholders’ equity
    71,182     74,790  
Share capital
    2,649     2,649  
Weighted average number of shares. (in thousands)7
    419,445     419,445  
Cash dividends per share 6
    8.00     8.00  
 
1
The consolidated financial statements of Volvo are prepared in accordance with IFRS, during 2004, 2005 and 2006. IFRS differs in certain respects from generally accepted accounting principles in the United States (US GAAP). See Notes 3 and 38 to the consolidated financial statements.
   
2
Net income (loss) in 2002 in accordance with US GAAP included value adjustments amounting to SEK 9,683 million pertaining to Volvo’s shareholdings in Scania AB, Deutz AB and Henlys Group plc. If a security’s quoted market price has been below the carrying value for an extended period of time, US GAAP includes a presumption that the decline is other than temporary. Under such circumstances, US GAAP requires that a value adjustment must be recorded in net income with a corresponding credit to Other comprehensive income.
   
3
In 2004, operating income from continuing operations under IFRS included a write-down of shares in Henlys Group plc amounting to SEK 95 million and a positive revaluation of shares in Scania AB amounting to SEK 915 million. In accordance with US GAAP earlier recorded value adjustments have been reversed amounting to net, positive, SEK 5.157 million.
   
4
Translated for convenience at US$ 1 = SEK 6.8342, the Noon Buying Rate on December 30, 2006. Such translations should not be construed as representations that the SEK amounts represent, or have been or could be converted into, United States dollars at that or any other rate.
   
5
Net income (loss) per share is calculated as net income divided by the weighted average number of shares outstanding during the year. The weighted average number of shares outstanding during 2006 was 404,663,051.
 
6

 
6
 
Cash dividends are those declared out of the unrestricted equity of the parent company as recommended by the Board of Directors and approved by the Annual General Meeting of Shareholders held in the spring of the following year. At the Annual General Meeting of AB Volvo held on April 4 2007, the Board's proposal to pay a dividend to the shareholders of SEK 25.00 per share was approved.
 
 
7
The weighted average number of shares outstanding during 2002 and 2003 was 419,444,842.
   
 
On June 17, 2004, the Board of AB Volvo decided to acquire, through purchase on the Stockholm Stock Exchange, a maximum of 22,076,045 Series A and/or B shares, not exceeding a total purchase amount of SEK 4,300 million. By year-end 2004, a total of 9,315,000 Volvo A and B shares were repurchased equivalent to SEK 2,532 million. The total number of shares held by Volvo as treasury stock at year-end was 31,391,043 or 7.1% of the registered shares whereof Series A shares 7,075,246 and Series B shares 24,315,797. The weighted average number of shares outstanding during 2004 was 418,528,773. During 2005, a total of 5,730,000 Volvo shares were repurchased. Total share capital by year end 2004 amounted to SEK 2,649 million and was based on 441,520,885 registered shares.
   
 
During 2005 the share capital was reduced by SEK 95 million through cancellation without repayment of 3,084,619 Series A shares and 12,752,222 Series B shares. After reduction the share capital amounts to SEK 2,554 million and is based on 425,684,044 registered shares. The total number of registered shares by year end 2005 amounted to 425,684,044. Volvo held 5% of the registered shares at year end 2005, 21,220,535 shares whereof Series A shares 4,145,627 and Series B shares 17,074,908. The total number of outstanding Volvo shares by year end 2005 amounted to 404,463,509 whereof Series A shares 131,374,699 and Series B shares 273,088,810. The average number of outstanding shares was 405,242,037 in 2005.
   
 
The total number of registered shares by year end 2006 amounted to 425,684,044. Volvo held 4.9% of the registered shares at year end 2006, 20,885,454 shares whereof Series A shares 4,145,627 and Series B shares 16,739,827. The total number of outstanding Volvo shares by year end 2006 amounted to 404,798,590 whereof Series A shares 131,374,699 and Series B shares 273,423,891. The average number of outstanding shares was 404,663,051 in 2006.
   
8
 
U.S. GAAP basic and diluted net income (loss) per share is calculated as net income (loss) determined in accordance with U.S. GAAP divided by the weighted average number of shares outstanding during the year. Diluting securities during the period have impacted the average numbers of shares with 11 thousand, 117 thousand, 494 thousand, 625 thousand and 315 thousand for the respective year 2002, 2003, 2004, 2005 and 2006.
 
Exchange Rates
 
Fluctuations in the exchange rate between the krona and the dollar will affect the dollar equivalent of the krona price of the B Shares traded on the Stockholm Stock Exchange and, as a result, should affect the price of the American Depositary Shares in the United States. Such fluctuations will also affect the dollar amounts received by holders of American Depositary Shares on conversion by the depositary of cash dividends paid in kronor on the B Shares represented by the American Depositary Shares.
 
Since a substantial portion of the Company’s sales are sales outside Sweden (93% in 2004, 94% in 2005 and 95% in 2006), earnings are materially affected by movements in the exchange rate between the krona and the currencies in which such sales are invoiced. See “ Item 5. Operating and Financial Review and Prospects - 5.A Operating Results - General Impact of Currency Fluctuations.”
 
The following table sets forth certain information with respect to the Noon Buying Rate for cable transfers in SEK as certified for customs purpose by the Federal Reserve Bank of New York for the years shown:
 
7


Year
 
Average1
 
High
 
Low
 
2001
   
10.4328
   
11.0270
   
9.3250
 
2002
   
9.6571
   
10.7290
   
8.6950
 
2003
   
8.0351
   
8.7920
   
7.1950
 
2004
   
7.3320
   
7.7725
   
6.5939
 
2005
   
7.5170
   
8.2434
   
6.7312
 
2006
   
7.3098
   
7.9656
   
6.7674
 
                     
December 2006
   
-
   
6.9204
   
6.7674
 
January 2007
   
-
   
7.0829
   
6.7818
 
February 2007
   
-
   
7.0839
   
6.9436
 
March 2007
   
-
   
7.1060
   
6.9622
 
April 2007
   
-
   
7.0057
   
6.6975
 
May 2007
   
-
   
6.9376
   
6.7093
 
_________
1
The average of the Noon Buying Rates on the last day of each month during the year.
 
The noon buying rate on June 8, 2007 was 6.9992.

Credit ratings
 
The following rating agencies confirmed their credit ratings on AB Volvo (publ) in 2006: Moody's Investors Service confirmed its global long term A3 rating (stable outlook) and its global short term P-2 rating. Standard & Poor's International Ratings confirmed its global short term A2 rating; Dominion Bond Rating Services confirmed its short term R-1 (low) rating for Volvo’s short term borrowing in the Canadian market, and its unsolicited long term rating A (low) (stable outlook) and Rating and Investment Information, Inc. upgraded its long-term rating to AA- in the Japanese market. Volvo Treasury AB is assigned a K-1 rating by Standard & Poor's for short-term borrowing in Sweden.
 
Inflation
 
The effects of inflation on the Group’s operations have not been significant in recent years.
 
 
Not applicable.

 
Not applicable.

 
All business operations involve risk - managed risk-taking is a condition of maintaining a sustained favorable profitability. Risk may be due to events in the world and can effect a given industry or market. Risk can be specific to a single company. At Volvo we work daily to identify, measure and manage risk - in some cases we can influence the likelihood that a risk-related event will occur. In cases in which such events are beyond our control, we strive to minimize the consequences.
 
We have chosen to classify the risks to which the Volvo Group is exposed into three main categories: External-related risk, Financial risk and Operational risk.
 
8

EXTERNAL-RELATED RISK
 
The commercial vehicles industry is cyclical. Historically, the Volvo Group’s markets have undergone significant changes in demand as the general economic environment has fluctuated. Investments in infrastructure, major industrial projects, mining and housing construction all impact the Group’s operations, since its products are central to these sectors. Economic trends in Europe and North America are particularly important for the Volvo Group, since a significant portion of the Group’s net sales are generated in these markets.
 
The cyclical demand for the Group’s products has, at times, restricted, and may in the future temporarily restrict, the ability of the Volvo Group to manufacture and deliver orders in a timely manner. A prolonged delay in the Group’s ability to deliver ordered products on a timely basis at a time when its competitors are not experiencing the same difficulty could adversely affect the Group’s market shares.
 
To cope with the peaks and troughs in demand, we need to act appropriately in the various stages of the business cycle. This involves adjusting production capacity and operating expenses. See “Item 5. Operating and Financial Review and Prospects ¾ 5.A. Operating Results.”
 
There can be no assurances as to the future performance of the commercial vehicles industry or the timing or severity of changes in economic conditions affecting the commercial vehicles industry.
 
Competition is intense among manufacturers of commercial vehicles and engines. Continued consolidation in the industry is expected to create fewer but stronger competitors. Volvo’s products face substantial competition, which may have a significant impact on the prices Volvo receives for its products and on the Group’s future sales volume. Our major competitors are DaimlerChrysler, Paccar, Navistar, MAN, Scania, Caterpillar, Komatsu, Cummins and Brunswick. In recent years, new competitors have emerged in Asia, particularly in China. These new competitors are mainly active in their domestic markets, but are expected to increase their presence in other parts of the world.
 
Our brands are well-known and strong in many parts of the world. For the Volvo Group, it is important that all brands in the Group are developed and supported. Strong brands combined with an attractive product portfolio make it possible for Volvo to be competitive.
 
There can be no assurance that Volvo will be able to compete successfully in the future. See “Item 4. Information on the Company ¾ 4.B. Business Overview.”
 
Prices for commercial vehicles may change. The prices of commercial vehicles have, at times, changed considerably in certain markets over a short period. This instability is caused by several factors, such as short-term variations in demand, shortages of certain component products, uncertainty regarding underlying economic conditions, changes in import regulations, excess inventory and increased competition. Overcapacity within the industry can occur if there is an economic downturn in the Group’s major markets or worldwide, potentially leading to increased price pressure.
 
The financial result of the business depends on our ability to quickly react to changes in demand and particularly to adapt production levels, reduce production and operating expenses, and deliver competitive new products and services.
 
There can be no assurances that such price volatility will not continue or that price volatility will not begin in markets which to date have not experienced such volatility. Overcapacity within the industry will likely occur if there is an economic downturn in Volvo’s major markets or worldwide, leading, potentially, to further increased price pressure. Price volatility in certain markets could adversely affect the Group’s results of operations.
 
The commercial vehicles industry is subject to extensive government regulation. Regulations regarding exhaust emission levels, noise, safety and levels of pollutants from production plants are extensive within the industry. These regulations are subject to change, often making them more restrictive. The costs to comply with these regulations can be significant for the commercial vehicles industry.
 
Most of the regulatory challenges regarding our products relate to reduced engine emissions. The Volvo Group is a significant player in the commercial vehicle industry and the world’s largest producer of heavy-duty diesel engines. The product development capacity within the Volvo Group is well consolidated to be able to focus resources for research and development to meet tougher emission regulations. Future product regulations are well known, provided that they are not changed and the product development strategy is well tuned to the introduction of new regulations. The new regulations regarding product emissions are stringent, but our current assessment is that they are manageable for the Volvo Group.
9

Volvo has had production facilities in numerous countries worldwide for many years. A worldwide production standard for environmental performance has been introduced by Volvo, enabling production plants to achieve best industry standard.
 
FINANCIAL RISK
 
In its operations, the Volvo Group is exposed to various types of financial risks. Groupwide policies, which are updated and decided upon annually, form the basis of each Group company’s management of these risks. The objectives of the Group’s policies for management of financial risks are to optimize the Group’s capital costs by utilizing economies of scale, to minimize negative effects on income as a result of changes in currency or interest rates, to optimize risk exposure and to clarify areas of responsibility within the Group’s finance and treasury activities. Monitoring and control that established policies are adhered to is conducted continuously centrally and at each Group company. Most of the Volvo Group’s financial transactions are carried out through Volvo’s in-house bank, Volvo Treasury, which conducts its operations within established risk mandates and limits. Credit risks are mainly managed by the different business areas.
 
The nature of the various financial risks and objectives and policies for the management of these risks is described in detail in “Item 18 - Financial Statements - Notes 36 and 37”. Volvo’s accounting policies for financial instruments are described in “Item 18 - Financial Statements - Note 1”. Various aspects of financial risk are described separately in the following paragraphs.
 
Currency-related risk. Approximately 90% of the net sales of the Volvo Group are in countries other than Sweden. Changes in exchange rates have a direct impact on the Volvo Group’s operating income, balance sheet and cash flow, as well as an indirect impact on Volvo’s competitiveness, which over time affects the Group’s earnings. Currency-associated risk as applied to Volvo’s business operations relates to changes in the value of contracted and expected future payment flows (commercial currency exposure), changes in the value of loans and investments (financial currency exposure) and changes in the value of assets and liabilities of foreign subsidiaries (currency exposure of shareholders’ equity). In addition, currency movements can affect Volvo’s pricing of products sold and materials purchased in foreign currencies as well as those of its competitors, which may be affected differently by such movements. Since Volvo has substantial manufacturing operations in Sweden and generates a substantial portion of its revenues in currencies other than the Swedish krona, Volvo’s earnings in Swedish kronor could be adversely affected short-term by an appreciation of the Swedish krona against other currencies. There can be no assurances that exchange rate fluctuations will not adversely affect the Group’s results of operations, cash flow, financial condition or relative price competitiveness in the future.
 
The objective of the Volvo Group’s currency risk management is to minimize the short-term negative effects of exchange-rate fluctuations on the Group’s earnings and financial position. The Volvo Group employs forward contracts and currency options to hedge the value of future payment flows in foreign currencies. As with all hedging instruments, there are risks associated with the use of foreign currency forward exchange contracts, as well as interest rate swap agreements. While providing protection from certain fluctuations in currency exchanges and interest rates, by utilizing such hedging instruments Volvo potentially foregoes benefits that might result from such fluctuations in currency exchange and interest rates. Volvo has entered into, and expects to continue to enter into, such hedging arrangements with counterparties that are carefully selected and approved primarily on the basis of general creditworthiness. However, any default by such counterparties might have an adverse effect on Volvo.
 
See “Item 11 Quantitative and Qualitative Disclosures about Market Risk” and “Item 18 - Financial Statements - Note 36”.
 
Interest-related risk. Interest-related risk include risks that changes in interest rates will impact the Group’s income and cash flow (cash flow risks) or the fair value of financial assets and liabilities (price risks). Interest-rate risk can be minimized through “matching” of the fixed interest terms of financial assets and liabilities. Interest rate swaps are used to adjust the fixed interest terms of the Group’s financial assets and liabilities. Currency rate swaps make it possible to loan from different markets in foreign currencies without assuming currency-associated risk. Volvo also holds standardized futures and forward rate agreements. The majority of these contracts are used to ensure interest rate levels for short-term loaning or investment.
10

 
Market risk from investments in shares or similar instruments. The Volvo Group is indirectly exposed to market risks from shares and other similar instruments as a result of managed capital transferred to independent pension plans being partly invested in instruments of these types.
 
Credit-related risk. Volvo’s extension of credit is governed by Group-wide policies and rules for classifying customers. Efforts are made to ensure that the credit portfolio is reasonably diversified among different customer categories and industries. Credit-associated risk is managed by actively monitoring credit, routines for follow-up and in certain cases repossession of materials. Additionally, continuous and necessary reserves are monitored in cases involving uncertain receivables. An important part of the Group's credit risk is related to how the financial assets of the Group have been placed. The majority are placed in Swedish Goverment bonds and interest-bearing bonds issued by real estate financial institutions.
 
Liquidity risk. Volvo ensures its financial preparedness by always maintaining a certain portion of revenues in liquid assets. A healthy balance between short-and long-term borrowing and access to credit in the form of credit facilities is used to hedge long-term financial needs.
 
OPERATIONAL RISK
 
The Volvo Group’s profitability depends on successful new products. The Volvo Group’s long-term profitability depends on the Company’s ability to successfully launch and market its new products. Product life cycles continue to shorten, putting increased focus on the success of the Group’s product development. It is highly important to meet and exceed customer expectations to be competitive in established markets and to be able to expand into additional markets and/or product segments.
 
Many of our products take a long time to develop from initial idea to finished product. It is important to involve customers in the early stages of the development process to ensure the success of new products. It is just as important to be at the forefront in the research and development of new technologies that are important to the development of successful products.
 
As both Volvo and its competitors either have recently introduced or plan to introduce new products or updated versions of existing products, Volvo cannot predict the market shares its new products will achieve. An inability by Volvo to introduce new innovating products in a timely fashion or to meet customer demand would have an adverse effect on the Group’s results of operations.
 
The Volvo Group relies on suppliers. Volvo purchases raw materials, parts and components from numerous outside suppliers. A significant part of the Group’s requirements for raw materials and supplies is filled by single-source suppliers. The effects of delivery interruptions vary depending on the item or component. Certain items are standard throughout the industry, whereas others are internally developed and require unique tools that are time-consuming to replace. A supplier’s inability to deliver raw materials or supplies could have negative consequences for production at certain Volvo Group manufacturing sites.
 
The Volvo Group’s costs for raw materials and components can vary significantly over a business cycle. Cost variations may be caused by changes in world market prices for raw materials or by an inability of our suppliers to deliver raw materials or supplies. The companies in the Volvo Group and their suppliers work closely together to manage material flows by monitoring suppliers’ financial stability, quality-control systems and production flexibility. However, there can be no assurances that it will not experience problems in the future. Unanticipated increases in the prices of raw material or components could also adversely affect the financial results of Volvo’s business.
 
Volvo Group is reliant on the proper protection and maintenance of its intangible assets. The Volvo Group’s products are primarily sold under the brand names “Volvo”, “Volvo Penta”, “Volvo Aero”, “Renault”, “Mack”, “Prévost” and “Nova Bus”. AB Volvo owns or otherwise has rights to a number of patents and brands that refer to the products the Company manufactures. These patents and brands, acquired over a number of years, have been valuable as the Volvo Group’s operations expanded and may continue to be valuable in the future. Volvo does not consider that any of the Group’s operations are heavily dependent on any single patent or group of patents. However, an inability to protect intellectual property would have an adverse effect on Group operations.
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Through Volvo Trademark Holding AB, AB Volvo and Volvo Car Coporation jointly own the brand "Volvo". AB Volvo has the exclusive right to use the "Volvo" name and trademark for its products and services. Similarly, Volvo Car Corporation has the exclusive right to use the name and trademark "Volvo" for its products and services. To protect these rights and avoid any weakening of the brand, AB Volvo and Volvo Car Corporation jointly introduced a control function to govern the use of the brand name and to prevent others from taking unfair advantage of it.
 
Similar control functions apply to the use of the “Mack” brand name, which is owned by AB Volvo. The Volvo Group’s rights to use the "Renault" brand are restricted to the truck industry only and are regulated by a license from Renault SA, which owns the “Renault” brand.
 
See “Item 4.B - Business Overview - Patents, Trademarks and Licenses”.
 
Complaints and legal actions by customers, employees, government agencies and other third parties. The Volvo Group could be the target of complaints and legal actions initiated by customers, employees, government agencies and other third parties alleging health, environmental, safety or business related issues, or failure to comply with applicable legislation and regulations. Even if such disputes were to be resolved successfully, without having adverse financial consequences, they could negatively impact the Group’s reputation and take up finance and management resources that could be used for other purposes. See “Item 8.A.7 - Litigation.”
 
Risk related to human capital. A decisive factor for the realization of the Volvo Group’s vision is our employees and their knowledge and competence. Future development depends on the company’s ability to maintain its position as an attractive employer. To this end, we strive for a work environment in which energy, passion and respect for the individual are guiding principles.
 
Volvo’s Financial Services business area conducts business under highly competitive conditions in an industry with inherent risks. Financing for users of Volvo’s products is available through a variety of competitive sources, principally commercial banks and finance and leasing companies. Volvo Financial Services emphasizes prompt and responsive service to meet customer requirements and offers various financing plans designed to increase the opportunity for sales of its products and to generate financing income for the Group. The financial services offered involve risks relating to residual value, credit risk and cost of capital. Competition for customers and/or these risks may affect the Group’s results of operations in the future.
 
Other factors. Volvo continuously reviews its manufacturing and administrative processes with the aim of ensuring that Volvo products and operations meet applicable legal and other regulatory requirements. Volvo does also have insurance coverage in certain areas, for example product liability, business interruption and property.
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AB Volvo is an international transport equipment group with a worldwide marketing organization and production. AB Volvo, which was incorporated in 1915 under the laws of Sweden, started production of cars in 1927 and of trucks in 1928. Historically Volvo has operated in two main areas: cars and vehicles for commercial use. The latter includes trucks, buses, construction equipment and marine and industrial engines. Operations also include production and maintenance of aircraft engines and financial services. In March 1999, Volvo sold Volvo Cars to Ford Motor Company. As a result of this sale, Volvo is today focused entirely on the commercial transport products segment. Through the acquisition of Mack Trucks Inc. and Renault V.I. in 2001, the Volvo Group strengthened its position as a producer of heavy trucks.
 
Headquartered in Göteborg, Sweden, the Volvo Group had 83,187 employees at December 31, 2006. With 47% of sales in Western Europe, 6% in Eastern Europe, 29% in North America, 5% in South America and 8% in Asia, the Group operates in an international environment with production and assembly carried out on six continents. Its shares are traded on the Stockholm Stock Exchange in Sweden and in the United States its American Depositary Shares are traded on the Nasdaq National Market (“NASDAQ”).
 
Volvo’s brand name is strongly identified with quality, safety and concern for the environment. The Group’s position in the fields of vehicle safety and quality is being consolidated through continuing improvements and technical innovations. In the environmental area, Volvo is intensifying its efforts to reduce the negative impact on the environment throughout the entire life cycle of its products.
 
AB Volvo is domiciled in Göteborg, Sweden. The address and telephone number of AB Volvo is S-405 08, Göteborg, Sweden, +46 31 660000.
 
Significant events in 2006 and 2007
 
AB Volvo acquired Nissan Diesel. In March 2006, Volvo became a major shareholder in the Japanese truck manufacturer Nissan Diesel through an acquisition of 40 million shares, corresponding to 13% of the votes and capital. In September of the same year, Volvo increased its ownership to 58.2 million shares corresponding to 19% of votes and capital. At the same time, Volvo purchased all 57.5 million preference shares in the company that through 2014 could be converted in stages into common shares and which in 2014, after full conversion, could provide Volvo with 46.5% of the votes and capital in the company, after full dilution.
 
On February 20, 2007, Volvo made a public offer to acquire the remaining outstanding shares in Nissan Diesel.
 
The offer was open through March 23 and was not conditional upon a lowest level of acceptance. When the acceptance period for Volvo’s offer for Nissan Diesel expired on March 23, Volvo had received a total of roughly 96 % of the shares outstanding.. A process is now being initiated to redeem the remaining shares outstanding.
 
Completion of the transaction requires the approval of the anti-trust authorities in the US and South Africa and Volvo has received approval from the US authorities. On May 16, Volvo received approval from the anti-trust authorities in South Africa.
 
Nissan Diesel will be consolidated in the balance sheet of the Volvo Group as of the first quarter of 2007. Sales and earnings will be reported from the beginning of the second quarter. Operations within Nissan Diesel will be reported within the Trucks segment.
 
In 2005, Nissan Diesel sold approximately 42,000 trucks and buses. In Japan, Nissan Diesel holds a market share of about 24% in heavy trucks and 15% in the medium-heavy segment. Sales in 2005 amounted to about SEK 32.5 billion. The company has 8,900 employees.
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The acquisition strengthens the Volvo Group's Asian strategy and is intended to provide the Group with access to Nissan Diesel's dealer and service network in Japan and Southeast Asia, and create a further industrial cooperation with Nissan Diesel in such areas as engines and transmissions.
 
The study of coordination possibilities carried out jointly by Volvo and Nissan Diesel identified synergies over five years of about EUR 200 M annually, slightly more than SEK 1.8 billion. The major portion of the integration gains is as a result of increased purchasing volumes, but positive effects also arise within product development, engines and drivelines. Other gains arise in that the companies have access to each other’s dealer and service networks, primarily in Asia but also in other parts of the world.
 
The effect of the acquisition on the Volvo Group cash and cash equivalents amounts to SEK -11.5 billion, whereof SEK -6.0 billion is related to the first quarter 2007 and SEK -5.5 billion relates to the holdings previously reported as shares in an associate company. Volvo is currently reviewing the recognition of certain financial arrangements in Nissan Diesel. This review is estimated to be completed at year-end.
 
Agreement between Renault Trucks and the GAZ Group On June 19, 2006 Renault Trucks signed a framework agreement granting the GAZ Group of Russia the right to manufacture the Renault dCi 11 engine under license. The engines will be manufactured for the Russian market and the states of the CIS (Commonwealth of Independent States). GAZ Group is a Russian automotive group with operations that include the manufacturing of trucks, buses, construction equipment and cars, and the aim of the agreement is to use Renault Trucks’ engines in various GAZ Group vehicles. The agreement includes the purchase of certain manufacturing machinery and the possibility of using the tooling as well as training.
 
Volvo plans bus body cooperation in India In 2006, Volvo Bus Corporation and the Indian company Jaico Automobiles have reached an agreement to start a joint company in India for production of bus bodies based on Volvo Buses’ body technology. Volvo Buses will be the majority owner with a 70% stake in the new company, which plans to build a new plant with a capacity of 1,000 bus bodies per year. The bus bodies will primarily be used for Volvo buses and coaches in the Indian market, but the new company will also investigate possibilities to export buses to other Volvo markets. Jaico Automobiles is a company in the Azad Group, which carries out body building production in Bangalore and Jaipur.
 
Volvo Construction Equipment invests in China In 2006, Volvo Construction Equipment (Volvo CE) signed an agreement covering an equity investment of 70% in Shandong Lingong Construction Machinery Co, a Chinese manufacturer of wheel loaders. In January 2007, it was announced that all necessary regulatory approvals for the equity investment of 70% in Lingong were received and the acquisition closed in 2007. Volvo CE has invested RMB 328 million, corresponding to slightly more than SEK 300 million, in exchange for 70% of the equity in Lingong. China is the world’s largest market for wheel loaders. The total market in 2005 was approximately 110,000 units. Lingong is the fourth largest producer of wheel loaders in China with a comprehensive dealer network throughout the country. In addition to 16 different models of wheel loaders, Lingong also has a smaller range of backhoe loaders, road rollers and excavators. Lingong has around 1,800 employees and in 2005 posted sales of SEK 2 billion.
 
Strategic decision on closure of Volvo Aero's operations in Bromma In November 2006, it was announced that Volvo Aero had initiated codetermination negotiations with the trade unions relating to the closure of Volvo Aero Engine Services (VAES) in Bromma, Sweden, which conducts overhaul of large aircraft engines. In recent years, the volumes of the engines overhauled in Bromma, the JT8D and JT9D, have declined sharply. Among other actions, VAES has tried to offset the declining volumes through complementing operations with a third engine type, the PW4000, but volumes have not reached the levels required. The company has investigated other possibilities, but all attempts have failed.
 
VAES in Bromma employs 456 persons, 145 salaried employees and 311 skilled workers. In accordance with the strategic decision, the operations will be gradually phased out during 2007 and in the fourth quarter of 2006, costs amounting to SEK 258 M were recognized.
 
Annual General Meeting of AB Volvo At the Annual General Meeting of AB Volvo held on April 5, 2006, the Board's proposal to pay a dividend to shareholders of SEK 16.75 per share, a total of about SEK 6,775 M, was approved.
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Per-Olof Eriksson, Tom Hedelius, Leif Johansson, Louis Schweitzer and Finn Johnsson were re-elected members of the Board of AB Volvo and Ying Yeh, Philippe Klein and Peter Bijur were newly elected. Finn Johnsson was elected Board Chairman.
 
The Meeting resolved to establish a share-based incentive program during the second quarter of 2006 for senior executives in the Volvo Group. The program mainly involved that a maximum of 518,000 Series B shares in the Company could be allotted to a maximum of 240 senior executives, including members of the Group Executive Committee. The allotment shall depend on the degree of fulfillment of certain financial goals for the 2006 fiscal year, which been set by the Board. These financial goals were achieved and consequently, full allotment was made during the first quarter of 2007. For more information on share-based incentive programs see “Item 18 - Financial Statements - note 34.”
 
Volvo Board decided on new financial targets AB Volvo’s Board of Directors has decided to adopt new financial targets for the company. The decision is based on the Board’s assessment that Volvo today has a structurally higher profitability, stronger cash flow and a different risk profile. The Board focuses on three external financial targets covering growth, operating margin and capital structure.
 
The previous target for operating margin was 5-7% over a business cycle, including the operations within Volvo Financial Services. The new target for operating margin is more than 7% over a business cycle and includes all operations within the Group except Volvo Financial Services, which currently contributes approximately another 1 percentage point. The restricting ratio for net debt to equity has also been increased from 30% of shareholders' equity to 40% of shareholders' equity. With regard to the Group’s growth target, the Board has chosen to retain the target of an annual growth rate of at least 10%.
 
Recognition of deferred tax asset yields positive earnings effect AB Volvo has decided to recognize a deferred tax asset through effective reversal of a related valuation allowance for deferred tax receivables in the Mack Trucks Inc. subsidiary. The decision is based on the fact that Volvo assesses that the company has a long-term higher profitability. Reporting of the deferred tax asset reduced tax expenses in the income statement in the third quarter of 2006 by SEK 2,048 M. In accordance with prevailing accounting rules, Volvo is adjusting goodwill by SEK 1,712 M, which affects operating income adversely. The combined earnings effect for the third quarter of 2006 was a positive SEK 336 M. Under US GAAP this effect has reduced goodwill. See more in “Item 18 - Financial Statements - Note 38”.
 
Volvo Group premiered hybrid technology for heavy vehicles In the beginning of March 2006, Volvo Group presented a new, efficient hybrid solution for heavy vehicles. The Volvo Group’s hybrid concept provides maximum fuel-saving effects on routes with frequent braking and accelerations, for example, city bus traffic, city distribution, refuse collection and construction work. Calculations indicate that fuel savings can amount to 35% in these applications.
 
Volvo Trucks launched new models for the North American market In March 2006 Volvo Trucks announced a broadening of its product program on the North American truck market with the launch of two models with new cab variants for the prestige segment, the Volvo VT830 and Volvo VN730. Both models are intended primarily for owner operators. The launched cab models offer the same interior roominess, and the lower roof provides better aerodynamics and correspondingly improved fuel economy for rigs with low trailers, such as tankers.
 
Volvo Trucks broadens its business with new, cleaner trucks for distribution Volvo Trucks is aiming to reach a broader clientele outside of the heavy, long-haul segment. In May 2006, Volvo Trucks presented two completely new distribution trucks - the Volvo FL and the Volvo FE. At the same time, a new business concept was introduced for distribution services in urban environments.
 
The Volvo FL and Volvo FE are cleaner, quieter and safer, which is important for distribution customers who operate primarily in urban areas. Both models meet the environmental requirements according to Euro 4 and Euro 5 emissions standards. The latter legal requirement does not take effect until 2009.
 
The Volvo FL and Volvo FE are intended for a wider category of customers who do not primarily have transport as their main line of business. For this reason, Volvo Trucks have developed an entirely new business concept that enables the customer to quickly and easily purchase a key-ready truck with a body, rear lift, and a number of support services, such as a service contract.
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Launch of new versions of Renault Midlum and Renault Premium Distribution Renault Trucks has launched new versions of the Renault Midlum and Renault Premium Distribution targeted for distribution applications. Among other features, the new vehicles are equipped with completely new cabs, chassis and drivelines.
 
Renault Trucks has placed heavy emphasis on reducing fuel consumption, and the new trucks are equipped with the new 5- and 7-liter (Renault Midlum) and 7- and 11-liter (Renault Premium Distribution) engines. The new generation of engines meets the Euro 4 emission standard that became effective October 1, 2006. Certain models are also prepared for the Euro 5 standard, which becomes effective in 2009.
 
World premiere for new Volvo 7700 city bus In June 2006, Volvo Buses premiered the new version of the Volvo 7700 city bus. The Volvo 7700 is available as a 12-meter bus for up to 95 passengers and as an 18-meter articulated bus with space for up to 150 passengers. An important feature is the shift from a 7-liter engine to Volvo’s new 9-liter engine, available in diesel and gas versions, that meets the Euro 4 emission standard. Due to Volvo choosing SCR (Selective Catalytic Reduction) technology, the company can already offer its customers an engine that also meets the proposed Euro 5 emission standard that does not become effective until 2009.
 
Mack Trucks launches new truck in construction segment Mack Trucks, Inc. is launching a new truck model in the construction segment, the TerraPro Cabover. Mack holds a leading position in the US as a supplier of trucks in this segment. The model is a further development of Mack’s popular MR series and is adapted specially for handling concrete pumping. The new model offers customers a new driver environment including an ergonomic seat, spacious driver cab, effective climate-control system, easily accessible instrument and control panel and substantial storage space. Major emphasis was placed on reducing noise levels and the vibrations that arise during work operations. TerraPro Cabover is equipped with an 11-liter MP7, available in the 325 to 405 hp classes, or the 13-liter MP8 engine, available in the 415 to 485 hp classes. Both engines are approved in accordance with EPA 07.
 
New wheel loader launched During the fourth quarter Volvo CE launched its largest wheel loader ever, the new L350F replacing the 330E model. The L350F is equipped with Volvos 16 liter engine and with its improved performance it is a very good bundle with the biggest haulers A35 and A40.
 
Dongfeng Motor Group, Nissan Motor and AB Volvo deepen discussions on possible future cooperation Following Volvo’s acquisition of shares in Nissan Diesel in March 2006 it was announced that AB Volvo, Nissan Motor and Dongfeng Group, intend, together with Chinese authorities to evaluate how to best develop Dongfeng Motor Co Ltd’s commercial vehicle business. Dongfeng Motor Co Ltd is jointly owned by Nissan Motor and Dongfeng Group.
 
In January 2007, it was announced that Dongfeng Motor Group Company Limited (DFG), Nissan Motor and AB Volvo are deepening discussions on a possible AB Volvo investment in the heavy and medium-duty commercial vehicle business currently operated by Dongfeng Motor Co, Ltd (DFL) - the Chinese joint venture between DFG and Nissan Motor.
 
Nissan Motor will focus its business on passenger cars and light commercial vehicles and has divested its holding in Nissan Diesel to AB Volvo. Subsequently, DFG, Nissan Motor and AB Volvo initiated discussions at the end of 2006 with the Chinese authorities on the future possible cooperation of the parties. DFG intends to establish more competitive alliances with Nissan and AB Volvo respectively, in order for all parties to achieve the best development in their specialized field.
 
To move forward on this issue, DFG, Nissan Motor, DFL and AB Volvo also have signed a non-binding framework agreement with the intention of AB Volvo to invest in the heavy and medium-duty commercial vehicle business and future engine business, while Nissan Motor remains committed to the long-term cooperation with DFG regarding passenger vehicles and the light commercial business. Any future definitive agreement regarding such a transaction will be subject to approval by Chinese authorities.
 
Renault Trucks in agreement with Nissan Motor regarding distribution of light trucks Renault Trucks announced in January 2007 that it had signed a distribution agreement covering the Renault Maxity light-duty vehicle with the manufacturer Nissan Motor. An agreement in principle had been signed in February 2006. Renault Maxity is a cab-over-engine light-duty vehicle developed and produced for Renault Trucks by Nissan Motor. Sales by Renault Trucks’ dealers began in March 2007. Renault Maxity complements Renault Trucks’ existing range of light trucks, comprising Renault Master and Renault Mascott, and is produced in a range of weight classes from 2.8 to 4.5 tons, with three engine alternatives.
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Renault Trucks launches new version of lightweight truck In January 2007, Renault Trucks announced the launch of a new version of Renault Mascott. The new Renault Mascott is equipped with a new gearbox, new driveshaft and new engine. Two engine alternatives are available, 130 hp or 150 hp, which meet the European Euro 4 emissions standard. In addition, the Renault Mascott features a new, effective brake system that provides the shortest braking distance in the lightweight truck segment. The Renault Mascott is one of Renault Trucks best sellers in its segment, with nearly 15,000 vehicles sold during 2006. Deliveries of the newest version are expected to start at mid-year 2007.
 
Volvo finalizes acquisition of Ingersoll Rand’s road development equipment division On April 30, 2007, Volvo concluded the acquisition of US based Ingersoll Rand’s road development equipment division, other than operations in India which followed on May 4. The division will be consolidated in the Volvo Group from May 1, 2007.
 
Ingersoll Rand’s operations in road development equipment comprise soil and asphalt compactors, asphalt pavers and milling machines as well as material handling equipment such as telescopic handlers and rough terrain forklifts. The purchase consideration for the assets amounts to about USD 1.3 billion, about SEK 8.8 billion.
 
Ingersoll Rand’s road development division - with production facilities in the US, Germany, India and China - has about 2,000 employees. Operations posted sales in 2006 of USD 864 million, about SEK 6.4 billion, with operating profit of USD 101 M, about SEK 745 million.
 
Decisions on several major investments The Volvo Group is investing a total of SEK 935 M in an assembly facility for trucks in Russia. The new facility will have a capacity of 10,000 Volvo trucks and 5,000 Renault trucks per year. The facility will be located in the city of Kaluga, approximately 200 kilometers southwest of Moscow, and is scheduled to be completed in 2009.
 
AB Volvo’s Board of Directors has decided to invest SEK 530 M in subsidiary Renault Trucks’ cab plant in Blainville, France. The investment is being made to increase capacity and comprises both assembly and painting. Renault Trucks’ cab plant in Blainville produces cabs for all of Renault Truck’s truck models.
 
Over the next three years, Volvo Construction Equipment (Volvo CE) will invest nearly SEK 1.1 billion in its Component Division in Eskilstuna, Sweden. The Component Division develops and manufactures power trains - i.e. axles and transmissions - for Volvo construction equipment.
 
Annual General Meeting of AB Volvo At the Annual General Meeting of AB Volvo held on April 4, 2007, the Board’s proposal was approved to pay an ordinary dividend to the shareholders of SEK 25.00 per share and a 6:1 share-split with automatic redemption, in which the sixth share is redeemed by AB Volvo for SEK 25.00 per share.
 
Peter Bijur, Per-Olof Eriksson, Tom Hedelius, Leif Johansson, Finn Johnsson, Philippe Klein, Louis Schweitzer and Ying Yeh were reelected members of the Board of AB Volvo and Lars Westerberg newly elected. Finn Johnsson was elected Board Chairman.
 
PricewaterhouseCoopers AB was elected as auditors for an additional three-year period.
 
The Board’s Chairman Finn Johnsson, Carl-Olof By, representing Svenska Handelsbanken and others, Lars Förberg, representing Violet Partners, Björn Lindh, representing SEB funds/Trygg Förs’kring and Thierry Moulonguet, representing Renault s.a.s. were elected as members of the Election Committee.
 
The Meeting resolved to establish a new share-based incentive program during the second quarter of 2007 for senior executives in the Volvo Group. The program mainly involves that a maximum of 2,590,000 Series B shares in the Company could be allotted to a maximum of 240 senior executives, including members of Group Management, during the first six months of 2008. The allotment shall depend on the degree of fulfillment of certain financial goals for the 2007 fiscal year and which are set by the Board. If these goals are fulfilled in their entirely and if the price of the Volvo B share at the time of allotment is SEK 114.80, the costs for the program will amount to about SEK 353 M. So that Volvo shall be able to meet its commitment in accordance with the program, with limited cash flow effect, the Meeting further resolved that Volvo may transfer own shares (treasury stock) to the participants in the program.
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Capital Expenditures
 
The following table sets forth the Group’s aggregate capital expenditures for property, plant and equipment, intangible assets and assets under operating leases, by principal business areas for each of the three years ended December 31:
 
   
2004
 
2005
 
2006
 
   
(In millions of SEK)
 
Capital expenditures
             
Trucks
   
5,030
   
7,190
   
6,260
 
Buses
   
176
   
250
   
263
 
Construction Equipment
   
1,158
   
906
   
1,580
 
Volvo Penta
   
297
   
243
   
248
 
Volvo Aero
   
801
   
904
   
843
 
Financial Services
   
4,784
   
386
   
999
 
Other and corporate capital expenditures
   
237
   
4,972
   
3.841
 
Group total
   
12,483
   
14,851
   
14,034
 

Investment projects were principally for plant and machinery for the production, design and development of commercial vehicles and machinery. The following table illustrates the geographic distribution of the capital expenditures:
 
   
2004
 
2005
 
2006
 
   
(In millions of SEK)
 
Sweden
   
3,690
   
5,935
   
3,970
 
Europe (excluding Sweden)
   
6,305
   
5,770
   
7,395
 
North America
   
1,835
   
2,451
   
1,851
 
Other countries
   
653
   
695
   
818
 
Group total
   
12,483
   
14,851
   
14,034
 

Capital expenditures for property, plant and equipment in 2006, amounted to SEK 6.3 billion (SEK 6.8 billion in 2005 and SEK, 5.8 billion in 2004). Capital expenditures in Trucks, which amounted to SEK 3.8 billion ( SEK 4.5 billion in 2005 and SEK 3.5 billion in 2004), were made in new top coat line for cabs in Umeå, Sweden, increasing the number of Volvo Truck centers (mainly in Europe), energy saving investments in the Macungie-plant in North America and development of production sites within Renault Trucks including the move from Villaverde to Bourg-en-Bresse. Trucks’ capital expenditures also included investments related to the new emission standards Euro4 and US’07, the final stage of the modification in the Hagerstown plant for engines and transmissions in North America and also investments related to new products. Capital expenditures increased in Construction Equipment from SEK 0.8 billion in 2005 and SEK 1.0 billion in 2004 to SEK 1.3 billion. The main part of the investments refers to capacity increases and a new generation of Excavators, the C-series. In Volvo Aero the level of capital expenditures increased from SEK 0.3 billion in 2005 and SEK 0.2 billion in 2004 to SEK 0.4 billion. Investments in Buses increased from SEK 0.1 billion in 2005 and 2004 to SEK 0.2 billion and increased in Volvo Penta from SEK 0.1 billion in 2005 and SEK 0.2 billion in 2004 to SEK 0.3 billion. Approved future capital expenditures amounting to SEK 6.8 billion (SEK 7.8 billion in 2005 and SEK 8.2 billion in 2004) relate mainly to investments for the next generation of trucks and engines.
 
Capital expenditures for intangible assets, mainly product and software development, amounted to SEK 3.1 billion (SEK 3.5 billion in 2005 and SEK 2.3 billion 2004). The capital expenditures were distributed among Trucks SEK 2.0 billion (SEK 2.4 billion in 2005 and SEK 1.2 billion in 2004), Buses SEK 0.2 billion (SEK 0.1 billion in 2005 and SEK 0.1 billion in 2004), Construction Equipment SEK 0.3 billion (SEK 0.2 billion in 2005 and SEK 0.1 billion in 2004) and Volvo Penta SEK 0.1 billion (SEK 0.1 billion in 2005 and SEK 0.1 billion in 2004) and Volvo Aero SEK 0.4 billion ( SEK 0.6 billion in 2005 and SEK 0.6 billion in 2004). A major part of those investments refers to entrance fees for phase two of the new GEnx engine in cooperation with General Electric.
 
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Capital expenditures for assets under operating leases amounted to SEK 4.6 billion (SEK 4.5 billion in 2005 and SEK 4.4 billion in 2004). The capital expenditures pertained mainly to vehicles and machines subject to new operating lease contracts with external customers within Financial Services’ operations in North America and Western Europe.
 
Capital expenditures currently in progress are shown in “Item 5.B - Liquidity and Capital Resources”.
 
 
General
 
2006 was an exam year for the strategy of the Volvo Group. A new generation of products would be on the market, developed and produced in a new industrial structure. The new engines would have to meet the dramatically more stringent emission standards in Europe, the US and Japan. As anticipated, it was an industrious year and a record year in many respects.
 
Challenging assignment Already at the acquisition of Renault Trucks and Mack six years ago, we knew that the road ahead was going to be challenging. We faced the integration of thousands of employees into new units, changing from three different production systems for engines to one common system, shrinking the engine families from 18 to two and coordinating the truck companies’ purchasing, product planning and product development in a new unit. In addition, the units for IT, logistics and spare parts were assigned to take a Group-wide lead for coordination within their areas. All these actions were aimed at gaining maximum benefit from technical resources and our combined volumes.
 
Volvo also had aggressive plans to strengthen and expand the dealer network to provide better service to customers and promote its products in new markets.
 
New and more efficient structure Accordingly, there were many reasons for concern at the beginning of 2006. We had never previously implemented such a comprehensive product renewal. We phased in new production systems at the same time as we phased out the old. This was in a booming business climate, with plants operating at peak capacity. Concurrently, we put time and resources into the investments in Asia and Eastern Europe.
 
In all significant respects, we carried out the changeovers as scheduled and although they increased costs temporarily our new products rolled out in a proper manner. The Group is now well integrated and our own as well as independent dealers have had a highly positive development.
 
Products The solid order bookings at the end of 2006 and beginning of 2007 demonstrate the strength of the new product generation. The diesel engines are leading in fuel efficiency and provide competitive advantages for all of the Group’s vehicles and equipment. As a result of the more efficient structure, we have been able to free up resources to develop more customer-adapted variants, which further strengthen competitive positions. As a result of the increased benefits for the customer, we believe we have been able to price our vehicles, equipment and services at the right levels.
 
Group-wide production The changes implemented are not solely significant structurally, but also important for the internal transfer of know-how. Increased coordination and common technical solutions have resulted in improved quality. Step by step we are developing a Group-wide production method based on standardization, best practice and a common corporate culture.
 
Aggressive strategy for growth The strategy to reach the growth target is to grow geographically and at the same time broaden our offering to customers. We are targeting organic growth of earnings of 5-6 percent annually and to obtain the remaining percent through acquisitions. In line with this, the Board has sought a distinct balance between the need for financial freedom of action for long-term value growth and an attractive level for annual share dividends.
 
Geographically, we are targeting the fast-growing economies in Eastern Europe and Asia.
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The economies in Eastern Europe are in a very dynamic phase and new transport patterns are being established. For many years we have been active in this region extending the dealer network and services. This is now bearing fruit. The nearly 40 percent sales increase during 2006 is evidence that we are taking a share of the rapid economic growth.
 
Major potential in Asia Since the quality and emissions standards in countries such as China and India are still relatively low, the challenge in these countries is greater. Pricing is different and local manufacturing is a necessity for competing with domestic producers. However, in the long term we see the greatest potential for growth in Asia. A favorable sign for the environment and our development is China’s ambition to establish more stringent emission standards.
 
In general, we foresee an increasing global harmonization of technical as well as environmental demands, which strengthens our position since we believe we have gone further than the competition in developing a global product program. With investments in India and China, we aim to share in their growing economies, in the manner that we are now experiencing in Eastern Europe.
 
In order to strengthen our position in Asia, we have taken several steps of significant strategic importance. Within the truck segment, we established a strategic alliance with Japanese Nissan Diesel. To start with, we acquired a 19 percent holding in Nissan Diesel and in February, 2007, we made a public offer for the whole company. When the acceptance period for Volvo’s offer for Nissan Diesel expired, Volvo had received a total of roughly 96 % of the shares outstanding. A process is now being initiated to redeem the remaining shares outstanding. Nissan Diesel will be consolidated in the balance sheet of the Volvo Group as of the first quarter of 2007. Sales and earnings will be reported as of the interim report for the second quarter 2007. The cooperation with Nissan Diesel has also resulted in more in-depth discussions about future coordination with China’s largest truck manufacturer, Dongfeng Motors.
 
In China we have also entered an exciting new phase through the purchase of 70 percent of the Chinese wheel loader manufacturer Lingong. As the first foreign manufacturer of construction equipment, we gain a base with a nationwide dealer network in China.
 
Broader offering to customers Parallel with investments on new markets, we are increasing efforts to expand our offering of services, accessories and spare parts. We view this as our greatest possibility to create long-term growth in established markets. In this respect, we are working with intensifying cooperation with customers to develop broader business solutions. Customer financing is an important component in this respect and for expansion in markets with a less developed credit system. An important part of our strategy for increased profitability is the growth of services, accessories and spare parts.
 
Market overview
 
Global economic trend The global economy continues to register solid growth. In recent years, global GDP growth has ranged from 4 percent to 5 percent, the highest level since the 1970s. The positive trend is evident in most global regions but is particularly noticeable in China, Eastern Europe and other emerging markets.
 
Transport requirements Social developments worldwide are fuelling an expansion in trade, locally as well as among regions and continents. The growth in trade is creating higher transport requirements, both for goods and people.
 
Transport vehicle requirements are cyclical but the industry has an underlying growth rate of about 4 percent annually in mature markets over a business cycle. In growth regions such as Asia and Eastern Europe, the growth rate is considerably higher.
 
Commodity prices Rapid growth in the global economy has resulted in high demand for energy. Oil prices have risen sharply in recent years, with a peak price of USD 75 per barrel in summer 2006. Price levels have fallen since then, reaching about USD 59 per barrel at year-end 2006. While at the same time that there is a high demand for energy, the supply is limited, due partly to the political unrest in the Middle East, which affects prices. The prices of raw materials, such as metals and rubber, also rose during the year.
 
Fuel costs are a significant part of the operating cost for many of Volvo Group's customers. Generally, Volvo Group customers have proven skillful in offsetting fuel costs.
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An industry in flux The transport industry is moving through a process of change in which increasingly stringent environmental standards are a major driving force. Substantial investments are required for R&D programs involving new technologies to reduce emissions from vehicles and for the development of alternative fuels and drivelines. To meet these challenges, consolidation is in progress among manufacturers through mergers and acquisitions.
 
In mature markets in the US and Europe, consolidation in the truck industry has been in progress over a number of decades and has made substantial progress. In other regions or sectors - such as Asia or the construction industry - the pressure to consolidate is expected to increase.
 
Meanwhile, new competitors have emerged as major regional players in growth markets with the aim of becoming global players. Restructuring creates the potential for the Volvo Group to further strengthen its positions in each business area by means of acquisitions.
 
Growth markets The Volvo Group’s goal is to be the world’s leading supplier of commercial transport solutions. Volvo currently has well-established positions in the European and North American markets. However, the most rapid growth is occurring in regions in which the Group had very limited operations ten or 15 years ago. The Volvo Group plans to expand in these markets - in Asia, for example.
 
China and India are examples of markets that are already considerably large and will prove even more important for the Volvo Group’s future growth. In addition, Eastern European markets are showing steep growth and the Group is well positioned to capitalize on expansion in these markets.
 
Sales by Geographical Areas
 
The following table sets forth the geographic distribution of the Volvo Group’s net sales. Sales are shown based upon the market where the customer is located.
 
   
2004
 
2005
 
2006
 
Market area:
 
(in millions of SEK)
 
Western Europe
   
108,015
   
112,037
   
121,921
 
Eastern Europe
   
11,062
   
11,986
   
16,421
 
North America
   
54,769
   
69,743
   
74,928
 
South America
   
7,338
   
12,479
   
13,159
 
Asia
   
20,789
   
22,699
   
19,655
 
Other markets
   
9,103
   
11,615
   
12,751
 
Total
   
211,076
   
240,559
   
258,835
 
 
Strategy
 
The Volvo Group’s customers mainly conduct transport-related operations. They impose rigorous requirements on both products and services. In a competitive market, customer satisfaction is a key factor, since it assures future sales and is essential for healthy profitability.
 
Developing and broadening cooperation with customers Close cooperation with customers is decisive for enabling the Volvo Group to better understand their needs and meet their expectations with the right products and services.
 
Quality in the Volvo Group’s offering is also linked to how customers are treated and how services are performed. While product characteristics and quality are of key importance, it is above all the people in the Volvo Group, and their skills, values, attitudes and conduct, which create success.
 
The Group must constantly be able to offer customers the solutions that are best commercially for their operations. At the same time, customers’ experience of the brands should be consistent and in line with the Group’s basic values. This applies both within the Group and at dealerships. Accordingly, the Volvo Group works continuously to develop its dealership network with the aim of further improving its service to customers.
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Building strong relations with key customers The Volvo Group strives to forge closer relations with key customers. There are several advantages; the Group can support customers’ growth even more effectively than before, while simultaneously helping to broaden the offering of products and services to existing customers. In this way, the Volvo Group can benefit from its broad range of products and services and establish synergies with key customers.
 
Profitable growth Since 2001, the Volvo Group has had an average annual earnings growth rate of 7 percent, which has been achieved through both organic growth and acquisitions. The Volvo Group’s objective is to continue growing with a focus on profitability. The growth target is 10 percent annually over a business cycle, to be achieved through organic growth and through acquisitions at approximately equal proportions.
 
Expanding geographic coverage and product offering The Volvo Group holds established positions in markets in Europe and North America. Today, however, the most rapid growth is occurring in markets where the Group had very little business only ten to 15 years ago. In growth markets, a stronger position and increased market shares are to be achieved by attracting new customers and through strategic alliances. The Group is making large investments in the dealer and service networks and concurrently carrying out a number of acquisitions. The aim is for markets outside Europe and North America, such as India, Japan, China and Russia, to account for a substantial portion of the Group’s total sales in the long term.
 
The aim in established markets is for an expanded customer offering, with an increased proportion of sales in the aftermarket and a high proportion of services to contribute to achieving the growth target. Strong brands increase customers’ trust and create loyalty to the Group’s products and services, thereby supporting profitable long-term growth.
 
Activities during a business cycle The sectors in which the Volvo Group operates are exposed to economic fluctuations. The Volvo Group endeavors to actively handle both upswings and downturns in each sector to achieve better profitability. The strategy of developing aftermarket services and growing in new markets enables the Group to achieve a more favorable balance between all the phases of a business cycle.
 
Renewal and concept development Development of innovative technology is the key to success for new generations of products, and to maintaining market-leading positions in the future. Efforts are constantly under way within the Group to improve the performance of products and thereby strengthen competitiveness. At the same time, research looking even further into the future is conducted in order to achieve new technical breakthroughs.
 
The Volvo Group cooperates worldwide with a large number of external partners in projects and forums that allow experience to be exchanged and contact to be made with cutting-edge technologies and innovations. The Volvo Group will continue to actively exchange information with many different players, such as universities, research institutes, customers, suppliers and government authorities.
 
Providing a complete, customer-oriented offering For a global organization such as the Volvo Group, product planning must ensure that the right products with the right specifications are offered in the right markets. Accordingly, products typically offer an extensive range of customer adaptations. Product adaptation supports the distinctive features of each brand and its competitive advantages as seen from the customer’s perspective.
 
Improving fuel efficiency and increasing the use of alternative fuels It is a major challenge to create a sustainable society that does not jeopardize the environment for future generations. The Volvo Group is a driving force within the transport industry in such areas as energy and the environment. This undertaking seeks to attain a gradual transition from fossil fuels, such as oil and natural gas, to fuels from renewable sources and hybrid drive systems.
 
Enhancing productivity and cost-efficiency The Volvo Group strives to continuously optimize cost-efficiency and productivity in all parts of its operations. This contributes to increased profitability and improves the Group’s capacity to handle economic fluctuations.
 
Part of the internal cost-efficiency work involves reducing production costs and costs for sales and administration. Product costs must be constantly scrutinized and kept to a minimum to generate competitiveness without compromising on quality.
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The Volvo Group strives to be characterized by the highest quality. Getting it right from the start increases customer satisfaction, keeps costs down and saves time and energy.
 
The Volvo Group plans to continue with the introduction of the Volvo Production System (VPS), which was designed to establish common production processes throughout the Group. VPS increases flexibility and efficiency in the industrial organization. It is also expected that VPS will create value for customers through improved quality, more reliable deliveries and reduced costs.
 
Execution in focus A key competitive advantage in the commercial transport sector is the capacity to be efficient and suited to purpose. The Volvo Group’s capacity to handle development projects, combined with its ability to rapidly introduce processes for new ways of working, contributes to improved results.
 
Maintaining expertise The Volvo Group is growing in new geographic markets and developing new technology, as well as meeting a number of demographic challenges. It is therefore vital to develop the appropriate expertise to assure the Group’s future competitiveness.
 
Diversity is a commercial driving force and a source of international competitiveness and hence profitability. The Volvo Group is increasing its efforts to benefit from the strength that stems from diversity in terms of gender, age, ethnic background and education, among other areas.
 
The quality of leadership is another key success factor for the Volvo Group’s capacity to generate future business.
 
Summary of Group Businesses
 
Volvo Trucks. Volvo began manufacturing trucks in 1928 and specializes in heavy trucks, with gross vehicle weight above 16 tons. Volvo Trucks products are marketed in more than 130 countries. The largest markets are Europe and North America.
 
Renault Trucks. Renault Trucks traces its origin to the Berliet and Renault companies founded in 1895 and 1898, respectively. With a product program that ranges from light trucks for city distribution to heavy long-haul trucks and military vehicles, Renault Trucks has the ability to meet the specific requirements of all types of road transport. Renault Trucks’ largest market is Europe.
 
Mack Trucks. Mack Trucks is one of the largest manufacturers of heavy-duty trucks primarily for construction, refuse and heavy regional transports. Since its founding in 1900, Mack has built on its reputation of strength and durability to become one of the leading heavy-duty truck brands in the North American market. In the US, Mack is a leader in the vocational segments of the heavy-duty truck market.
 
Buses. Volvo Buses has a broad range of modern buses that offer efficient transport solutions. The product offering includes complete buses and chassis for city and intercity traffic as well as coaches. Volvo Buses’ largest markets are Europe and North America.
 
Construction Equipment. Volvo CE’s products, spare parts and services are offered worldwide in more than 125 markets through proprietary or independent dealerships. Customers are using the products in a number of different applications including general construction, road construction and maintenance, forestry, demolition, waste handling, material handling and extraction. Volvo Construction Equipment’s largest markets are Europe and North America.
 
Volvo Penta. Volvo Penta offers complete power systems and service for leisure boats, workboats and industrial applications such as power-generating equipment. Volvo Penta operates within three areas of activity: Marine Leisure, Marine Commercial and Industrial. The major markets for Volvo Penta are Europe and North America.
 
Volvo Aero. Volvo Aero specializes in a number of highly advanced components for aircraft engines and space rockets. More than 90% of all new large commercial aircraft are equipped with engine components from Volvo Aero. Volvo Aero also has a substantial after-market.
 
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Financial Services. Volvo Financial Services (VFS) offers traditional financial services such as installment contracts, operating and financial leasing and dealer financing. In many markets, insurance and rental services and other offerings are also available.
 
Trucks
 
The total market. The number of trucks sold in 2006 reached record levels primarily in Europe and North America, exceeding the previous all-time-highs reported in 2005. Demand in Europe seems to be continuing on this positive trend. Particularly noteworthy in this respect is that the new EU members in Eastern Europe are reporting sharp increases in truck sales.
 
Developments in Asia in 2006 point to favorable economic growth in several markets, with major markets such as China and India reporting rising sales of heavy trucks.
 
In Brazil truck sales declined due to such factors as a strong domestic currency in relation to the USD, resulting in problems for key agricultural exports.
 
In 2006 the total market in Europe 27 increased by 7%, amounting to 295,038 (276,822) vehicles, whereof Western Europe grew by 4% and the new EU countries advancing a full 34%. Moreover, in Russia the number of imported trucks increased by approximately 90%.
 
In North America, the overall market for heavy trucks (class 8) in 2006 rose 13% to 348,866 (307,973), with the USA reporting growth of 12% to 284,008 vehicles (252,792).
 
The Brazilian market retreated 9% to 39,873 vehicles in 2006. Among the major markets in Asia, Japan grew 6%, China 29% and India 41%. In the Middle East, however, the overall market fell 50%, due largely to the decline in Iran, which fell by a full 94%.
 
Business environment. In all of Europe, there is a strongly increasing need for transport, particularly between east and west, resulting in increased demand for heavy trucks. A significant factor is the strong economic trend in Europe. The strongest growth is seen in Eastern Europe, where the new EU member states are major contributors. Eastern European countries outside the EU also showed a very positive trend and are expected to show continued strong demand for transports and thus heavy trucks during 2007.
 
Demand in the North American market is expected to decline sharply during the first half of 2007 as a consequence of pre-buying during 2006. Demand in the second half of the year remains difficult to assess.
 
In 2006, Trucks accounted for 67% of Volvo’s sales.
 
Volvo Trucks. Product renewal within Volvo Trucks has been intensive in recent years. Volvo Trucks has invested a total of more than SEK 9 billion in product renewal and product improvement over the past five years.
 
The 2006 fiscal year was characterized by continued launching of new products following an intensive 2005 when the new Volvo FH and Volvo FM were introduced in Europe, Volvo VT in North America and a modification of Volvo VM in Brazil.
 
First out in 2006 was an upgraded version of the flagship, Volvo FH16. It is equipped with a new 16-liter engine with up to 660 hp, which makes it the world’s most powerful mass-produced truck.
 
The corresponding flagship for the US market is the Volvo VT series, which was launched in 2005. With its 625 hp, the Volvo VT is the most powerful truck in the US. During the year, the product program was further developed and the offering broadened to include more cab variations, such as a mid-roof cab, to satisfy more customer segments.
 
In terms of environment, Volvo Trucks is continuing developments within the truck sector. The new engine program not only complies with the new environmental legislation in Europe, but also has considerably lower fuel consumption than its predecessors.
 
On January 1, 2007, new emission regulations were introduced in the US. In order to meet these regulations, Volvo Trucks launched a completely new engine program for the North American market. Volvo I-Shift was also presented to US customers, which is the first automatic Volvo gearbox to be introduced in North America.
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During 2006, the Volvo FL and Volvo FE were also introduced in Europe and are aimed at a broader category of distribution customers, for example, tradesmen, fruit traders and bakers. For the benefit of these customers, Volvo Trucks has developed a completely new business concept, which facilitates the rapid and simple purchase of key-in-hand trucks equipped with bodies, tail lift and all types of support services, for example, service contracts.
 
During 2006, Volvo Trucks delivered 105,519 trucks, an increase of 1.7% compared with a year earlier. Deliveries rose 15.5% in North America and 15.4% in Europe. Deliveries in Asia decreased by 57.5%, due largely to the decline in Iran.
 
Strategic development - VolvoTrucks. The ambitions for 2007 are:
 
 
·
Manage the expected sharp decrease in demand in North America.
 
 
·
Ensure production capacity for a continued strong European market.
 
 
·
Continue developing customer relations in line with the implemented dealer strategy.
 
 
·
Stronger focus on communicating the company's core values.
 
Renault Trucks. Renault Trucks is a high-profile specialist in four segments: City Distribution, Regional Distribution, Construction Transport and Long-Distance Transport. In 2006, Renault completed the renewal of all products, a program that met with enthusiastic customer response. This program commenced just three years ago with the Renault Master, and subsequently with the Mascott in 2004 (City Distribution), and then with Magnum and Premium Route (Long-Distance Transport) in 2005 and finally with Midlum, Premium Distribution (Distribution) as well as Lander and Kerax (Construction) during 2006.
 
The past year also marked the introduction of the Euro 4 standard and incentive for Euro 5, while at the same time the sale of certain versions were terminated.
 
Deliveries by Renault Trucks amounted to 77,574 vehicles, which was 4.1% more than a year earlier. Deliveries in Europe rose 6.8% to 65,189 trucks, while deliveries in the rest of the world decreased by 8.1% to 12,385.
 
Strategic development - Renault Trucks. The ambitions for 2007 are:
 
 
·
Achieve the Service Quality program.
 
 
·
Improve brand image based on the new product portfolio and quality achievements.
 
 
·
Harvest the benefits of the totally renewed range.
 
 
·
Launch successfully the new Renault Maxity.
 
 
·
Develop soft products sales.
 
 
·
Implement cost reduction plan.
 
 
·
Secure the product cost-reduction plan.
 
Mack Trucks. In 2006, the most rapid and comprehensive product renewal in Mack’s 106-year history continued, as the company brought to market its new highway application tractor, redesigned construction application offering, and new engine technology designed to meet the stringent US’07 emissions regulations.
 
The Pinnacle model highway tractor and the Granite model straight truck each feature entirely new driver environments based on extensive research of customer preferences and ergonomics - with more belly and leg room, easier-to-read instrument displays, and more storage among the improvements.
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Mack offered its concrete customers an important safety improvement in 2006 with the introduction of the Mack Road Stability Advantage (RSA) system for concrete mixers. Designed to reduce the potential for rollover incidents and enhance profitability, the full electronic stability system is the first of its kind in the vocational segment of the heavy-duty truck market in North America. In addition to making RSA available to concrete mixer customers, Mack also announced in 2006 that it was making the system standard on all of its highway tractors.
 
During 2006, a number of new product programs were launched through which Mack Trucks - in cooperation with transport companies - provides support and assistance regarding the availability of spare parts and service. These include MV Preferred and Mack Credit Card offerings, which simplify the purchase of spare parts and service repairs, while simultaneously providing customers with tools for reporting, monitoring and controlling costs.
 
In addition to the optimal development of in-house operations, the distribution network continues to be improved to be able to manage variations in economic conditions. Since 2001, Mack Trucks’ independent dealers have jointly invested more than USD 50 M, or approximately SEK 370 M, in new facilities, modernization and extension of existing facilities and retraining programs for sales personnel. Combined with the extended offering of accessories and services, these improvements permit dealers to raise sales of aftermarket products and services and boost the level of absorption throughout the network. This will dampen the effects of the expected significant decline in sales of new trucks during the first half of 2007.
 
Deliveries by Mack Trucks amounted to 36,838 vehicles, which was 1.6% more than a year earlier.
 
Strategic development - Mack Trucks. The ambitions for 2007 are:
 
 
·
Manage the challenges throughout operations arising from the market cycle, while maintaining profitability and cost control.
 
 
·
Continue working with the completion of Mack Trucks’ product renewal.
 
 
·
Continue the development of the North American dealer network to strengthen sales, customer support and aftermarket services.
 
 
·
Continuing growth in Mack Trucks’ international operations.
 
Products. The customer offering is based on an adequate vehicle specification for every customer's needs. The truck operations of the Volvo Group have a broad range of truck specifications for all kinds of transport needs, from city distribution to construction work and long-distance transports. More than 90 % of the trucks branded Volvo are sold in the heavy truck segment (above 16 tons), where all models are based on the company's shared technology and architecture.
 
Customers are also offered an extensive range of support services. For example, financial services include many different kinds of leasing solutions, often in combination with service and insurance agreements.
 
Production. The following table sets forth, by series, the number of trucks produced by Mack, Renault and Volvo during each of the years 2002 through 2006.
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 Number of trucks produced
 
2002
 
2003
 
2004
 
2005
 
2006
 
Volvo FL, FE-series
   
5,640
   
4,820
   
4,980
   
5,052
   
4,799
 
Volvo FL7, 10, and 12-series and
FM7, 9, 10, and 12-series
   
15,300
   
17,480
   
19,150
   
20,102
   
20,704
 
Volvo FH-series
   
31,880
   
33,720
   
45,010
   
42,951
   
41,302
 
Volvo NL and NH-series
   
1,490
   
1,940
   
1,170
   
2,312
   
556
 
Volvo VN, VT series and VHD
   
14,300
   
17,080
   
25,640
   
32,256
   
37,281
 
Volvo VM
   
-
   
400
   
1,600
   
1,842
   
2242
 
Total
   
68,610
   
75,440
   
97,550
   
104,515
   
106,884
 
Mack CH/CHN
   
7,540
   
1,744
   
2,006
   
3,786
   
3,880
 
Mack CL
   
288
   
64
   
170
   
364
   
584
 
Mack Vision
   
2,523
   
4,811
   
7,283
   
9,403
   
8,394
 
Mack Granite
   
4,592
   
6,217
   
10,935
   
16,568
   
17,019
 
Mack Pinnacle
   
-
   
-
   
-
   
-
   
1,076
 
Mack DM
   
528
   
458
   
519
   
365
   
1
 
Mack DMM
   
47
   
-
   
-
   
-
   
-
 
Mack LE
   
1,084
   
964
   
849
   
1,238
   
937
 
Mack MR
   
1,668
   
2,034
   
2,603
   
3,325
   
3,901
 
Mack RB
   
103
   
130
   
130
   
23
   
-
 
Mack RD
   
2,298
   
921
   
17
             
Mack RD8
   
35
   
54
   
4
             
Other
   
-
   
1,122
   
1,121
   
1,126
   
976
 
Total
   
20,706
   
18,519
   
25,637
   
36,198
   
36,768
 
Renault Kerax
   
7,677
   
6,674
   
7,063
   
8,800
   
9,732
 
Renault Midlum
   
12,545
   
12,801
   
16,018
   
15,484
   
12,696
 
Renault Premium
   
16,150
   
15,567
   
17,250
   
18,991
   
23,253
 
Renault Magnum
   
7,848
   
7,516
   
8,801
   
8,208
   
7,000
 
Total
   
44,220
   
42,558
   
49,132
   
51,483
   
52,681
 
Total Volvo, Mack and Renault
   
133,536
   
136,517
   
172,319
   
192,196
   
196,333
 

Production and capacity. Production of trucks in 2006 amounted to 106,884 Volvo Trucks (104,515), 52,681 Renault Trucks (51,483) and 36,768 Mack Trucks (36,198). In addition, Renault Trucks also distributes the Renault Mascott and Renault Master trucks, which are produced by Renault SAS, and the SISU trucks.
 
In August 2006, a new plant was opened in Durban, South Africa, at which Volvo FM and Volvo FH trucks will be assembled.
 
In 2006 Volvo Trucks announced its intention to make all production units in Europe carbon-dioxide neutral. In 2005 Volvo presented the initiative to make the truck plant in Tuve, Göteborg, carbon-dioxide neutral. The investments also comprise energy deliveries from windpower plants.
 
Renault Trucks’ deliveries and productivity were affected negatively by extensive production changes in the industrial system in conjunction with the introduction of new truck models and engines. During the fourth quarter of 2006, phasing out of the Renault Kerax plant in Villaverde was completed. Assembly of Renault Trucks’ heavy truck program was thus concentrated to the plant in Bourg-en-Bresse. The current focus is on improving productivity and ensuring delivery capacity to meet the strong demand.
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With regard to Mack Trucks, manufacturing operations at the Macungie plant reached record levels in summer 2006, with output reaching 107 construction vehicles daily. Higher demand was partly due to purchases ahead of the introduction of new emission regulations in January 2007. The production of Mack’s long-distance trucks also increased at New River Valley, but manufacturing was negatively impacted by the capacity limits of suppliers in delivering key components.
 
Plans were announced in the fourth quarter to downsize the workforce in the North American production facilities. This move was part of preparations ahead of an anticipated decline in demand in conjunction with new emission regulations. The reduction of the workforce by 450 employees at the Macungie plant took place during the fourth quarter of 2006 and first quarter of 2007. In the first quarter of 2007, order bookings in North America remained low as expected, since customers are hesitant when it comes to ordering trucks with the new engines that meet the US07 emissions requirements. In North America, production cutbacks were implemented to adapt build rates to the currently lower demand in the market. There have also been disturbances in conjunction with production realignments and delays in the introduction of trucks with the new generation of engines. To assure the quality of the new products, a slow increase in the delivery rate will take place over the next few months.
 
Markets and Sales. In 2006, Trucks accounted for 67% of Volvo’s sales. Volvo’s truck operations’ sales by principal geographic market area and operating income for the years 2004, 2005 and 2006 are set forth in the following table:
 
       
2004
 
2005
 
2006
 
   
(In millions of SEK)
 
Western Europe
         
68,664
   
70,567
   
75,157
 
Eastern Europe
         
8,767
   
9,139
   
13,166
 
North America
         
35,154
   
46,129
   
50,605
 
South America
         
5,223
   
7,657
   
9,213
 
Asia
         
12,378
   
13,551
   
8,975
 
Other markets
         
6,693
   
8,353
   
9,190
 
Total sales
         
136,879
   
155,396
   
166,306
 
Operating income
         
8,992
   
11,717
   
12,657
 
 
Total deliveries from the Group’s truck operations amounted to 219,931 trucks in 2006, an increase of 2.5% compared with 2005. In Europe, 114,417 trucks were delivered, compared with 103,622 trucks in 2005. Deliveries in North America were up 8.5% compared with 2005 and totaled 70,499 trucks. Deliveries in Asia decreased by 50.1% due primarily to the decline in Iran. During 2006, 12,817 trucks were sold in Asia, compared to 25,706 in 2005.
 
Buses
 
The total market. The total global bus market remained at a high level in most parts of the world in 2006, but there are signs that globally the business cycle in the bus industry is now nearing its peak and will soon turn downward. However, economic growth in Asia remains strong and bus sales continue to rise in many countries.
 
General. Volvo Buses' product line comprises complete buses, bus chassis and bodies for various applications such as city, intercity buses and coaches as well as related services. Priority is given to transport economy, reliability and environmental characteristics in the development of products of Volvo Buses. Buses’ customers are primarily bus operators with vehicle fleets varying from a single bus up to as many as 20,000 buses.
 
With today’s high fuel prices, Volvo Buses’ customers' focus is on fuel consumption. Volvo has chosen the SCR (Selective Catalytic Reduction) technology to meet the new emissions standards, primarily because fuel consumption is then lower. Combined with improvements in gearboxes and drive shafts, fuel costs are reduced for customers.
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Volvo Buses is a leader in environmentally sound engines. Already today, customers can purchase Volvo engines meeting emissions standards that are not proposed to become effective until 2009. In addition, a new gas engine with very low emission levels was released during the year, an engine that can operate on biogas from renewable energy sources.
 
During the year, Volvo Buses introduced its first city bus in India. The city of Bangalore purchased 50 modern, air-conditioned city buses with low entry.
 
In 2006, Buses accounted for 7% of Volvo’s sales.
 
Business environment. The trend toward larger bus operators continues. They are focusing increasingly on lifecycle costs, which increases the demand for fuel economy, quality and aftermarket services.
 
Regional authorities place high demand with regard to the environmental impact of buses. As a result, an increasing number of bus manufacturers are conducting research and developing buses with alternative drivelines and for alternative fuels.
 
Strategic development. Volvo Buses' ambition for 2007 is to:
 
 
·
Continue the implementation of the earnings-improvement program within Volvo Buses.
 
 
·
Shorten lead times from order to invoicing.
 
 
·
Further strengthen positions in China and India.
 
 
·
All employees shall be involved in the Operational Development program.
 
Products. Volvo Buses has a broad range of modern buses that offer efficient transport solutions. The product offering includes complete buses and chassis for city and intercity traffic, as well as coaches.
 
In the coach segment, a stylish exterior and interior design of the bus is important for passenger satisfaction. During 2006, the Volvo 9700 and Volvo 9900 were launched with a new exterior design and with a broad range of interior design options. Volvo Bus was also first in the bus world to introduce front underrun protection that reduces the risk of injuries to drivers and passengers in an automobile in a frontal collision with a bus. The 7700 city bus was also redesigned and equipped with a new 9-liter engine, which provides for more comfortable and efficient driving in city traffic.
 
Volvo Buses’ subsidiary in Canada, Nova Bus, launched an articulated version of its city bus Nova LFS during the year.
 
Production and capacity. During the year, Volvo produced 10,440 buses (10,406) and bus chassis. The company decided during the year to start a joint-venture company in India that will build a plant in the country for production of bus bodies, primarily for the Indian market.
 
Markets and Sales. Sales by Volvo Buses by principal geographic market area and operating income for the years 2004, 2005 and 2006 are set forth in the following table:
 
       
2004
 
2005
 
2006
 
   
(In millions of SEK)
 
Western Europe
         
6,422
   
6,564
   
6,975
 
Eastern Europe
         
526
   
578
   
534
 
North America
         
2,960
   
4,247
   
4,910
 
South America
         
521
   
2,641
   
1,537
 
Asia
         
1,632
   
1,612
   
2,003
 
Other markets
         
661
   
947
   
897
 
Total sales
         
12,722
   
16,589
   
16,856
 
Operating income
         
158
   
470
   
633
 
 
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Volvo delivered 10,360 buses and bus chassis (10,675) in 2006. Higher sales were reported mainly in North America, South America and Asia. During the year, 1,300 of an order for 2,000 midi-buses were delivered to Shanghai in China.
 
Volvo Buses market shares were strengthened in, for example, Mexico, China and North America. In contrast, the business area lost market shares in Europe, due mostly to intense price competition. However, Volvo Buses is still the market leader in the Nordic region and the UK.
 
Volvo CE
 
The total market. Market conditions were once again favorable in 2006. The total market for Volvo CE’s product segments rose by 10%. The market declined by 4% in North America and rose by 11% in Europe, while other markets rose by 21%. The growth was attributable to overall positive business conditions for the industry.
 
Public and private investments in infrastructural projects contributed to the sales increase for heavy construction machines. The North American market for heavy construction machines grew by 3%, while the European market increased by 15%. Other markets rose 22%.
 
During 2006, the total market for compact construction equipment increased by 6%, compared with the preceding year. The North American market decreased by 8% while the European market rose by 9%, and other markets grew by 20%.
 
General. Volvo Construction Equipment has grown considerably in recent years. Customers from all parts of the world have shown their appreciation of Volvo CE’s comprehensive investments in new products and the company can currently offer one of the most modern product ranges in the industry.
 
In addition to the actual equipment, Volvo CE offers such services as financing, spare parts, used equipment, renovated spare parts and equipment, service agreements, tools and the opportunity to rent machinery and equipment.
 
As a result of the renewed and expanded product offering, new customer segments are reached. The recently launched excavators for demolition and forest work are excellent examples of how the company is approaching additional market segments.
 
Volvo CE’s products and services are offered in more than 125 countries worldwide through proprietary or independent dealerships.
 
Rental is the segment of the industry that is growing fastest, and Volvo CE currently has nearly 135 rental outlets, primarily in North America and Europe.
 
In September 2006, Volvo CE announced its intention to acquire the equivalent of 70% of the shares in Shandong Lingong Construction Machinery CO (Lingong), a major Chinese manufacturer of construction equipment with an extensive network of dealers in China. The acquisition was finalized in January 2007. Since Lingong was founded in 1972, the company has established a position as one of the leading players in a market subject to intense competition. Lingong, which had a share of 11% of the Chinese market for wheel loaders in 2005, is a technologically advanced company with very modern production plants.
 
China is the world’s second largest market for construction equipment and the world’s largest market for wheel loaders. The Chinese market is expected to grow, and Volvo CE intends to participate actively in this growth.
 
In 2006, Construction Equipment accounted for 16% of Volvo’s sales.
 
Business environment. The trend in the global industry for construction equipment has been highly intensive in recent years. Suppliers, manufacturers and dealers are working hard to satisfy very high customer demands. In certain cases, this resulted in a shortage of components and raw materials, such as tires and steel, leading in turn to long delivery times.
 
More stringent rules regarding exhaust emissions and noise, combined with lower fuel consumption and reduced operating expenses, have forced the industry to invest more in research and development in these areas. For many types of machines, the cost of fuel accounts for one third of the annual operating expenses, although it can be as high as 50% for certain machines.
 
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Strategic development. Volvo CE’s ambitions for 2007 are:
 
 
·
Continued development of the excavator business.
 
 
·
Penetration of the domestic market for wheel loaders in China.
 
 
·
Continued upgrade of the industrial system to satisfy customer demand.
 
 
·
Focused strategy for India and Russia.
 
 
·
Growth within services.
 
 
·
Continued focus on tools in order to reach new segments and customers.
 
Products. Products launched in 2006 included the L350F, a new wheel loader. Equipped with a 16-liter Volvo diesel engine, the L350F is the largest wheel loader in Volvo’s history, which means that the company can approach new customer segments.
 
Markets and Sales. Sales by Construction Equipment by principal geographic market area and operating income for the years 2004, 2005 and 2006 are set forth in the following table:
 
       
2004
 
2005
 
2006
 
   
(In millions of SEK)
 
Western Europe
         
12,443
   
14,213
   
16,871
 
Eastern Europe
         
1,010
   
1,311
   
1,888
 
North America
         
8,601
   
10,337
   
11,280
 
South America
         
922
   
1,238
   
1,358
 
Asia
         
4,961
   
5,717
   
6,903
 
Other markets
         
1,423
   
2,000
   
2,264
 
Total Sales
         
29,360
   
34,816
   
40,564
 
Operating Income
         
1,898
   
2,752
   
3,888
 
 
Production and capacity. Volvo Construction Equipment increased deliveries in 2006. For example, Volvo’s deliveries of excavators rose by 20%. The high deliveries were the result of new products and improved distribution. The number of machines sold during 2006 increased by 11% to a record level of more than 37,000 units.
 
Volvo Penta
 
The total market. The total European market for marine as well as industrial engines was strong in 2006. The total market for marine engines weakened in North America, while demand for industrial engines was more stable. The total market in Asia remained weak, due primarily to the low demand for diesel gensets in China. In contrast, the development on markets in other parts of the world was positive, for example, Turkey and South Africa.
 
General. Volvo Penta was founded in 1907 in conjunction with the production of the first marine engine, B1. Pentaverken soon became an established engine manufacturer, which in 1927 delivered the engine to Volvo’s first passenger car. Volvo acquired Pentaverken in 1935 and Volvo Penta has been part of the Volvo Group since then.
 
Volvo Penta has written marine history through a number of pioneering innovations, such as the Aquamatic drive and the counter-rotating Duoprop propellers, both of which are among the marine industry’s most important innovations in history.
 
In recent years, Volvo Penta IPS, the drive system with forward-facing propellers, and the joystick, are recognized in the same fashion as radical innovations in the way to propel boats.
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The IPS system is a clear example of how product development contributes to creating competitive advantages for Volvo Penta's customers, for example, such world-leading boat builders as Bavaria, Beneteau/Jeanneau, Cranchi, Sessa Marine, Azimut, Tiara, Four Winns, Mustang and Intermarine.
 
By installing the IPS system, boat builders can reduce installation times by up to 75 percent compared with traditional straight shafts, which facilitates more efficient production. At the same time, the boat builder can offer the end customer a quieter and cleaner boat, with up to 30 percent lower fuel consumption as well as significantly improved performance and maneuverability.
 
Volvo Penta works in the same fashion with its industrial engine customers. By creating customer benefits, such as shorter installation times, improved fuel economy, environmental features and performance backed by global service support, Volvo Penta contributes to enhanced competitiveness for customers, such as Kalmar Industries and Atlas Copco.
 
In 2006, Volvo Penta accounted for approximately 4% of Volvo’s sales.
 
Business environment. Volvo Penta continued to capture market shares in most areas of its operations, particularly the inboard market, in which the volumes for Volvo Penta IPS increased steadily. At year-end, there were slightly more than 100 boat models from the world’s largest boat builders with the new drive system.
 
In the industrial engine segment, diesel-powered generator sets are the predominantly most important product for Volvo Penta, which during the year strengthened its global market shares in this segment.
 
Today, Volvo Penta sells about 20,000 engines annually for industrial applications and, consequently, contributes to substantial diesel engine synergies in the Volvo Group. Volvo Penta is now focusing on benefiting from the Group’s new generation of diesel engines for further growth in the industrial engine business. This will occur partly through strong growth in the core segment, diesel-powered generator sets, as well as through a broader customer base within various types of mobile applications, such as terminal forklifts, stone crushers and compressors.
 
Strategic development. Volvo Penta has implemented extensive product introductions in recent years. In 2007, the ambitions are:
 
 
·
Increased growth and strong focus on profitability.
 
 
·
Broadened customer base in industrial engines.
 
 
·
Delivery precision and shortened lead times in production.
 
Products. In recent years, Volvo Penta has moved to increase the use of electronics in the marine engine industry. End customers benefit through customer value in the form of cleaner and quieter engines and better performance while at the same time boat builders can enhance the efficiency of their production.
 
Electronics also facilitate a new type of functionality, for example Volvo Penta’s new joystick that makes docking of boats significantly easier and safer. Volvo Penta is the only company in the leisure boat industry that can currently offer this function.
 
Production and capacity. To meet the increased demand for the own-developed D4 and D6 marine engines, SEK 100 M was invested in the Vara plant, which resulted in increased capacity to about 18,000 engines annually. During the past five years, Volvo Penta has invested about SEK 800 M in the Vara plant, which more than doubled production and the number of employees.
 
Markets and Sales. The following table sets forth Volvo Penta’s sales by geographic market area and operating income for the years 2004, 2005 and 2006:
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2004
 
2005
 
2006
 
   
(In millions of SEK)
 
Western Europe
         
4,723
   
4,845
   
5,459
 
Eastern Europe
         
184
   
257
   
363
 
North America
         
2,500
   
2,832
   
2,815
 
South America
         
142
   
208
   
221
 
Asia
         
1,324
   
1,427
   
1,359
 
Other markets
         
184
   
207
   
268
 
Total sales
         
9,057
   
9,776
   
10,485
 
Operating income
         
940
   
943
   
1,002
 

Volvo Aero
 
The total market. Market fundamentals remained strong in 2006. World airline passenger traffic increased by 4.5% in 2006. Traffic growth varied between world regions, with airlines in Europe and the Asia-Pacific region experiencing the strongest rates of traffic growth during the year, followed by carriers in the US. The year 2006 was also another record-breaking load factor year.
 
The year 2007 is expected to be the first profitable year for the airline industry since 2000. However, the International Air Transport Association (IATA) states that airlines must continue keep load factors high by carefully managing capacity and by finding further efficiency gains to achieve the USD 2.5 billion industry profit projected for 2007.
 
General. Volvo Aero offers its customers and partners responsibility for the development and manufacture of advanced engine components for aircraft and space rockets. Volvo Aero’s technologies, including a world-leading role in lightweight structures which is an expertise that is increasingly in demand in the aerospace industry and which contributes to Volvo Aero’s greater involvement in new aircraft engines.
 
Lightweight design is one of Volvo Aero’s strengths and has a major impact on fuel consumption and, consequently, the environment, an aspect that is highly in focus in the aerospace industry today.
 
Through applying Volvo Aero’s expertise in lightweight structures, simulation and newly patented production methods, engine manufacturers can reduce lead times for complete engine development, while at the same time engines becomes quieter and lighter. The results are reduced costs and lower weight, two decisive parameters for future aircraft engines. Reduced weight means lower fuel consumption and, consequently, lower emissions of carbon-dioxide and nitrogen oxide.
 
In 2006, Volvo Aero accounted for approximately 3% of Volvo’s sales.
 
Business environment. Order bookings for large commercial jets reached record levels and the total number of orders at the end of December 2006, for new aircraft was 4,988, corresponding to more than five year’s volumes at the current rate. The order intake at 1,882 large commercial aircraft in 2006 was a decrease of 12% compared to 2005, but still among the strongest in modern time. Airbus and Boeing have delivered 832 aircraft, up 25% compared with the year-earlier period. The current production up-cycle is expected to continue to rise driven by the sizable backlog and the anticipated return to airline industry profitability.
 
Strategic Development. For 2007, the ambitions are to:
 
 
·
Further develop Volvo Aero’s technology offering, to ensure a role in future engine programs.
 
 
·
Fulfill commitment in the development and manufacture of the new GEnx engine.
 
 
·
Expand Volvo Aero’s component business.
 
 
·
Increase volumes and improve profitability in the aftermarket.
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Products. Volvo Aero is in the midst of an expansionary period with many new production start-ups for aircraft engine components. During 2006, some 20 new production starts were initiated, the largest number ever in a single year. The company has invested heavily in research and product development and in a modern machine park.
 
Production and capacity. Development continued during the year on the GEnx engine, the single, largest investment in Volvo Aero’s history. At the beginning of the year, it was clear that Volvo Aero would be producing six different components for the GEnx engine. The first ground tests of the engine were carried out in March, with successful results and on schedule.
 
Volvo Aero has also continued assuming a role in the new engine programs that in a few years will be installed on aircraft replacing the popular Airbus 320 and Boeing 737. It was also finalized during the year that Volvo Aero will be involved in demonstrating technology in the US engine manufacturer Pratt & Whitney’s new geared turbofan engine. This new cooperation is a first strategic step toward positioning Volvo Aero for the future in this important market segment.
 
Through the acquisition of Aero-Craft, based in Newington, Connecticut, in December 2004, Volvo Aero’s specialized product portfolio was expanded with fan cases. A number of contracts for fan cases have been signed, for example for engines such as the GEnx, Trent 1000 and GE90. Building commenced in 2006 for the expansion of Aero-Craft’s plant in Newington.
 
Volvo Aero Services signed a five-year agreement with Emirates Airlines that gives the company exclusive rights to sell Emirates entire surplus spare parts inventory for aircraft and aircraft engines. In conjunction with this, Volvo Aero Services will open a distribution center for spare parts in Dubai. Volvo Parts will handle the logistics service, as assigned by Volvo Aero Services.
 
Markets and Sales. The following table sets forth Volvo Aero’s sales by geographic market area and operating income for the years 2004, 2005 and 2006:
 
       
2004
 
2005
 
2006
 
   
(In millions of SEK)
 
Western Europe
         
3,130
   
3,346
   
3,489
 
Eastern Europe
         
49
   
60
   
124
 
North America
         
3,127
   
3,612
   
3,815
 
South America
         
138
   
168
   
173
 
Asia
         
400
   
284
   
356
 
Other markets
         
81
   
68
   
91
 
Total sales
         
6,925
   
7,538
   
8,048
 
Operating income
         
403
   
836
   
345
 

Financial Services
 
Financial solutions are vital to the Volvo Group. They increase customer satisfaction, competitive benefits, profitability and growth. Financial Services offers traditional financial services such as installment contracts, operating and financial leasing and dealer financing. In many markets, insurance and rental services and other offerings are also available.
 
At its heart, a successful finance company is about relationships. Financial Services finds this to be true in each of its nearly 60 markets. Thus the year 2006 was characterized by intense efforts to align Financial Services more closely with its customers' operations. For example, new customer finance companies were started or approved in the emerging markets of China, Hungary and Slovakia. In Europe, a new regional structure to improve synergies, transparency and availability was introduced. The US sales organization was strengthened and restructured based on product categories.
 
At the end of 2006, management of the real estate and treasury operations was transferred to AB Volvo, which meant that the business area is solely a financial service operation from 2007.
 
Commercial Focus (CF), the strategic initiative launched in 2005, made it possible for Financial Services to better capitalize on existing growth possibilities. The CF initiative is a centralized business strategy that was formed to provide high quality financial solutions by utilizing knowledge and experience from local and international business teams. The goals are to integrate Financial Services´ activities more closely with the sales processes of the Volvo Group’s business areas, enhance the depth and breadth of the product offering and develop the supply of services to key accounts.
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Within the Danafjord real estate unit, a number of projects were started aimed at meeting the Volvo Group’s growing need for office premises and lighter duty properties. For example, investments were made in a new head office for Volvo 3P and Volvo Powertrain, both in Lundby, Göteborg. Non-strategic properties were divested or prepared for divestment during the year. The occupancy rate at the end of 2006 was 99.7% (99.9), and 49% (52) of the leases was to external tenants and 89% (81) of the leases extends for five years or more.
 
Volvo Treasury, the Group’s internal bank, coordinates the Group’s global funding strategy and financial infrastructure. It is also responsible for the management of all interest-bearing assets and liabilities and the execution of foreign exchange transactions. Volvo Treasury experienced strong earnings in 2006, with significant value creation in management of assets and in foreign exchange transactions.
 
Strategic development. For 2007 the ambitions for Financial Services are:
 
 
·
Improve customer satisfaction.
 
 
·
Enhance employee recruitment, development and retention activities.
 
 
·
Execute on market growth plus fee income opportunities.
 
 
·
Use better technology and processes to improve productivity and customer service.
 
 
·
Continue to sharpen risk management activities
 
Expanding credit portfolio. During 2006, the volume of new financing amounted to SEK 35.3 billion, up by more than SEK 2.2 billion compared with 2005.
 
On December 31, 2006, total assets amounted to SEK 84 billion (86 billion), of which SEK 77 billion (79 billion) related to the net credit portfolio. Adjusted for the effects of foreign-exchange movements, the credit portfolio grew by 5.3% during the year, compared with growth of 10% in the preceding year.
 
Suppliers
 
Volvo’s decision on whether to manufacture or to purchase from suppliers any particular component is made competitively on commercial terms. Although Volvo manufactures certain major components, including engines, transmissions and truck cabs, components are, to a large extent, purchased from suppliers outside of the Volvo Group. Increasingly, Volvo contracts with suppliers to manufacture an entire functional unit, such as completely finished seats, with the supplier assuming full responsibility for production to Volvo’s specifications. The primary prerequisites for cooperation with suppliers are near zero-defect quality level, competitive cost, and flexible and reliable delivery performance. Volvo also considers other factors, such as environmental matters, in its selection of suppliers.
 
Sources and availability of raw materials. Volvo purchases raw materials, parts and components from numerous outside suppliers. A significant part of the Group’s requirements for raw materials and supplies is filled by single-source suppliers. The effects of delivery interruptions vary depending on the item or component. Certain items are standard throughout the industry, whereas others are internally developed and require unique tools that are time-consuming to replace. A supplier’s inability to deliver could have negative consequences for production at certain Volvo Group manufacturing sites.
 
The Volvo Group’s costs for raw materials and components can vary significantly over a business cycle. Cost variations may be caused by changes in world market prices for raw materials or by an inability of our suppliers to deliver.
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See “Item 3.D - Risk Factors - The Volvo Group relies on suppliers”.
 
Marketing
 
The greater part of the sales of Volvo’s products takes place in Europe, North America and Asia. Globally the majority of Volvo’s products is sold through independent dealers. In Europe a majority of Volvo’s products is sold through independent dealers but a significant part of sales is carried out through Volvo’s own dealer network. In North America products are sold mainly through independent dealers but Volvo also has a substantial part of direct sales to large fleet customers.
 
Research and Development
 
In 2006, 2005 and 2004, research and development expenses were SEK 8,354 million, SEK 7,557 million and SEK 7,614 million, respectively. Considerable research work is devoted not only to traditional product development, but also to developing effective software and total solutions designed to improve profitability in Volvo’s customer’s business.
 
New improved products Volvo's research and development focuses on its customers' business, environmentally adapted solutions and safety awareness. In the beginning of 2006, the Volvo Group presented a new efficient hybrid solution for heavy vehicles. In May 2006 Renault Trucks announced the launch of new versions of the Renault Midlum and Renault Premium Distribution with new engines that meet the Euro 4 emission standard. Volvo Trucks also announced in May 2006 the launch of two completely new distribution trucks - the Volvo FL and the Volvo FE. Both models meet the environmental requirements according to Euro 4 and Euro 5. In June 2006, Volvo Buses premiered the new version of the Volvo 7700 city bus. An important feature is the shift from a 7-liter engine to Volvo’s new 9-liter engine, available in diesel and gas versions, that meets the Euro 4 emission standard. In product development, all business areas and business units use a well-structured process with quality gates and milestones specifying the requirements that have to be fulfilled before a project is allowed to continue. Safety and environmental requirements are also key parameters in the process.
 
The focus on product quality in the development process as well as in the interface with the customer has led to improved results in customer satisfaction measurements.
 
Safety in focus. For the Volvo Group, safety is about how its products are used in society. The company works consistently to minimize the risk and consequences of accidents, and to improve drivers’ safety and work environment.
 
The safety program’s first focal point is accident prevention. Human errors or misjudgements are decisive or strongly contributory causes of most traffic accidents, a fact that reflects the importance of preventative safety characteristics such as good visibility, driving qualities and brakes. The human factor is also the most common cause of accidents involving construction equipment.
 
The second focal point is injury prevention. The Volvo Group is a leader in designing vehicles that protect the driver and passengers in the event of a collision. Safety solutions include rollover-tested cabs and bodies, frontal collision protection, deformation zones, seat belts, deformable fittings and airbags. Seat belts are by far the most important safety feature.
 
From an early stage, the Volvo Group has worked on improving safety for other road-users. A large proportion of accidents between trucks and passenger cars involve frontal collisions. As early as 1996, the company introduced the Front Underrun Protection System to prevent passenger cars from becoming wedged beneath trucks in a frontal collision. This protection system became fitted as standard on Volvo trucks in the EU in 2001, and in 2003 the protection system became a legal requirement in EU countries. Accident investigations show that the Front Underrun Protection System substantially reduces injuries.
 
Environmental improvement and utilization. The greatest environmental impact caused by the Volvo Group’s products occurs during use.
 
The Volvo Group primarily uses diesel engines in its products due to their high energy efficiency and low emissions. Improved fuel efficiency is a highly effective way of reducing carbon-dioxide emissions and cutting costs for customers.
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In order to improve air quality, governments in many countries are making increasingly stringent demands for the reduction of emissions, primarily nitrogen oxides and particulates. New, stricter emission laws were introduced in the EU on October 1, 2006 and in the USA on January 1, 2007 for trucks and buses. Even stricter requirements will be introduced in a few years’ time. To meet these requirements, the Volvo Group is continuously developing new engine technology to minimize fuel consumption and emissions. The primary focus of this development work is on diesel engines.
 
One of the most important environmental issues is climate change, which affects all aspects of society. The way in which climate issues are handled will impact strongly on global development. Rising carbon dioxide levels in the atmosphere are primarily caused by the combustion of fossil fuels from oil, coal and natural gas. The transport sector is responsible for roughly 25% of fossil fuel consumption, and for 25% of carbon dioxide emissions. Road traffic is responsible for approximately 15%.
 
Climate change and access to energy sources may strongly affect the Volvo Group. It is therefore vital to prepare for the use of fuels other than crude oil. These efforts focus largely on the development of new drivelines, energy efficiency and alternative fuels.
 
Patents, Trademarks and Licenses
 
Volvo’s patents, trademarks, trade names and licenses are important to the business of each of the business areas within Volvo. Volvo owns or otherwise has rights to a substantial number of trademarks that it uses in conjunction with its business. Volvo believes that the level of protection of trademarks and other intellectual property rights used in its business is and has historically been adequate relative to its business. Volvo will use its best efforts to maintain the protection of such rights to the same extent in the future and is continuously evaluating and renewing its trademark and trade name registrations in all countries in which Volvo does any material amount of business. After the sale of Volvo Cars to Ford, the Volvo trademark is owned by Volvo Trademark Holding AB, which is jointly owned by AB Volvo and Volvo Car Corporation. The right to use the trademark “Volvo” has thereafter been regulated through license agreements made between Volvo Trademark Holding AB and AB Volvo and Volvo Car Corporation, respectively.
 
Volvo Car Corporation has the right to use the “Volvo” trademark for passenger cars, minivans carrying up to 10 passengers, light trucks with payload up to 1,500 kilograms, sports utility vehicles and other vehicles, but not buses or other vehicles used solely for commercial purposes, that have a gross vehicle weight of not greater than 5,400 kilograms (12,000 lbs. gross weight). AB Volvo has the right to use the trademark for trucks, buses, construction equipment, industrial and marine engines, aerospace equipment and all other products (apart from those for which Volvo Car Corporation has the right to use the trademark). To secure these rights and avoid having the trademark eroded AB Volvo and Volvo Car Corporation have jointly adopted mechanisms to control their respective use of the trademark and to prevent others from taking undue advantage of it.
 
With regard to the “Mack” trademark, which is owned within the Volvo Group, similar control mechanisms apply. Volvo’s right to use the “Renault” trademark is limited to the truck sector only and is governed by a license agreement with the French company Renault SA, the owner of the “Renault” trademark.
 
Regulatory Matters
 
Environmental and Other Regulatory Matters
 
The corporate values of quality, safety and environmental care are present in the daily operations of the Volvo Group. Quality and environmental management systems are used in all parts of the organization as the means for addressing responsibility and objectives. The Group policies and a common network of environmental auditors monitor compliance with Group guidelines and objectives.
 
The Group's environmental targets are used for follow-up purposes throughout the organization and are closely linked to its business plans. The Volvo Group’s environmental targets can be summarized in the following environmental challenges.
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The challenges facing production are:
• Reducing energy consumption by 50% per unit produced by 2008 compared with 2003
 
• Doubling the use of carbon-dioxide neutral energy by 2008 compared with 2003
 
• Terminating all use of oil and coal for the heating of facilities.
 
Challenges regarding product use:
 
• Achieving high fuel efficiency and low emissions throughout product life cycles
 
• Measuring against the best
 
• Consistently carrying out activities to become the industry leader
 
• Producing environmental data for follow-up and communication for each new product developed
 
• Implementing a strategy for tomorrow’s fuels
 
• Including alternative fuels and alternative drivelines in product plans.
 
Reduced emissions. Since 1980, the fuel consumption of Volvo’s trucks has dropped by 30% at the same time as the engines have become cleaner. Over the past 30 years, diesel engines have seen a hundredfold reduction of regulated emissions.
 
Further important strides were taken in 2006. The Volvo Group presented a completely new engine family to meet the stricter environmental requirements introduced in the United States on January 1, 2007. The engines have been approved according to US'07 by the US Environmental Protection Agency.
 
The US has a highly ambitious plan for reducing emissions from heavy traffic. Starting from 2007, the proportion of nitrogen oxide and particulates will be reduced by 50% and 90% respectively in new engines. Emission requirements in the US will become even stricter in 2010.
 
In Europe, the Group’s heavy engines meet the stricter Euro 4 emission requirements that took effect on October 1, 2006. Meanwhile, Volvo has developed engines that already meet the new requirements to take effect in 2009. Since April 2006, a refuse truck has been in use with a D13 engine that meets Euro 5 requirements - three years before these requirements come into force. This is the Group’s first delivery of a Euro 5 product.
 
 
The Volvo Group's operations during 2006 were organized in eight business areas: Volvo Trucks, Renault Trucks, Mack Trucks, Buses, Construction Equipment, Volvo Penta, Volvo Aero and Financial Services. In addition to the eight business areas, there are other operations, consisting mainly of service companies that are designed to support the business areas' operations. For financial reporting purposes the business areas Volvo Trucks, Renault Trucks and Mack Trucks are reported as one segment.
 
Each business area except Financial Services has total responsibility for its operating income and operating capital. The Financial Services business area has responsibility for its net income and total balance sheet within certain restrictions and principles that are established centrally.
 
The supervision and coordination of treasury and tax matters is organized centrally to obtain the benefits of a Group-wide approach. The legal structure of the Volvo Group is based on optimal handling of treasury, tax and administrative matters and, accordingly, differs from the operating structure.
 
See “Item 18 - Financial Statements - Note 4” for information concerning Volvo’s group structure and significant subsidiaries, including the name, country of incorporation, proportion of ownership interest and, to the extent different, proportion of voting power held.
38

 
At December 31, 2006, the eight business areas of Volvo had manufacturing facilities worldwide.
 
Major components for the Group’s products are manufactured in Sweden, including engines, power transmission systems, cabs and sheet metal components.
 
Trucks are primarily assembled in plants in Sweden, Belgium, France, Spain, Brazil, Venezuela, Australia, the United States, China, India and South Africa.
 
Volvo’s bus production takes place in Sweden, Finland, Poland, Brazil, Canada, Mexico, India, China and South Africa.
 
Facilities for production of construction equipment are located in Sweden, Germany, France, Poland, the United States, Canada, Brazil, South Korea and China.
 
Volvo Penta’s production facilities are in Sweden, United States and China.
 
The production facilities of Volvo Aero are located in Sweden, Norway and the United States.
 
The major part of the properties owned by the Volvo Group is used in the Group’s own operations. A certain number of the properties owned are leased to others, primarily Volvo Car Corporation. The greater part of Volvo’s production facilities is owned by Volvo.
 
Volvo believes that the Group’s principal manufacturing facilities and other significant properties are in good condition and are adequate to meet the needs of the Volvo Group.
 
Environmentally adapted production. Volvo Group has production facilities on every continent, ranging from state-of-the-art, highly automated factories to small-scale production.
 
Regardless of size and location, all production units must meet the Group’s minimum requirements for environmental performance. These requirements include guidelines for chemical use, energy consumption, air and water emissions, waste management, environmental organization and improvement efforts. If local laws and regulations are more comprehensive than the Group’s requirements, they must be followed. Most factories meet the requirements by a wide margin and are showing constant improvement.
 
Since 1989, Volvo has been carrying out environmental audits to ensure that all the plants comply with the Group’s environmental policy.
 
The Volvo Group has insurance coverage for environmentally related damage to its immediate surroundings, for instance in the event of unexpected emissions. Newly acquired companies and properties are subjected to due diligence examinations which, in addition to financial and legal aspects, also examine environmental factors and risks.
 
All the Volvo Group’s production facilities have the requisite environmental permits. In Sweden, there are 16 facilities that require permits. These permits encompass waste, noise and emissions into the air, ground and water. One Swedish environmental permit was renewed in 2006, and four permits are due for renewal in 2007.
 
Freight. Air pollution from our own industrial operations is substantially lower than the emission from transport of goods to and from our production facilities. In order to encourage environmental improvement measures in our transport systems, Volvo Logistics, the Group's procurement company for transport services, continuously assesses the environmental work of contracted transport companies according to a classification system. Every new supplier contract includes an environmental clause whereby the transport company undertakes to operate in accordance with the ISO 9000 and ISO 14001 standards.
39

 
There are no unresolved staff comments.
40

 
 
The following operating financial review should be read in conjunction with the Company's Consolidated Financial Statements included herein. The Consolidated Financial Statements and the financial information discussed below have been prepared in accordance with International Financial Reporting Standards, IFRS, as adopted by European Union, EU. For a discussion of the principal differences between IFRS and US GAAP, see “Item 18.  Financial Statements—Note 38.”
 
General

The following table sets forth the Volvo Group’s sales and operating income by business areas for each of the years in the three-year period ended December 31, 2006.
   
2004
 
2005
 
2006
 
       
(In millions of SEK)
 
Net sales
             
Trucks
   
136,879
   
155,396
   
166,306
 
Buses
   
12,722
   
16,589
   
16,856
 
Construction Equipment
   
29,360
   
34,816
   
40,564
 
Volvo Penta
   
9,057
   
9,776
   
10,485
 
Volvo Aero
   
6,925
   
7,538
   
8,048
 
Financial Services
   
9,598
   
7,549
   
8,969
 
Other and eliminations
   
6,535
   
8,895
   
7,607
 
Total, as reported
   
210,401
   
240,559
   
258,835
 
                     
Operating income (loss)
                   
Trucks
   
8,992
   
11,717
   
12,657
 
Buses
   
158
   
470
   
633
 
Construction Equipment
   
1,898
   
2,752
   
3,888
 
Volvo Penta
   
940
   
943
   
1,002
 
Volvo Aero
   
403
   
836
   
345
 
Financial Services
   
1,365
   
2,033
   
2,301
 
Other
   
923
   
-598
   
(427
)
Total, as reported
   
14,679
   
18,153
   
20,399
 
____________
 
Volvo’s investment in Scania AB
 
During 1999 and 2000, Volvo acquired 45.5% of the capital and 30.6% of the voting rights in Scania AB, one of the world’s leading manufacturers of trucks and buses. As a condition in connection with the European Commission’s approval of Volvo’s acquisition of Renault V.I. and Mack Trucks Inc. in 2001, Volvo undertook to divest its holding in Scania not later than April 2004. In April 2004, the Annual General Meeting approved a dividend to AB Volvo's shareholders of 99% of the shares in Ainax AB, a wholly owned subsidiary holding all of Volvo's Scania Series A shares. The distribution of shares in Ainax AB to Volvo’s shareholders was made on June 8, 2004 and the value of this dividend was SEK 6,310 million. Volvo has no longer any holdings in Scania AB or Ainax AB.
Volvo’s investment in Henlys Group plc

During 1998 and 1999, Volvo acquired 9.9% of the capital and voting rights in Henlys Group plc at a total acquisition cost of SEK 524 million. Henlys Group was a British company involved in manufacturing and distribution of buses and bus bodies in Great Britain and North America. Volvo and Henlys Group jointly owned the shares of the North American bus operations Prévost and Nova Bus. In February and March 2004, Henlys announced that its earnings for 2004 were expected to be significantly lower than previously anticipated. As a consequence of receiving this information, it was determined at the date when Volvo issued its 2003 financial statements that Volvo's holding in Henlys Group plc was permanently impaired at December 31, 2003, and a write-down was charged to Volvo’s operating income under Swedish GAAP for 2003. On June 10, 2004, Henlys Group announced that it was holding discussions with its lending banks and other principal creditors regarding a restructuring of the Henlys Group, and that it intended to delist its shares from the London Stock Exchange, Volvo wrote-down its remaining stake, SEK 95 million, in the second quarter 2004.
41

In October 1999, Volvo issued a convertible debenture loan to Henlys Group of USD 240 million in connection with Henlys Group’s acquisition of the US school bus manufacture Bluebird. The convertible debenture loan matured in October 2009. During the autumn 2004 Henlys Group was restructured. As part of the restructuring, Volvo Group reached an agreement to acquire the remaining 50% of the North American bus manufacturer Prévost Car Inc., containing the Prévost and Nova brands. The purchase price was SEK 554 million including two loans made available to Prévost Car Inc. by Henlys. In accordance with the agreement, Prévost Car Inc. became a wholly owned subsidiary of Volvo Bus Corporation. The agreement also involved Volvo converting part of the convertible debenture loan of SEK 1,601 million issued to Henlys into common and preferred shares in a newly established US-based company, Peach County Holdings Inc, containing the US school bus manufacturer Blue Bird. After the conversion Volvo owned 42.5% of the common shares in the new company. The conversion resulted in a write-down of approximately SEK 1.3 billion 2004, see “Item 18.  Financial Statements—Note 11.”
 
Peach County Holdings, Inc
 
During the fourth quarter of 2005 Volvo wrote down its shareholding in Peach County Holdings, Inc. by about SEK 550 M. At December 31, 2005 Volvo held 42.5% of the US-based company, which in turn owns the American school bus manufacturer Blue Bird. Since its reconstruction in the preceding year, Blue Bird did not develop well. The write-down was made as a consequence of Volvo’s decision not to participate in continued financing efforts. After the write-down, the value is zero. In January 2006, Peach County Holdings entered into reorganization proceedings (Chapter 11) and as a consequence of Volvo choosing not to participate in the continued reconstruction, Volvo’s shares in the company were cancelled.
 
Volvo and Renault agreement
 
In July 2000, AB Volvo reached an agreement with Renault S.A. to acquire Mack Trucks and Renault V.I., the truck operations of Renault, in exchange for 15% of AB Volvo's shares.
 
During 2001, AB Volvo and Renault S.A. entered into a dispute regarding the final value of the acquired assets and liabilities in Renault V.I. and Mack Trucks. The dispute was settled during the fourth quarter of 2004 and an amount of SEK 981 million has reduced the goodwill amount pertaining to the acquisition of Renault V.I.
 
Economic and market conditions. The global economy continued to register solid growth in 2006 with a global GDP ranging from 4 percent to 5 percent. The positive trend was evident in most global regions but is particularly noticeable in China, Eastern Europe and other emerging markets. Rapid growth in global economy has resulted in high demand for energy. Oil prices have risen sharply in recent years, with a peak price of USD 75 per barrel in summer 2006. Price levels have fallen since then, reaching about USD 59 per barrel at year-end 2006. While at the same time that there is a high demand for energy, the supply is limited, due partly to the political unrest in the Middle East, which affects prices. The prices of raw material to industry, such as metals and rubber, also rose during the year.
 
Overall, demand was very high in the markets in Europe, North America and South America. The total market for heavy trucks, based on the number of registered vehicles, in EU member countries plus Norway and Switzerland) rose 7% to 295,000 trucks in 2006. The overall market for heavy trucks in North America (Class 8) rose 13% in 2006 to 348.900 heavy trucks, compared with 308,000 trucks in 2005. This was driven by favorable market conditions in the US which resulted in increased needs for transports. In addition, customers chose to purchase new trucks prior to the new, stricter emissions legislation that became effective on January 1, 2007. The market for heavy trucks in Brazil declined by 9%. Among the major markets in Asia, Japan grew 6%, China 29% and India 41%. In the Middle East, however, the overall market fell 50%, due largely to the decline in Iran, which fell by a full 94%.
42

In 2006, the total market for heavy and compact construction machines in Volvo Construction Equipment’s product segment rose by 10%. In North America, the market declined by 4% while Europe rose by 11%, and the other markets by 21%. Total market growth was driven by both heavy and compact construction machines. The North American market for heavy construction machines grew 3%, while the market in Europe rose 15%. The other markets increased by 22%. The total market for compact construction equipment grew in 2006 by 6%, compared with the preceding year. The North American market showed a decrease of 8% while the European market was up 9%. Other markets rose by 20%.
 
Factors affecting results. The Volvo Group’s sales are principally affected by unit sales volume and vehicle prices as well as by currency fluctuations, product mix and sales of optional equipment. The profitability of Volvo’s operations depends on a number of factors, including research and development expenses and the ability to achieve cost and capital efficiencies in product manufacturing.
 
Impact of Currency Fluctuations. A substantial amount of Volvo’s assets and debt are denominated in currencies other than Swedish kronor or located in countries other than Sweden. Most of Volvo’s sales take place outside Sweden with invoicing in U.S. dollars and other currencies. The sales outside Sweden amounted to SEK 196,470 million, SEK 225,225 million and SEK 245,030 million, or 93%, 94% and 95% of Group sales in 2004, 2005 and 2006, respectively.
 
A large part of Volvo’s production takes place outside Sweden. In addition, a large percentage of the Group’s suppliers are located outside the production countries from which Volvo imports, among other things, parts and various raw materials, which may be invoiced in currencies other than kronor. Volvo’s sales and income, expressed in kronor, may be materially affected by fluctuations in the exchange rates between the kronor and the currencies in which the Group sells to customer or purchases from suppliers.
 
Changes in exchange rates have both dynamic and direct effect on income. The dynamic effects include the pricing of products sold and materials purchased in foreign currency. Changes in exchange rates also affect competitors and thus have an indirect impact on Volvo’s competitiveness. The direct effects arise mainly when income, expense, assets and liabilities in foreign currencies are translated to Swedish kronor at rates different than those used to translate financial items for an earlier period.
 
The average exchange rates between the Swedish krona and the US dollar strengthened by 1.3% while the Euro was almost unchanged for 2006 compared to 2005.
 
The total effect of changes in currency exchange rates on operating income in 2006 compared with 2005 was negative by approximately SEK 1.000 million. The transactional effect of changed spot-market rates was negative, approximately SEK 1,200 million. The effect on income of forward and option contracts amounted to a gain of SEK 484 million (gain of SEK 828 million in 2004 and loss of 566 million in 2005).Changes in spot rates in connection with the translation of income in foreign subsidiaries and the revaluation of balance sheet items in foreign currencies had a positive impact of SEK 453 million.
 
Adoption of International Financial Reporting Standards. From January 1, 2005, AB Volvo prepared its consolidated financial statements in accordance with IFRS. See Notes 1 and 3 to the consolidated financial statements. In addition, consolidated net income and stockholders’ equity are reported as reconciled to U.S. GAAP. Unless otherwise indicated, all amounts and percentages presented herein are based on IFRS. IFRS as applied by the Company differs in certain significant respects from U.S. GAAP. For a discussion of the significant differences between IFRS and U.S. GAAP affecting AB Volvo’s consolidated financials statements and reconciliation to U.S. GAAP of consolidated stockholders’ equity and consolidated net income as of and for each of the years ended December 31, 2006 and 2005, see Note 38 to the consolidated financial statements.
 
Results from continuing operations
 
2006 compared with 2005

Volvo Group. Net sales in 2006 amounted to SEK 258,835 million (240,559), an increase of 8% compared with a year earlier. Adjusted for changes in currency rates, net sales rose 6%. Net sales for the Group's truck operations amounted to SEK 166,306 million, which adjusted for changed exchange rates corresponded to an increase of 7%. The increase was attributable to higher sales, primarily in North America, Europe and Other markets. Demand in North America was driven by the fact that customers chose to buy trucks before the new emission legislation came into force by January 1 2007 and also increased transport needs. In Europe, demand rose from an already historically high level. In all of Europe there is an increased need for transports and especially between the Western and Eastern parts of Europe, which means an increased need for heavy trucks. The strongest development is happening in Eastern Europe, where new member countries of the EU contribute substantially. Also countries outside the EU in Eastern Europe are developing favorably. In total, Volvo delivered 219,931 trucks in 2006, 3% more than in the preceding year.
43

Net sales within Buses rose 2% compared with 2005. Adjusted for currency effects the increase was 2%. As a result of a broadened production range and improved market shares in a rising world market, net sales in Construction Equipment increased by 17%. Adjusted for currency effects the increase was also 17%. Volvo Penta succeeded in offsetting the reduction in deliveries of industrial engines to China through growing on other markets. Net sales rose 7% in 2006, or 8% adjusted for currency changes. The recovery in the aerospace industry affected Volvo Aero positively and net sales increased by 7%. Adjusted for changes in currency rates, the increase was also 7%.
 
Strong economic growth combined with a major need to replace ageing fleets of trucks and construction equipment contributed to an increase of 10% in net sales in North America. Net sales in Europe was 10%, but the growth rate varied substantially between the Eastern part of Europe, where net sales increased by 41%, and the Western part, where net sales increased by 7%. Net sales in South America were up 5% as a consequence of the increased sales of mainly trucks and construction equipment.
 
Operating income in 2006 increased 12% to SEK 20,399 million (18,153). AB Volvo has decided to reverse a valuation reserve for deferred tax receivables in the Mack Trucks Inc. subsidiary. The decision is based on the fact that Volvo assesses that the company has a long-term higher profitability. Reporting of the deferred tax receivables reduced tax expenses in the income statement in the third quarter of 2006 by SEK 2,048 M. In accordance with prevailing accounting rules, Volvo is adjusting goodwill by SEK 1,712 M, which affects operating income adversely. The combined earnings effect for the third quarter of 2006 was a positive SEK 336 M. Excluding the goodwill adjustment operating income rose by 22% compared to 2005. The improvement is the result mainly of improved product and market mix and higher prices on new products with increased customer value.
 
Trucks. Net sales for the Group’s truck operations amounted to SEK 166,306 M, which adjusted for changed exchange rates corresponded to an increase of 7%. The increase was attributable to higher sales, primarily in North America, Europe and Other markets. Demand in North America was driven by the fact that customers chose to buy trucks before the new emission legislation came into force by January 1 2007 and also increased transport needs. In Europe, demand rose from an already historically high level. In all of Europe there is an increased need for transports and especially between the Western and Eastern parts of Europe, which means an increased need for heavy trucks. The strongest development is happening in Eastern Europe, where new member countries of the EU contribute substantially. Also countries outside the EU in Eastern Europe are developing favorably. In total, Volvo delivered 219,931 trucks in 2006, 3% more than in the preceding year.
 
Research and development expenses for Trucks in 2006 amounted to SEK 5,872 million, compared with SEK 5,200 million in 2005.
 
Operating income for Trucks improved and amounted to SEK 14,369 million (11,717), excluding adjustment of goodwill of a negative SEK 1,712 million. The increase was 23% compared to 2005. The improved result is attributable primarily to North America, where Mack Trucks and Volvo Trucks increased profitability through a favorable price realization and increased volumes. In Europe, Volvo Trucks continued to improve its earnings while profitability for Renault Trucks’ operations in Europe declined somewhat.
 
Buses. Volvo delivered 10,360 buses and bus chassis (10,675) during 2006. High sales were reported mainly in North America, South America and Asia. During the year, 1,300 of an order for 2,000 midi-buses were delivered to Shanghai in China.
44

Net sales during 2006 were largely unchanged compared with a year earlier, SEK 16,856 million (SEK 16,589 million). Operating income rose from SEK 470 M to SEK 633 M. Operating margin increased from 2.8% to 3.8%.
 
Among other factors, the stronger earnings are attributable to better product and market mixes and increased cost awareness resulting in more efficient production methods as well as increased use of components that are common with Volvo Trucks. Operating income included a positive effect of SEK 47 million following settlement of a dispute regarding export credits in Brazil.
 
Research and development expenses for Buses in 2006 amounted to SEK 603 million, compared with SEK 569 million in 2005.
 
Construction Equipment. Net sales rose by 17% to SEK 40,564 million (SEK 34,816 million). Adjusted for exchange-rate effects, the increase was 17%. The increase was attributable mainly to increased volumes, improved distribution and advantageous product and market mix.
 
Operating income improved by 41% during the year and amounted to SEK 3,888 million (SEK 2,752 million), which represents an operating margin of 9.6% (7.9%). The earnings and margin improvements were due to the advantageous product and market mix, high capacity utilization and good control of selling and administrative expenses, as well as to active price management.
 
Research and development costs for Construction Equipment in 2006 amounted to SEK 1,008 million compared with SEK 1,083 million in 2005.
 
Volvo Penta. Sales rose by 7% to a total of SEK 10,485 million, compared with SEK 9,776 million in the preceding year. Operating income increased to SEK 1,002 million (943). Sales and operating income are the highest ever in Volvo Penta’s history. The operating margin remained at the same level as in 2005 9.6%.
 
Research and development costs for Penta in 2006 amounted to SEK 445 million compared with SEK 413 million in 2005.
 
Volvo Penta maintained its high profitability during 2006 and at the same time implemented aggressive investments in product development and substantial marketing efforts to capitalize on the new and competitive product portfolio. Operating income increased by 6% and amounted to SEK 1,002 million.
 
Volvo Aero. Volvo Aero’s net sales rose by 7% to SEK 8,048 million (7,538). The sales increase is attributable mainly to higher volumes, primarily in the engine component production.
 
Operating income amounted to SEK 345 million (836). The decline in earnings is due among other reasons to continued profitability problems in the aftermarket business. This was also one of the reasons why Volvo Aero in November made the strategic decision to close the engine overhaul operations in Bromma, Sweden. Earnings were negatively affected to the extent of SEK 258 M and operating margin decreased to 4.3% (11.1).
 
Development in the engine component business remained strong, with increased production volumes and higher sales volumes for new spare parts. The positive trend was offset partly by many production start-ups of new engine components, which had a negative impact on capacity utilization in the production plants. Higher raw material prices also affected earnings negatively.
 
Research and development costs in Volvo Aero amounted to SEK 288 million in 2006, compared with SEK 225 million in 2005.
 
Volvo Financial Services, VFS. Operating income for VFS in 2006 amounted to SEK 2,301 million, up 13% from the SEK 2,033 million reported in 2005. Return on equity was 15.5% (15.3), with a year-end equity ratio of 11.5% (11.2%). Throughout 2006, VFS successfully achieved a healthy balance among credit risk, volume, sales penetration and professional pricing. All customer finance regions improved performance over the prior year. Write-offs in 2006 totaled SEK 259 million, corresponding to an annualized write-off ratio of 0.33% (0.40). On December 31, total credit reserves amounted to SEK 1,578 million giving a credit-reserve ratio at year-end of 2.01%.
45

Other. Operating income from the Group’s other operations including AB Volvo and certain internal service companies, amounted to a loss of SEK 427 million (loss SEK 598 million) . In 2005 other operations included a capital gain of SEK 430 million from the divestiture of Celero Support and a write down of AB Volvo’s holding in Peach County Holding, Inc. (Blue Bird) which impacted operating income negatively with an amount of SEK 653 million.
 
Net interest expense. The net interest income for 2006 amounted to SEK 81 million compared to a net interest expense of SEK 318 million for the preceding year. The improvement is primarily a result of higher short-term interest rates in Sweden and lower cost for the pension liability due to lower pension liabilities as a result of capital injections to the Group’s pension foundations.
 
Other financial income and expense. Other financial income and expenses were negatively impacted by marked-to-market revaluation of derivatives used for hedging of the customer finance portfolio. The negative revaluation impact was SEK 61 million during 2006 and was a result of declining long-term interest rates in the US and Canada during the second half of 2006. During 2005 the revaluation impact was positive amounting to SEK 251 million.
 
Income taxes. The income tax expense for 2006 was SEK 3,981 million corresponding to a tax rate of 20%. During the third quarter of 2006 AB Volvo reported a tax income of SEK 2,048 million due to the reversal of a valuation allowance for tax receivables in Mack Trucks Inc. During 2005 the income tax expense amounted to SEK 4,908 million and a tax rate of 27%.
 
Minority interest. Minority interests in income (loss) for the period and in shareholders' equity consisted mainly of the minority interests in Volvo Aero Norge AS (22%), in Wuxi da Hao Power Co, Ltd (30%) and in Berliet Maroc S.A (30%).
 
Financial Services operations

Supplementary income statements and balance sheets
 
In the supplementary income statements and balance sheets below, all Financial Services activities are separated from Volvo’s other operations in order to show how the activities have developed.
Condensed income statements, Financial Services
 
2004
 
2005
 
2006
 
   
(In millions of SEK)
 
Net sales
   
9,598
   
7,549
   
8,969
 
Income after financial items
   
1,365
   
2,033
   
2,301
 
Income taxes
   
(430
)
 
(609
)
 
(756
)
Net income
   
935
   
1,424
   
1,545
 
 
Separate condensed balance sheets are presented for Financial Services and for Volvo’s industrial and commercial operations (“Volvo Group excluding Financial Services”) since the capital structures of these operations are significantly different and therefore this additional information is requested from shareholders and creditors in order to be able to better evaluate the financial position of the Volvo Group. The condensed balance sheets below are presented for the Total Volvo Group as well as separately for Financial Services and for the Volvo Group excluding Financial Services. The Volvo Group’s financial targets as established by its Board of Directors further include separate targets for the capital structure within Financial Services and Volvo’s industrial and commercial operations.
46

 
   
Volvo Group, excl Financial Services 1
 
Financial Services
 
Total Volvo Group
 
Condensed balance sheets
 
2004
 
2005
 
2006
 
2004
 
2005
 
2006
 
2004
 
2005
 
2006
 
   
(In billions of SEK, except for %)
 
Assets
                                     
Intangible assets
   
17.6
   
20.3
   
19.1
   
0.0
   
0.1
   
0.1
   
17.6
   
20.4
   
19.1
 
Property, plant and equipment
   
27.3
   
31.3
   
30.5
   
3.9
   
3.7
   
3.9
   
31.2
   
35.1
   
34.4
 
Assets under operating leases
   
8.5
   
10.3
   
11.8
   
0.8
   
0.7
   
0.3
   
19.5
   
20.8
   
20.5
 
Shares and participations 
   
10.1
   
10.3
   
16.6
   
0.2
   
0.0
   
0.0
   
2.0
   
0.8
   
6.9
 
Long-term customer finance receivables
   
0.1
   
0.7
   
0.6
   
33.9
   
39.1
   
39.3
   
25.2
   
31.2
   
32.1
 
Long-term interest bearing receivables
   
1.8
   
1.4
   
3.5
   
0.0
   
0.1
   
0.1
   
1.7
   
1.4
   
3.1
 
Other long-term receivables
   
6.5
   
7.2
   
7.7
   
0.2
   
0.3
   
0.4
   
6.1
   
7.0
   
7.9
 
Inventories
   
28.3
   
33.6
   
33.9
   
0.3
   
0.3
   
0.3
   
28.6
   
33.9
   
34.2
 
Short-term customer finance receivables
   
0.1
   
0.6
   
0.6
   
29.5
   
38.9
   
37.0
   
26.0
   
33.3
   
32.6
 
Short-term interest bearing receivables
   
10.3
   
6.3
   
9.7
   
0.0
   
0.0
         
1.6
   
0.5
   
1.0
 
Other short-term receivables
   
30.0
   
36.8
   
35.6
   
1.7
   
1.6
   
1.5
   
29.7
   
35.9
   
34.7
 
Non-current assets held for sale
               
0.8
                                 
0.8
 
Marketable securities
   
25.8
   
28.7
   
20.3
   
0.1
   
0.1
   
0.0
   
26.0
   
28.8
   
20.3
 
Cash and bank accounts
   
8.8
   
7.4
   
9.6
   
0.9
   
0.9
   
1.2
   
8.8
   
8.1
   
10.8
 
Total assets
   
175.2
   
194.9
   
200.3
   
71.5