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Edited Transcript of 051910.KS earnings conference call or presentation 24-Jul-19 7:00am GMT

Q2 2019 LG Chem Ltd Earnings Call

Seoul Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of LG Chem Ltd earnings conference call or presentation Wednesday, July 24, 2019 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Ho-Young James Jeong

LG Chem, Ltd. - CFO, Internal Accounting Control System Officer and Director

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Conference Call Participants

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* Dong Jin Kang

HMC Investment Securities Co., Ltd., Research Division - Analyst

* Min Seok Won

HI Investment & Securities Co., Ltd., Research Division - Research Analyst

* Yeon-ju Park

Mirae Asset Daewoo Securities Co., Ltd., Research Division - Research Analyst

* Young-chan Baek

KB Securities Co., Ltd., Research Division - Analyst

* Yusik Hwang

NH Investment & Securities Co., Ltd., Research Division - Chemical and Refinery Analyst

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Presentation

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Unidentified Company Representative, [1]

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Good afternoon. I am [Hong Sun Beom], Head of IR at LG Chem. Thank you for taking interest in LG Chem and joining this call despite your very busy schedules.

We will now start LG Chem's 2019 Q2 earnings conference call. We will begin with the introduction of the company executives on this call, followed by 2019 Q2 earnings performance, Q3 outlook, and we'll invite our COO for COO highlights, which will be followed by a Q&A session.

The earnings and outlook and highlight will be interpreted simultaneously while the Q&A will be consecutively interpreted.

Let's begin today's call with the introduction of the management team. We have with us, COO, Ho-Young Jeong; Head of Business Strategy, Chul Nam; Treasurer, [Beom Seuk Lee]; and [Peong Goon Sung] from Petrochemicals; and [Hung-Shi Kim] from Energy Solutions; and [Wu-Sung Kim] from Advanced Materials.

With that, we will now present LG Chem 2019 Q2 earnings performance, followed by our outlook for the third quarter.

First, 2019 Q2 P&L. Q2 sales were KRW 7,177.4 billion, up 8.1% Q-on-Q and 1.8% year-over-year. Operating profit was KRW 267.5 billion, and operating margin was at 3.7%. Q2 EBITDA was KRW 725.2 billion. EBITDA to sales was 10.1%. Pretax income reported KRW 192.9 billion and net income came in at KRW 83.9 billion.

Next, our financials. As of end of Q2 2019, asset was KRW 32,435.6 billion, a 3.9% increase from the end of 2018. Liabilities was up 8.2% at KRW 15,156.7 billion and borrowings increased by KRW 1,575.6 billion, reporting KRW 8,480.4 billion compared to the end of the previous quarter.

Last April, there was about KRW 1.8 trillion of foreign currency green bond issuance, which led to a rise in both the debt ratio and liability to equity ratio.

Next, divisional results and outlook. First, on petrochemicals. 2019 Q2 petrochemical sales was KRW 3,936.4 billion, operating profit KRW 382.2 billion and operating margin was 9.7%. Although, the impact from onboarding of new downstream capacity came through driven by rising feedstock prices and heightened macro uncertainties from U.S.-China trade conflict, demand for core product was slow, which led to squeeze on the spread and one-off expenses, including turnaround, in turn pressured on the profitability.

Lower spread for core products on weak demand is expected to continue for the time being. But on robust profitability from high value-added products, i.e. SAP and Specialty Polymer and completion of capacity additions for premium products in the first half of the year, we expect profitability to be supported as new capacity comes on board.

Next, Energy Solutions. Q2 Energy Solutions sales was up 21.8% on quarter, reporting KRW 2,009.4 billion. In Q2 also, there was some one-off losses from ESS business and on the back of sizable automotive battery investment, which drove higher fixed costs as well as delay in stabilization of yield from the new lines. There was KRW 128 billion of operating loss.

In Q3, shipment to all of the battery business segment is expected to rise, which will accompany top line growth, and as we see productivity stabilize, we expect profitability improvement in the second half of the year.

Next is on Advanced Materials. 2019 Q2, Advanced Materials sales was KRW 1,253.5 billion. On higher premium display product shipments and rise in other IT materials volume, Advanced Materials sales was up 10.3% year-over-year, reporting a profit of KRW 19 billion. We expect marginal top line growth in Q3 as well with a comparable level of profit.

Next is Life Sciences and Farm Hannong. 2019 Q2, Life Sciences sales was KRW 154 billion and operating profit was KRW 10.9 billion. On higher shipment of core products, i.e. Zemiglo and Eucept, sales was up 2.1% year-over-year. Farm Hannong sales were KRW 159.6 billion and operating profit came in at KRW 9.1 billion due to profit-driven selective bidding responses for the fertilizer business and sales delays caused by time required for product registration, following the introduction of the crop protection registration this year, sales declined on a year-over-year basis.

For the Life Science business, we project sustained sales growth underpinned by higher vaccine and YVOIRE sales, but we also expect increase in expenses for new drug R&D. For Farm Hannong, we also plan to bring top line growth and improve bottom line profitability by increasing sales of high value-added products such as specialty fertilizers.

Next, I will invite our COO, Ho-Young Jeong, who will walk you through the highlights of this quarter.

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Ho-Young James Jeong, LG Chem, Ltd. - CFO, Internal Accounting Control System Officer and Director [2]

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First of all, before I begin, I would first like to share with the investors my regret and apology for not meeting the market expectations. Last quarter, if you look at the petrochem business, there was T/A impact and also some troubles from certain processes. And nonrecurring loss from Energy Solutions as well as delay in initial yield stabilization from newly installed lines, there was one-off expense of around KRW 180 billion.

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Questions and Answers

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Unidentified Company Representative, [1]

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So if I could maybe discuss this subject, taking a long-term view about our overall petrochemical business in terms of the strategy and the direction going forward. For the past couple of years, continuously, what we have been trying to be committing to and engaging upon is to try to expand the overall product range that we have had. So as a result of that, the product focus has been not on the commodity product side, but also more on the Specialty products and the high value-added or premium products that we have. This is [despite] of the fact that we do believe that this is better in terms of increasing the margin levels that we are able to have and also creating a more stable base for our profitability. So as a result of that, the product diversification has continuously been an emphasis for our company.

So as a result of that, if you look at the past few years, 3 years ago, the overall percentage of our Specialty products accounted for a low 10% range. However, now we currently have that number standing at around low 20%. As mentioned before, in the next 3 years, we do believe that we can take this to the mid-30% range. So if we say that the 40% level would be, ultimately, our overall target for the percentage of business that we want to have in the specialty area, we do think that this is an area that we are continuously making inroads in, and as a result of that, we'll be able to achieve in the next 3 to 4 years.

At the same time, with this product diversification taking place in a more robust lineup of products that we're able to provide and see in terms of the overall expansion, another thing that we're trying to do at the same time in terms of our strategy is to have more diversification in terms of our regions. Right now we do have some exports to North America and Europe. However, the bulk of our volume of products right now is focused in the Asia market.

So we do believe that we need to diversify our sources of demand, and this comes from more regional diversification. To enable this diversification to take place, right now, we are looking at local production hubs that we would be able to create. In addition to that, we're also looking at various business models that would include a joint venture with other parties and various opportunities that would present themselves.

At the same time, we -- because you have mentioned ECC before, I do also believe that feedstock and the diversification of that is also another thing that we would like to achieve. Right now we are 100% dependent upon our NCC facilities and as a result of that, we do think that, that gives us an advantage in creating a specialty downstream that we have. And also in terms of sourcing the intermediate material and also the upstream products that are required, that does give us a very sound footage. But at the same time, we do believe that over the longer term that there can be risks inherent to having a high dependency on only one feedstock.

So as a result of that, including ESS, we would be interested in diversifying into other feedstock sources. And therefore, maybe just to lay out the overall priority that we would have, first would be the diversification of our product portfolio, the second would be our regions, and the third would be the feedstock. So that is the order in which we're looking at right now. And if we look at the overall progress to date, we do believe that in terms of the regional diversification and the feedstock diversification that -- overseas, there are various projects that we are currently reviewing, that would enable us to achieve some progress on that front.

So as a result, we do recognize that for our local competitors and for the strategies that they have. In some cases, there can be differences in the priorities or in some cases, there may be some shifts in the ways that we proceed with these various areas. However, that have been said, the standpoint that we're coming from is that for the product line in itself, we do want to focus and highlight and emphasize the overall specialty areas and the premium product areas that we want.

In addition to that, in diversifying overseas in terms of the regions, the emphasis there would also be to be able to achieve more specialty. And also for the feedstock at the end of the day, the diversification there, motivation also comes to enable more emphasis or more support to our specialty products in terms of the upstream products that we have and also the intermediate material.

So all in all, just depending upon one feedstock does have risks. So we do think that through this overall portfolio diversification, we will be able to gain a better play.

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Operator [2]

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Young-chan Baek from KB Securities.

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Young-chan Baek, KB Securities Co., Ltd., Research Division - Analyst [3]

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There are 2 question that I would like to ask you. First is that if you look at PVC demand in terms of the change in 2016 coming from India, we do see a lot of volume of import taking place there. Going forward for the PVC market, what do you believe the overall dynamic will be between the supply and demand and the balance there. In addition to that, if we were to compare PVC versus PE, what would your outlook be of the overall market?

The second question that I would like to ask you is that in light of the recent trade frictions that are taking place with Japan, I would like to know if this is having any impact on your overall strategy and in having more of your battery material being created or being produced in-house, for example for your cathodes. So in addition to that, if we look at other parts whether it be your anodes or your separators, I do think that you probably are looking into diversifying your sources in that area also. So what would be the strategy there?

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Unidentified Company Representative, [4]

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So maybe I can take your first question. I am [Jang Hoon Sung] from the Petrochemical business. As you have mentioned, in India, since the Modi administration took office, there has been a very strong drive for infrastructure investment. As a result of that, if we look at the overall PVC demand, it has been very strong and has been growing very rapidly.

After the Parliamentary elections that took place in India, we do see that there is a renewed emphasis on infrastructure investment again. So as a result of that, we do think that the strong momentum that has been created for PVC demand is something that we will continue to see at a strong growth level going forward.

At the same time, if we were to talk about the supply side dynamics, if we look at the China and the carbide-based PVC that is available there, right now the capacity utilization of that capacity is very low. In addition to that, 4 various coal-related capacity that is available due to various environment-related regulations and also accidents that had led to big explosions. We do think that it would be very difficult for that capacity to go back online. So therefore, for the competitive technologies that are available on the supply side, we do think that the actual supply add-on will be limited.

For our LG chemicals perspective in the second half of this year, one of the areas that we had seen absent in the overall vertical integration that we had tried to create was on the CA capacity side. And this is something that we will be [pulling] in. So as a result of that, we will have a full integration that would be taking place. So as a result, if you look at the overall supply and demand dynamics, providing a very favorable backdrop. And the overall completion of our vertical integration, we do think that the profitability should improve for the time being.

Secondly, to talk about the PE side of the market. It is true that because of the conflicts between the U.S. and China on trade and the various issues there, the overall demand has been a bit contracted. And if we look at the global market space for PE demand, the run rate has been a bit poor. However, for the NCC/PO business as a whole, we do think that the overall run rate will continue to deteriorate until about 2020. So that would be our view.

However, if we were to compare general PE products to the metallocene catalyst, high value-added or specialty POs, we do think that the overall growth trajectories going forward will show changes or differences rather in the overall path that they take going forward. So the strategy that we have is to try to expand as early as possible on the side of our specialty PO as much as we can. So for any PE capacity additions that we will -- that we have completed, this will fully be utilized. And at the same time, if we complete the NCC #2 factory in Yeosu, then in the market that would be adding on around 800,000 tons of metallocene catalyst POs. So we think that this would be a very valid strategy within a very challenging market, which will give us a very sound foothold.

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Unidentified Company Representative, [5]

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So maybe I can address the second question that you have in terms of the overall cathode outsourcing and the purchasing strategy that we have on that side. To walk you through the overall supply chain that we have built for this, right now of the overall demand that we have for cathode is around 20% is what we in-source, meaning that we produce that. And for the 80% -- remaining 80%, this is what we purchase across suppliers that exist in Japan, China and also Korea. So as a result of that, we cooperate with them in developing the product and also purchase from them -- these suppliers.

Going forward, for the newer models that we have and also for the more technical and higher value-added cathodes that we require, we are planning to increase the in-sourcing portion to up to 35%. In addition to that, we do want to cooperate further with the local suppliers that we have. And this is something that would take place across the next 3 to 4 years. So as a result of that, we do think that the local sourcing percentage will go up to around 50% in total as a result of these efforts.

Currently, if we look at the number of companies that we do business with, we do believe that there is a multiple number there. And in addition to that, even if it is sourced from outside, we do think that we have built out a very strong and diversified portfolio. So as a result of that, recent frictions between Korea and Japan, is something that we would be less impacted by because of the overall structure. However, that have been said, this is an issue that we continue to monitor and watch very closely.

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Operator [6]

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Our next question is Min Won from Hannah Investment Securities.

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Min Seok Won, HI Investment & Securities Co., Ltd., Research Division - Research Analyst [7]

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There are 2 questions that I would like to ask you. The first question is about your petrochemical business. If we look at next year, and if we look at the issues that exist within the petrochemical space, of course, IMO 2020 will be introduced. And as a result of that, we do think that there are changes that will take place, on the crude oil side and also for the various refineries that exist. So in terms of the use of naphtha and also on the refinery side, for products such as propylene or also BTX, we do think that there could be a change in the overall dynamics as a result of the recent development. How do you see this taking place? And what do you believe the overall change would represent?

Secondly, recently, your Vice Chairman, Mr. Shin Hak Cheol set forth an overall long-term plan by the year 2030 to reach certain level of revenue. What were the basic assumptions that were used for this longer-term vision?

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Unidentified Company Representative, [8]

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So maybe I can address your first question. I'm the VP of Business Strategy for the petrochemical business. As you have mentioned, IMO 2020 will go into effect next year. And as you have mentioned for the refineries, we do think that according to the level of sulphur content that they have in their products, there can be some impact in the overall business or trades that they would be involved in. However, if we look at it from our standpoint in terms of sourcing the naphtha that we require as feedstock, right now we are sourcing from local refineries, and this is under various long-term supply agreements that we do have. So as a result of that, we do not believe that there will be any significant risk that we would be exposed to.

In addition to that, in preparation for our Yeosu NCC number 2 facility, we have been looking into the possibility of directly purchasing naphtha, or diversifying the overall sources through which we would source our naphtha requirements.

So all in all, even if IMO 2020 goes into effect as planned, we do not believe that there will be any changes or any risks that we would be exposed to with regards to our naphtha sourcing.

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Unidentified Company Representative, [9]

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So for the revenue target that we would have for 2023 to reach KRW 32 trillion in revenue, what that would represent in terms of the overall capacity investment would be 100 gigawatt hours. So that means that across the next 4 years, we would be investing around KRW 13 trillion as a result of that. Most of the investment in terms of the capacity will be taking place in the EV battery business. So that would represent approximately KRW 10 trillion of the amount that we do each year. And in addition to that, for the capacity, all in all, we do believe that, that will represent more than 250 gigawatt hours. So that would be the basis for the overall KRW 32 trillion revenue that was discussed.

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Operator [10]

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The next question is Yusik Hwang from NH Investment Securities.

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Yusik Hwang, NH Investment & Securities Co., Ltd., Research Division - Chemical and Refinery Analyst [11]

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I actually only have one question that I would like to ask you about. If you look at your Energy Solutions business as a whole, the performance, to be frank, as you have mentioned, is less than we had expected. And I do believe that there could be various reasons behind that. But I do think that one of the most predominant is because of the delay in the stabilization of your new EV factory and capacity that you have built out. So I would like to ask you why this overall process has been delayed.

In addition to that, when you say that the factory has been stabilized or the capacity is stabilized, what would you measure that against? What would be stabilization? I am assuming that it's a certain yield level. And if it is a yield level, what yield is that? In addition to that, if you look at your initial expectations about the stabilization timing when you expected the overall capacity to be stabilized versus when you do believe that will actually take place in terms of the stabilization timing, if you were to compare those 2 timeframes, what would that be?

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Unidentified Company Representative, [12]

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So maybe I can address that question. The Poland factory is up and running and the initial expectations were that in the first quarter. It might be running at a fairly low level. However, going into the second quarter that the overall capacity would be able to be stabilized. However, against our expectations, if you look at the overall capacity that we have built here, it is a wider width. It is a higher speed line. So the equipment and the processes are different from what we were doing before. In addition to that, the products that we are creating here are more difficult products. So as a result of all this coming together, we have seen a bit of delay in the overall stabilization process.

When we talk about the stabilization of the capacity, it would be the yield and also the comprehensive facility efficiencies that we have for this capacity. In terms of the yield level, it would be at around 90%. And this is in light of deals that we are able to achieve in [UTown] and also in China.

So if we look at the overall electrodes and also the assembly yield that we would be able to see, we do think that 90% is the benchmark. As of the current time, from the third quarter to the fourth quarter, we do think that we will be able to achieve this level. So we do see an overall improving trend. So as we pass through the third quarter and move on to the fourth quarter, our expectations are that we would be able to reach this target level.

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Operator [13]

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The next question is Yeon-ju Park from Mirae Asset.

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Yeon-ju Park, Mirae Asset Daewoo Securities Co., Ltd., Research Division - Research Analyst [14]

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There are a couple of questions that I would like to ask you. First, if you look at the overall losses that you have seen in the second quarter for your EV battery business, it does seem to be a bit large. And therefore, if you are going to achieve your overall target by reaching the [BT] level on the [OP] by the full year, then I do think that, that means that towards the fourth quarter that you do believe that the overall profitability of the business will significantly improve.

So in addition to the yield management that you have just talked about, if we were to look at upside factors and both downside factors to this overall business plan, what factors do you believe exist? And what do you believe we should be monitoring? In addition to that, if we are to talk about your EV battery order book, I think that there is a lot of activity by the OEM manufacturers for their overall EV platforms. So where does your order book stand currently?

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Unidentified Company Representative, [15]

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So maybe I can address the first part of your question and then move on to the second part. The second quarter performance was a bit sluggish versus expectations. So I do believe that you do have some concerns there. And added to that, I think that there is concern that this is a situation that will continue into the second half of the year. However, if you look at the overall analysis that we have been doing for this business. We think that the biggest factors that would actually determine our performance would be, again, as mentioned before, the overall yield that we see and also what we call the hit ratio.

So on the yield side, as mentioned before, going into the third quarter and then across to the fourth quarter, we think that continuously, there will be an improvement process that we will be able to see here. So there will be higher levels of yield. And in terms of the overall stabilization, of course, the number that the yield represents in itself is important. But also to have a daily -- a very consistent number in terms of the yield, is also a very important barometer for our stabilization. So the yield plus the consistency of that yield is probably one of the risk factors that we would be able to identify.

The second is the hit ratio. And what this is actually talking about is that, of course, we are creating batteries for EV vehicles and how well those vehicles sell at the end of the day is very important for our business. So as a result of that, for the -- so for the cars themselves, that will be launched in the second half of the year. Whether these will be hits in the market, whether they will be very popular and sell very well, which is an external factor to our business, would be another important component.

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Unidentified Company Representative, [16]

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And maybe to just continue with the overall answer. So in the first half of the year, of course, the losses that we saw on the OP level was a mid-single digit. However, though, of course, there can be downside or upside risks related to the yield and also the hit ratio. We do think that in the second half of the year, if we're able to record a mid-single digit profit, then that will equal out the situation. So that for the full year, we will be able to have a performance of breakeven or better.

To talk about the overall order book, as of the first quarter, we did say that our order book stood at KRW 110 trillion. Currently, there are ongoing discussions with our key clients and the key OEMs that we have about the third generation EV platforms. However, nothing has been decided yet.

In addition to that, for the existing orders that we have received, there are -- is a continuous flow of an increase of volume under those contracts. So all in all, we do think that the year-end order book will stand at a stronger level than what we see today.

In addition to that, if we do see any meaningful updates with regards to the order book status, we will make sure to share that with you at that time.

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Operator [17]

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The last question is Dong Jin Kang from HMC Securities.

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Dong Jin Kang, HMC Investment Securities Co., Ltd., Research Division - Analyst [18]

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The question that I would like to ask is that if you look at the second quarter one-off losses that we have seen for the overall battery solutions business, would you be able to break that down by the various business lines? In addition to that, the revenue in this business also has significantly grown. So would it be possible to break down the revenue for the ESS business, the small IT battery businesses and also the other EV batteries?

And lastly, if we look at the overall cylinder type battery, there seems to be capacity expansions that have taken place in that area. Do you have further power plants to build out capacity in 2020? And in addition to that, for the cylinder-type batteries, right now there does not seem to be a lot of adoption of this for automobile applications, but what would you -- be your view going forward?

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Unidentified Company Representative, [19]

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So maybe I can take your question and answer it. First, to give you the overall revenue breakdown. If we look at the second quarter, first for the EV battery business, it was much stronger than the first quarter on the top line side. So the overall revenue represented KRW 1 trillion or more. So that would be the level there. And then if we go on to the ESS revenue side, there was some negative impact from our local business. And added to that, we did have some production issues on the overseas side. So the revenue for ESS was slightly under KRW 200 billion. If we go on to the smaller IT batteries, then the revenue was flat through the first quarter. So that would be around KRW 700 billion or more.

To go into the one-off losses that we have seen, going from the first quarter to the second quarter for the ESS business in itself, there was around KRW 50 billion. And what this KRW 50 billion would represent would be in terms of the reserves, net amount of around KRW 20 billion in additional reserves. And then there was

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[Statements in English on this transcript were spoken by an interpreter present on the live call.]