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Edited Transcript of DEZ.DE earnings conference call or presentation 1-Aug-19 8:30am GMT

Half Year 2019 DEUTZ AG Earnings Call

Cologne Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Deutz AG earnings conference call or presentation Thursday, August 1, 2019 at 8:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Andreas Strecker

DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management

* Frank Hiller

DEUTZ Aktiengesellschaft - Chairman of Management Board

* Leslie Isabelle Iltgen

DEUTZ Aktiengesellschaft - SVP Communications & IR

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Conference Call Participants

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* Charlotte Friedrichs

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Franz Schall

Warburg Research GmbH - Analyst

* Frederik Bitter

Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst

* Gordon Schönell

Bankhaus Lampe KG, Research Division - Analyst

* Jasko Terzic

Metzler Equities, Research Division - Research Analyst

* Patrick Speck

Montega AG - Analyst

* Peter Rothenaicher

Baader-Helvea Equity Research - Analyst

* Richard Schramm

HSBC, Research Division - Analyst

* Yasmin Steilen

Commerzbank AG, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the DEUTZ AG conference call regarding the half year 2019 results. (Operator Instructions) Let me now turn the floor over to Leslie Iltgen.

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Leslie Isabelle Iltgen, DEUTZ Aktiengesellschaft - SVP Communications & IR [2]

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Good morning, everybody. A warm welcome to our conference call on the first half year 2019 results. My name is Leslie Iltgen, Head of Investor Relations and Corporate Communications at DEUTZ. And with us today is our CEO, Dr. Frank Hiller; and our CFO, Dr. Andreas Strecker. Mr. Hiller will give an overview of the key highlights and financials before handing over to our CFO, Dr. Strecker, who will then cover the results in more detail. As always, both will be happy to answer any questions you may have in our Q&A session at the end of this call. Also let me remind you that this call will be recorded. A replay will be available on our Investor Relations website following this call.

Before I hand over, please also pay attention to our usual disclaimer that you will find in the presentation. It is now my pleasure to hand over to our CEO, Mr. Hiller. Please go ahead.

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [3]

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Yes. Ladies and gentlemen, I would like to welcome you all to our conference call marking the publication of our half year results. But before I get into the details, I feel it's important for me to once again address the comments I made on July 8 during an interview with Bloomberg. On that day and on the days that followed, our share price fell significantly. And that was after I had merely commented on the situation in the market, mainly that we find ourselves in an increasing challenging market environment, which should be obvious to all market participants.

I was and still am surprised by the magnitude of the reaction to my remarks. After all, one thing is clear, DEUTZ is sticking to its guidance for 2019. We grew again in the first half of the year and are making good progress with our strategy aimed on further improvement -- of improving margins. DEUTZ of today is nothing like DEUTZ of a few years ago. The action that has been taken is getting the desired impact and has made the company much more robust. This is helping to ensure that the business can continue to operate successfully even in an increasingly challenging economic environment.

So far, as an introduction, and I'm switching now to the highlights of the first half 2019 on Page 4. So we had a positive revenue and earnings development, a further increase in revenue, plus of nearly 6%, plus 5.9%, generated across all regions and main application segments. So we had a strong growth in Americas and Asia Pacific. Both regions were above 15%. That's our clear intention, to grow the company much more international.

We had a further growth in our profitable service business. As mentioned in calls before, the service business is very important for us. It's important for the result of DEUTZ, and it's also important for the stability also in more difficult times. So we grew the business by 7.9% to nearly EUR 180 million in the first half of 2019. This is a higher increase than the whole revenue increase of the company.

New orders exceed revenue. So this means we had a positive book-to-bill ratio in the first half, and this is also very important for us. Looking into the last year 2018, we had a tremendous situation on the order intake. There were some months where we had a book-to-bill ratio which was nearly 150%. So this was an outstanding situation, and we are coming back now to a normal situation.

The operating profit before exceptional items grew up by 41.3% to EUR 47.2 million. The EBIT margin before exceptional items increased from 3.8% in 2018 first half, to 5.1% in 2019. And so we confirm the group guidance for 2019.

So far to the figures, and now about our strategic topics. There are mainly 2 topics, it's electrification and it's our China strategy, which will be very important in the future for DEUTZ. On the electrification side, we are on plan and the projects are running well. There will be seen, the first market solutions at the end of 2020. The focus was, in the first half year in 2019, was really focused on our China strategy. The agreement with SANY on the joint venture was signed in June. DEUTZ will take over within the next months the existing engine production activities of SANY. This has, today, a capacity of around 10,000 units, and we'll build that up to a higher capacity of around 80,000 units.

So we will deliver the first DEUTZ engines in Q4 2020. Some of them will be still delivered out of Cologne to ramp up the corporation. What we have already done is the first steps into localization of purchasing parts in China. This is running very well and has a big potential, not only for our Chinese business, also for our European and German business to use Chinese sub-suppliers.

The strategic alliance with BEINEI is well on the way. So there will be a new factory which will be built by BEINEI in Tianjin. This will be completed in Q1 2020. And also here, we will have the first local products at the end of next year. So DEUTZ is aiming to generate revenue of around EUR 500 million in China in 2022. So this will be consolidated hedge equity with the add-equity method.

Going now on Page 5 and having a closer look at the sales figures. New orders were below the first half of 2018. This was an exceptional first half year in 2018, with an order intake of nearly EUR 1.1 billion. And now, we are back, I would say, on a normal level with more than EUR 950 million. Our target for this year on the revenue side is to stay above EUR 1.8 billion.

So revenue outperforms unit sales because of a positive mix effect and increased prices. So the revenue increase was by nearly 6%, 5.9%, and a revenue was generated of nearly EUR 930 million. On the Torqeedo side, pure electric drives, we sold more than 6,000 units. That's more or less on the same level like last year.

Revenue by region, you see this on Page 6. And you see that we have now a share of around 40% in the 2 regions, Asia Pacific and Americas, both regions grow by more than 15%. Looking at EMEA, existing out of Africa, Middle East, Europe and Germany, we have a slight increase of around 1%. So also here, our strategy to grow the company international works out very well.

Page 7, revenue by application segments. First, what I want to mention is that our service business now is taking a share of around 19%, and we increased it by 7.9%. These actions were taken already 2 years ago. To achieve our target 2022, was a total turnover of EUR 400 million on the service side. Also on Material Handling and Agricultural Machinery, we had a nice increase, with 8.8% revenue increase, Construction Equipment. The market was very strong in 2018. Also here, it was possible to increase slightly by 1.5%.

Maybe so far from my side. And now I'm handing over to Andreas Strecker for the key financials in detail.

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [4]

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Good morning, ladies and gentlemen. I would like to lead you through the financial details. On the EBITDA side, we were able to improve the numbers by 29% to EUR 85.8 million. The EBIT showed a strong increase to now EUR 47.2 million compared to EUR 33.4 million. Last year, we had a positive onetime impact of EUR 9.3 million from the sale of the land in Cologne-Deutz. And also the net interest expense and income taxes remained on a low level, so net income increased by 79% to EUR 45.3 million.

If you look on the EBIT margin in more detail, we can see that we had some nonrecurring effects in the first half of the year, this further deconsolidation of the Argentinian joint venture that happened in Q1. We had a onetime provision at Torqeedo, and also we had a slight reversal of impairment loss on engine series. So overall, the EBIT margin would be at 5.5% without the nonrecurring effects. The results improved both from the complex engine side as well on the customized solution.

The other segment is negative. As I mentioned before, Argentina was EUR 2.9 million and the provision at Torqeedo is at EUR 2.5 million. If you look at the DEUTZ Compact Engines segment, you will notice [we received a] growth on the unit sales to 81,900 units. That is because we moved the series 2011 from Cologne to Ulm, and it will be recorded now on the segment Customised Solutions. Overall, EBIT margin improved to 4.8%. As you certainly remember, in the first half of 2018, we had the onetime effect at the joint venture in the DDE, where we recorded a loss of EUR 14.1 million, and that was recorded in the segment, Compact Engines.

If you look on the Customised Solutions, here you have, again, the effect of the 2011 unit sales increase. Some 10,000 of that was based on the 2011. Business performance remained very strong. EBIT margin remained in the double digits, based on the strong aftersales revenue and profit margin that we generated in that segment.

On the R&D side, you see an increase on the spending from EUR 37 million to EUR 47 million. That is according to plan with the E-DEUTZ strategy in full swing, and we continue to have new engine projects.

On the capital expenditure, you see also a strong increase, which was planned for E-DEUTZ expense. Also we ordered some second sets of toolings for forging parts as we have announced late last year. We would like to reduce the single-source dependability on the forging parts.

On the working capital side, you can notice an increase to EUR 336 million. We have higher inventory levels based on Brexit-formed charters, and we just wanted to make sure that we can fulfill all customer orders. We have now additional efforts to reduce working capital back to more regular levels.

On the cash flow for operating activities, sure, you see the impact on the increased working capital, and also we had, early in January, a repayment of factoring liabilities.

Based on that all, on the free cash flow side, you will see that impact the net financial position. There, we have to keep in mind that through IFRS 16, we had to record EUR 41 million in leasing liabilities. As a liability, that's a massive change. So effort to effort, you would have to increase the minus EUR 17.8 million by EUR 41 million so the drop is not big, even if it is shown on the paper.

The equity ratio is very strong with 49%. On the funding side, we extended the credit line of EUR 160 million into the year 2024. So on the funding side, we are extremely healthy and has enough firepower if we need money to spend. For the outlook, I will hand back to Frank Hiller.

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [5]

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Yes. Last, but not least, I would like to confirm our group guidance 2019 with a revenue of more than EUR 1.8 billion, EBIT margin of 5% or higher and R&D expenditure, EUR 85 million to EUR 90 million and CapEx, excluding R&D, EUR 85 million to EUR 95 million.

Maybe so far, the presentation from our side, and we are open now for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And the first question comes from Richard Schramm from HSBC.

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Richard Schramm, HSBC, Research Division - Analyst [2]

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I have one question concerning your outlook. Maybe, as far as I see that you have left your key forecast for the regions and customer segments unchanged. Although, yes, we know that the environment has become more difficult over the recent months. So what's behind this confidence that you might still see, all in all, a slightly positive growing market environment here, especially for Europe? I was a bit surprised that's still, although, plus 5% here across all segments. And the second question, concerning the development at Torqeedo, where the unit declined by 3% in the first half, which, yes, looks to me a bit disappointing as I assume that this would be a real growth market for the years to come, with solid double-digit growth from a low level. So what has prevented here this business from growing in the first half? And should we be more careful also for the full year? And what does this mean for your expectations here for this business?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [3]

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Yes. Yes, Mr. Schramm. Thank you for the question. I will start with the market outlook. Right now, I think it's really quite difficult to see the real end market. There are a lot of influences right now, especially in these weeks and months. We have the holiday season, where, normally, order intake is quite low. If we compare that with the last year, it was on a high level also during the holiday season. Now I would say, all the customers are a little bit cautious, like we also are cautious, and everybody is reducing stock. So it's not really a clear foreseeable what is coming from reducing stock on the customer side, what is coming from the end markets. So that was the reason why we kept our outlook. And we will adjust that within the next weeks and months if we have a clearer picture on that. We are looking very carefully in our order intake, and I can tell you that, last month, the order intakes were on a stable level. There was very much stability, so that order intake was more or less on the same level like revenue. So it's not really clear what's going on right now in the market. But I think we will have a clearer picture within the next weeks.

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [4]

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Okay, Mr. Schramm, then I would talk too about Torqeedo. The Torqeedo reason is relatively straightforward. We have a new high-volume product, where the presentation into the markets was slightly delayed by 2 main customers. That has taken place right now. And the order intake for that new product is exceeding expectations. So in Q3, you will see a good growth as you may have expected already. So it was customer-driven, but the products are on track and are successful in the marketplace.

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Operator [5]

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Next up is Charlotte Friedrichs from Berenberg.

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Charlotte Friedrichs, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [6]

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I think the first one, you already started talking about a little bit. I was interested in current trading and how the order intake has been developing over the last month. So you said that you are pretty much at a book-to-bill ratio of 1 over the last weeks, correct?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [7]

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Yes, Ms. Friedrichs, that's correct. And maybe some other comments on this. If we are looking at our main customers, customers which are also listed with their shares in the public, their results, here, you see, in many cases, the end market is still working quite well even if those customers are reducing their orders. So that gives us a little bit the feeling that there is -- there are some programs going on, on reducing the stock. So it's not really clear if this is a real effect on the end market.

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Charlotte Friedrichs, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [8]

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And when you look at your order intake right now, is there anything that you see in terms of particular regions getting stronger or weaker or any particular end markets where maybe the composition of the order intake has been changing over the last months?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [9]

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We see some markets weaker in Europe. And we also see a little bit of, I would say, challenge in the U.S. In Asia, I would say this is not really -- in our situation, this is not the market development. It's not really relevant because we are on the way in -- especially in China, with a completely new management team, winning new orders, having our new strategy together with the partner. So this is all about winning market share, and the effect of plus 5% or minus 5% on the market development is not really relevant for us today.

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Charlotte Friedrichs, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [10]

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Okay. Understood. And my last question would be around the EBIT margin in the Compact Engines segment. That was a little bit weaker in the second quarter than in the first. Could you maybe talk a little bit about why that is the case?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [11]

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What we see is, in the first quarter, were still produced duties of the 2011 in Cologne. So we have there better fixed-cost utilization. Then we removed to Ulm, volume in Cologne went down a little bit. And so it's about fixed-cost utilization.

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Charlotte Friedrichs, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [12]

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Okay. Understood. Could you remind us again when exactly did you move around the 2011 series? Was that just towards the middle of Q1 or...

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [13]

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It was middle of Q1. Yes.

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Operator [14]

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And the next question comes from Yasmin Steilen from Commerzbank.

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Yasmin Steilen, Commerzbank AG, Research Division - Equity Analyst [15]

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So I got a question on your CapEx development. So to what extent does Q1 CapEx already reflect the expansion CapEx in China? And could you please give us the split of the CapEx increase of the around EUR 80 million year-over-year related to new engine projects and which is related to E-DEUTZ? And what kind of level of CapEx requirement for China and E-DEUTZ should we pencil in going forward?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [16]

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China is not included there in relevant stages. The -- this is a double-digit expense for tooling, for second sets of tooling, for forging parts. As we have announced in the fourth quarter, there is a middle million digit for E-DEUTZ, and the rest is upgrades in component factories in Spain and in Herschbach, a little bit in Cologne, plus also some things in Ulm for the movement of the 2011. So it's a mixed bag, but according to [them].

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Yasmin Steilen, Commerzbank AG, Research Division - Equity Analyst [17]

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And going forward, I mean what should we pencil in? Some...

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [18]

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Good. We provided the guidance, and we will stay in that guidance. So there is no -- everything is according to plan.

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [19]

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Maybe about China. Investments in China will be done by the JV.

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Yasmin Steilen, Commerzbank AG, Research Division - Equity Analyst [20]

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By the JV. So okay that's still intact.

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [21]

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And here, we are also in, deeply, discussions with our partner, SANY, because there are now things going on about subsidies and so on. This could be very much supported by the Chinese government. So here, we also see some potentials for the joint venture to receive subsidies. This is exactly right now under discussion.

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Operator [22]

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And next up is Jasko Terzic from Metzler.

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Jasko Terzic, Metzler Equities, Research Division - Research Analyst [23]

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Yes. My first question is maybe again on current trading, just to get it right that I didn't misunderstand you. Is it right that you said your book-to-bill for current trading, July, is at least 1? And it was also the effect for June, is that right?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [24]

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Well, we are talking about July. These are the latest figures. And they are just completed this morning. This was on a level around 1.0. Yes.

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Jasko Terzic, Metzler Equities, Research Division - Research Analyst [25]

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And for Q2, just to get a feeling for the sequential development there. I think there was a tremendous decline from April to June. So what makes you really confident that July could be a first signal that it is stabilizing?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [26]

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Yes. That's still -- there are still some uncertainties because, I mentioned, you always have the holiday season, and it was always in the past that you have to wait until September and see how this develops. Last year was completely different. Very interesting for us is really, the thing I mentioned, to see big customers of ours, what they are communicating on their order intake and how they behave on orders on our side. And this is sometimes really in a big difference. And so if we see there a market outlook, in some cases, I think that could be an indicator that the situation is really stabilizing.

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Jasko Terzic, Metzler Equities, Research Division - Research Analyst [27]

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Okay. But in the past, if I recall it correctly, your visibility on orders from customers was in the range of 2 to 6 weeks. So you are not nervous due to the fact that it could also quickly become even more worse.

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [28]

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No, we don't see that for 2019 because also now, looking into quarter 3 and quarter 4, we know that quarter 4 will be an extremely challenging quarter on the production side. There are a lot of engines for -- on the pre-buy side. I think the visibility for 2019 is really very good. 2020, it's really too far down the road. The important thing for us, and that's part of our strategy, we know out of the past that DEUTZ was always seen as a very volatile company, and we did a lot of measures also to compensate, to a certain degree, a downturn. So what will happen, if the market is going down, we have new orders on hand. There are some big orders which will start in 2020. We have our Chinese -- China strategy. So this might be all things which compensate also in a downturning market and which makes DEUTZ quite robust. And I think also in a downturning market, DEUTZ will perform better than the competition.

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Jasko Terzic, Metzler Equities, Research Division - Research Analyst [29]

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Okay. Good to hear. Maybe also getting to your reference to those new ramp-up customers. Maybe first on KEYOU, and then also for China, are there any, let's say, minimum threshold levels that the customers must -- have to order? Or is it purely driven by their demand?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [30]

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It's always driven by their demand. But the price level we agreed is always on a basis of volume. If this will not come, then we can talk to our customers about the pricing. And for China, we are right now in the phase of bringing all the data together. There will be an effect in 2020 by the new strategy, that's for sure. But right now, it's -- we are figuring out what will be the effect to our production in Cologne. What will be, in a first step, delivered out of Cologne? What will be done locally? These are things we are now looking into.

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Jasko Terzic, Metzler Equities, Research Division - Research Analyst [31]

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Okay. And finally, KEYOU, could you give us maybe the ramp-up figure in terms of units for second half this year and next year? And what do you think of -- that they are also guiding somewhat more cautiously regarding their demand, especially for ICE trucks?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [32]

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Yes. KEYOU, today, is already an existing customer, and we have now this big contract taking mainly over the VW volumes. And this will really start with high figures end of this year, and then the positive effect will be there. 2020, with the ramp-up phase, it will take around 2 years. So I don't want to mention now the concrete figures now for 2020, but there will be a significant effect in 2020.

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Jasko Terzic, Metzler Equities, Research Division - Research Analyst [33]

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But they haven't changed their orders so far, although they become a bit more cautious for the industrial truck business?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [34]

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Not so far.

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Operator [35]

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(Operator Instructions) And the next question comes from Peter Rothenaicher from Baader Bank.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [36]

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Could you give us an explanation if I take a purely operating result? And then this means also the correction of last year's DDE effect. Then we had, in the second quarter, a decline in the operating margin despite higher sales volume and then also the solution in the purchasing area. What is the reason for this margin decline?

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [37]

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Well, we had some onetimers like the Torqeedo provision for the recall. We had a slightly lower production volume, and now it's getting quite technical as we had an increase in inventory. We had a negative impact on the internal profit elimination and the consolidation, which was higher than it was last year. So with these 3 items, that's the main explanation. The underlying purchasing savings are online. But the flow had been only at 3 months, and then you have nonrecurring items and then the impact is obviously to be felt. Yes, but that's the main explanation.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [38]

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Yes. A technical question. Why did you not correct in Q2 last year this DDE effect in the operating results? So last year, and in Q2 reporting, it was adjusted, and this time, not. I think this made it not easy to have a direct view on your profitability and the development in Q2 this year.

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [39]

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It was an operating item. We have written it in the comments. Yes, but I understand the point.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [40]

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Then on Torqeedo. You mentioned the development, that you had obviously a slight delay in the presentation of new engines. What is your current view on profitability of Torqeedo in 2019? I think comments before were that the company is achieving a better result in 2018, that we are gradually approaching breakeven.

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [41]

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2019 will be better than 2018 from what we see. We had that accrual which we would like to -- are confident to reverse in the second half of the year because the reason for the recall was for products that were made before we bought the company. So there are some activities going on to reverse that. With the increased volume, we will see better results in '19. So the company is moving in the right direction.

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [42]

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Absolutely.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [43]

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Could you give us already a range? What can we expect for Torqeedo?

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [44]

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It will be still negative. So as expected, not yet breakeven in 2019. We will see that in 2020, '21, as expected. So the company is behaving in a -- moving in a direction where we expect it to do.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [45]

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Okay. And perhaps, last question, in terms of order intake for the second quarter. So we were aware in April at the bauma trade shows, the sentiment was still very good. So you mentioned April order intake looked very good. To what extent do you think the decline in the order intake had to do with the reduction of inventories from your customer side? And to what extent was there a market impact?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [46]

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Frank Hiller. Mr. Rothenaicher, this is really difficult to touch on. As you mentioned, after the bauma, there was -- before the bauma, a lot of analysts and customers were a little bit nervous, I would say, because the cycle was very long for the construction industry. But the bauma brought a very positive impact, so we had a very strong order intake in April, also beginning of May. Then it turned a little bit in the other direction. And I think it's both. In some cases, it's really on the end market side. Some of the end customers are also rental companies. They also react quite strict. In some cases, it's reducing of inventory on the OEM side. I would say it's both, maybe half-half. We'll find that out within the next weeks and months. Especially, after the holiday season, we will see how this goes along.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [47]

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And yes, that's one aspect regarding the holiday season last year. We had a problem with the shortage in components, though this is not the case. So is it fair to assume then, in the third quarter, that we should see here a significant increase in production and therefore also in sales versus last year?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [48]

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Yes, looking ahead, I think the Q4 will be a very challenging quarter for the production and the output. Talking about shortages, yes, we had, last year, the topic with the casting company [Hauda]. There was a shortage, and this was, I would say, communicated in a clear and open way because we can read it in the newspapers. For sure, also this year, in the first half, there were some challenges with some suppliers, smaller issues, but the supply chain was also a challenge in the first half year 2019. I think this will be also -- could be also a positive effect for the second half, that here, the challenges are much lower.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [49]

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And therefore, production in Q3. For last year, we had the closure of your current DEUTZ plants, I think, for 1 or 2 weeks, therefore, some positive impact here.

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [50]

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That is to be expected. I think August will run higher than last year. That's what we feel right now. I see also the good order intake we saw last year. Some of it is everybody could read about the delivery issues, and everybody wants to make sure they get enough. And so this year, in the summer, there are no shortages around anymore in the industry. So -- and as we reduce our inventory, as I said, so do others. And I think that's a good portion of the current situation. I think production will be quite good there.

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Operator [51]

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The next question comes from Franz Schall from Warburg Research.

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Franz Schall, Warburg Research GmbH - Analyst [52]

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I have one on your inventory level. You mentioned that Brexit was one of the reasons why your inventory level was that high. Can you give us more color on that, please?

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [53]

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(foreign language) Sorry, English. We increased inventory for our U.K. supplies quite strongly as did the rest of the industry. That's why you have seen the peak in U.K. production so early. We had -- now we are now in the process to reduce that somewhat. So there will be still a safety stock for U.K. here, but I think not as high as we anticipated in March, where we really had, of course, many weeks inventory on hand. Now we have a couple of weeks less, but we still think that even in the case of an uncontrolled Brexit, we have enough safety cushion.

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Franz Schall, Warburg Research GmbH - Analyst [54]

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And can you give us a rough number just to get a bit of feeling?

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [55]

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It's in the neighborhood of EUR 7 million to EUR 8 million surplus inventory.

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Franz Schall, Warburg Research GmbH - Analyst [56]

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And regarding profitability in H2, taking all those one-offs into account, and you mentioned the 5.5% margin on a clean level in H1. Is it fair to assume that you can reach such a margin in H2 also?

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [57]

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Because I mean we confirm our guidance of 5% plus. And looking at the performance in the half year, there may be some, I think it's the second half, something that always happens. But I think we are on a good way, and that's why we confirmed the guidance.

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Operator [58]

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Now coming to the next questioner, it is Frederik Bitter from Hauck & Aufhäuser.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [59]

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A few I had, please? And the first one would be how do you compare July order intake this year compared to July order intake last year on an underlying basis? And that means excluding Halberg and also pre-buy effect.

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [60]

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This is a very difficult question. In last year, we had this challenge with Halberg, and all the customers were aware of this. In some cases, they were also affected by the shortage by themselves, receiving or not receiving enough casting parts. So also order intake to that time could be higher as it really was because they are building up. So -- and this, to that time, didn't reflect the market demand. So it's really -- it's not a comparable situation. And also looking into last year, the holiday season was outstanding. We had more or less an order intake which was on a level like having no holiday. And this was in contrary to all the years before and also in contrary to this year. So this is really -- it's not feasible to comment on that really in a quantity, in a quantity way, I would say.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [61]

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Yes. Tough to compare. Okay. And then the next one, and it remains a bit technical and also had to do with pre-buy effects. I was just wondering if you could talk a bit about the effect we've seen, actually, in the first half of 2018. I mean your orders stay at about EUR 1.1 billion of orders. That's obviously the base you were facing this year. And I was wondering how much do we need to take out for engine pre-buy and also Halberg again. Do you have an idea how much that was around about to EUR 1.1 billion, if we look at the numbers a bit better?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [62]

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Yes. On the pre-buy effect, we calculated that was around 30,000 engines over the whole period, and the period was spread over 2 years. So there was a positive effect of around 15,000 last year, which is missing now -- in already now in 2019. And in 2019, we have another 15,000, which will be already out of the year 2020, but this is in our calculation. Pre-buy effect, I would say, is half that big as it was 4 or 5 years ago when we had the switch from -- or the switch to TIER 4 final.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [63]

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So about 15,000 engines in '18, your 5 pre-buy. And then how much was Halberg then actually?

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [64]

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Halberg, nobody told us whether they bought things because Halberg may not be able to deliver. So that is -- that really nobody can put any analysis to it. We only know if somebody has a delivery issue, you increase orders. That's exactly what we did with a couple of suppliers that we are limping. So you increase to make sure that you get something, yes, and then it normalizes. And I think that's what we are seeing now.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [65]

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Okay. Sure. And then on Torqeedo, the provision for the product recall. It would be interesting to learn a bit more about the background of that. And obviously, you booked EUR 2.5 million now in Q2. Is that it? Or would you think there is some residual risk, so we might see another provision maybe in Q3 now or Q4 even?

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [66]

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No. The EUR 2.5 million is a solid calculation. It's a production item where some fields were not applied sufficiently. Again, it goes back to the time before we bought Torqeedo, and we are in discussion now to talk to previous owners, that they take over that -- the cost of the recall. It's an ongoing process. But the EUR 2.5 million are solid.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [67]

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Okay. That obviously would be -- the EUR 2.5 million will be for a complete recall, refinishing, send the product out again to the customer, et cetera. It's an all-in number.

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [68]

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Yes.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [69]

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Okay. Perfect. And then you were mentioning earlier there was an elimination effect in Q2, which has also negatively impacted EBIT. How much was that? Could you quantify that?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [70]

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Got it. And they would have, in the Q3, EUR 4 million.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [71]

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Okay. Only in Q2?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [72]

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For the first half.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [73]

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Okay. And how much is there -- how much in there -- how much more for Q1 and how much then in Q2? Was it all...

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [74]

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The majority was in Q2.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [75]

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Okay. That's quite significant, actually. Okay. And then the last one also on the free cash flow. Obviously, at minus EUR 46 million as of H1, how do you -- what's the expectation for the second half or respectively, the full year, in the end?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [76]

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Quickly now, we said it will be positive, and we stick to that. We will reduce the working capital back to normal levels. We are now some EUR 30 million, EUR 40 million higher than we would like to be. So that will go down, and so we expect a positive cash flow by the end of the year as planned.

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Operator [77]

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And next up is Patrick Speck from Montega.

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Patrick Speck, Montega AG - Analyst [78]

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I'm referring to the construction industry. Your revenue increase was -- at Construction Equipment was rather weak compared to other applications. From my point of view, the construction industry is one which is still running quite well and with good perspectives. So could you please share with us some details for the development in this specific sector, also with regards to different regions?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [79]

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Yes. Overall, we have this plus 1.5%, taking into account that last year already, the construction industry was running very well on a high level. Compared to, for example, the agricultural industry, this was, I would say, always on a very normal or lower level. So the -- this is the reason why you see now this big increase on the agricultural side. On the construction side, we see not really that we have some tremendous downturns in some markets. There are always some markets, some products, some customers behind who are reducing their stock level. So I would say it's not that we can say there's a market or a region really completely going down.

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Patrick Speck, Montega AG - Analyst [80]

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So you would quantify it more as a base effect because of the strong previous quarter?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [81]

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Yes. Yes.

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Operator [82]

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It seems there is a follow-up question from Richard Schramm from HSBC.

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Richard Schramm, HSBC, Research Division - Analyst [83]

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Yes. Just a quick one, coming back to this supplier issue. You mentioned that you have increased investments here to build up a second store, especially for the forging parts. Where do you stand here? And when do you think these new suppliers will be fully up and running so that you have here a more stable basis?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [84]

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But we have numerous parts, as you can imagine. So we've got -- gradually, I think that everybody is fully online in Q3 of next year. Some suppliers will be ready in Q1 and then it stays from here in Q3. But we also have to say that from the Guss [group] that board Halberg, we have 0 supply issues as we speak. So that is not an operational problem right now. It's just a precaution that we announced last year already, that we go more into a second source for main components.

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Operator [85]

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And the next question comes from Gordon Schönell from Bankhaus Lampe.

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Gordon Schönell, Bankhaus Lampe KG, Research Division - Analyst [86]

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Also on that supply issue for Halberg Guss group again negatively in the press. End of June, there was an article saying that Halberg again faces liquidity issues. Can you give us an update on the situation? You obviously see no risk related to Halberg. But what does it mean for you? Do you have to put additional money on the table? Can you give us an update, please?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [87]

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With I think the restructuring plan, as far we can see, the Guss [group] is progressing. I think they have a good agreement with the union. And so also they will line up the funding from the [Spalund] and [Bexony]. So that is coming forward. We helped, so do others, in between with liquidity, and so far, things are progressing in the right direction. So everybody is committed, as far as we know. I mean we cannot talk directly to the other customers for the first release, but as far as we hear, everybody is supporting.

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Operator [88]

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The next question comes from Peter Rothenaicher from Baader Bank.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [89]

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Yes. Regarding the pricing environment, in the weaker market, do you experience here some more pressure in pricing which might weigh on your margins in the next year or so?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [90]

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No. From pricing, we have a positive price development. So we don't see price reductions overall. In average, we have a positive pricing situation.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [91]

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Okay. Then regarding the one-off profit from the sale of the DEUTZ property, so you had now EUR 9 million profit in. When do we expect the remainder to come?

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [92]

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With the overall situation, what will we build on that property in DEUTZ, [the key] is up, it's now in the public domain. We will see how quickly the final decisions will be made. It's -- and I've spent -- and the vital is in the end of -- on the end of this year, whether it moves on. But it's positive.

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [93]

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We are still planning for end of this year, Q4, probably that the second portion will come.

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [94]

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Could then the EUR 9 million, maybe I just said, it's over and above the EUR 50 million that we project. So the portion is in addition.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [95]

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Just coming then on top. Okay.

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [96]

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Yes.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [97]

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And my last question, you mentioned with your China activities for 2021 approximately EUR 500 million additional sales. But is it then all really on pure equity accounting, so not consolidated in your P&L in terms of sales?

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Andreas Strecker, DEUTZ Aktiengesellschaft - CFO, Human Resource Director & Member of the Board of Management [98]

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On this EUR 500 million, just to talk in rough numbers, 80% of this EUR 500 million will come out of the joint venture with SANY. And this will be consolidated equity, means you will not see it in the sales. The other 20%, talking roughly about EUR 100 million, this you will see in our sales figures because this is a business which comes mainly out of the cooperation with BEINEI, and also a little bit will come out of the activities with Far East Horizon, the partner for the service activities. This you will see in our sales figures.

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Operator [99]

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At the moment, there are no further questions. (Operator Instructions) And we have another question from Frederik Bitter from Hauck & Aufhäuser.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [100]

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Sorry, a follow-up. Actually, on what you said earlier, you were mentioning that there will be some engine deliveries from Germany to China in Q4. And I was just wondering if you could just explain a bit how you will account for those. Will it be obviously sales and also earnings booked into, I suppose, DCE? Or will it be -- how will it be accounted for on the joint venture line? And also if you ship those engines into China, will you be able to expense delivery cost, et cetera? Or will there be an additional, let's call it, ramp-up cost that you have to carry in Q4 on your P&L?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [101]

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Yes. This is, right now, under discussion with the joint venture. We will have, in the middle of 2020, we will have the new emission legislation for on-road engines. So together with SANY, we will step into the on-road engine business again, providing engines for their trucks. That will be at the mid of 2020. Those engines are mainly SANY-designed engines, which will be produced in China. And then we will have, at the end of 2020, so this is at the 31 of December, the new emission legislation for off-road, China 4B. And this means that in 2021, all the engines have to be according to new emission legislation. And this needs some preproduction. And here, we are right now in the phase of investigating what we can do to that time already in China, what have to be done here in Cologne. This will be a positive effect for Cologne. We will also discuss on the prices right now with the partner. So that's ongoing right now.

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Frederik Bitter, Hauck & Aufhäuser Privatbankiers AG, Research Division - Analyst [102]

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Yes. Okay. And then when I look at the -- again, a follow-up basically on this topic. And also obviously, we see R&D expenses increasing quite a bit year-on-year also in terms of percentage of sales. And you were talking about new engine projects. Are those the on-highway engines in China? Will that be R&D expenses for you on your P&L? Or will it be something that will be booked also in the equity line accordingly then?

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Frank Hiller, DEUTZ Aktiengesellschaft - Chairman of Management Board [103]

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That will be also paid by the joint venture. To be honest, those engines are more or less already developed. This was done by SANY in the past, together with external engineering partners, and we are now doing some upgrade work on these engines for the new emission legislation, which was now defined. But this is, I would say, this is overseeable. That's not that much business. But in the end, this will be paid by the joint venture.

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Operator [104]

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There are no further questions.

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Leslie Isabelle Iltgen, DEUTZ Aktiengesellschaft - SVP Communications & IR [105]

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Okay. Thank you, everybody, for joining our call today. Should there be any follow-up questions following this call, don't hesitate to contact us here at DEUTZ. We're happy to answer any questions you may still have. Other than that, I wish you a good remainder of the day. Cheers, and goodbye.