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Edited Transcript of HDD.DE earnings conference call or presentation 6-Aug-19 11:00am GMT

Q1 2020 Heidelberger Druckmaschinen AG Earnings Call

Heidelberg Aug 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Heidelberger Druckmaschinen AG earnings conference call or presentation Tuesday, August 6, 2019 at 11:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Dirk Kaliebe

Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment

* Rainer Hundsdörfer

Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer

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Conference Call Participants

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* Malte Christoph Schulz

Commerzbank AG, Research Division - Equity Analyst of Industrials

* Markus Schmitt

ODDO BHF Corporate & Markets, Research Division - Fixed Income Analyst

* Peter Rothenaicher

Baader-Helvea Equity Research - Analyst

* Piotr Ossowicz

Ironshield Capital Management LLP - Senior Analyst

* Richard Phelan

Deutsche Bank AG, Research Division - MD & Head of the European Credit Research

* Richard Schramm

HSBC, Research Division - Analyst

* Stefan Augustin

Pareto Securities, Research Division - Analyst

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Presentation

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [1]

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Thank you very much. Ladies and gentlemen, hello from Wiesloch. I'd like to welcome you to our Q1 conference call, and I'm glad to tell you about what has happened in the last 3 months. The first quarter certainly did not go as we had imagined. This was due to the reluctance of many customers to invest due to the economic slowdown, especially in Central Europe, as we have already communicated on several occasions. The numerous profit revisions carried out by other companies in the industry sector shows that this does not affect Heidelberg only. However, the quarter and our situation are by no means as bad or negative as some are currently describing. I would, therefore, like to make it quite clear today that Heidelberg is well on the way to achieving its strategic goals and establishing the company as a profitable player in the long term. Heidelberg has introduced numerous innovations that are almost revolutionary for our group, but which, as we have several times, take time to translate into significant operational improvements. And Heidelberg is in a solid financial position to implement.

And now I come to the central message of my presentation today: To systematically implement the digital transformation of our company. A journalist wrote after the AGM, Heidelberg lost in transformation. This is certainly a good eye-catching headline, but it's just not right. The expansion of innovative digital business models that we began in 2017 is, in our view, the right way to stabilize our demand in the future.

Without the massive increase in the share of reoccurring sales from the contract and subscription business that we have consistently pushed forward, Heidelberg will continue to suffer significantly from the economic fluctuations like all other machine manufacturers do as well. Our goal is to increase the share of contract and subscription business to more than 1/3 of total sales, which has been around 10% to 15% so far. And customer demand for such contract models remains good despite, or precisely because of, the current economic uncertainties. And numerous customers have approached us about this. The range of products on offer has also been significantly expanded. In addition to the complete package of equipment, services, consumables and software in a multiyear usage-dependent contract, it will also be possible in future to combine and use individual components of this offering over a certain period of time in accordance with defined standards.

And there is another positive aspect that I would like to draw your attention to in the first quarter, and this applies to China. The country is and will become much stronger in the future, the largest single market for our industry. The good demand, especially for our classic sheetfed presses, but also our digital offerings in China print in April, shows that we have the right offerings for our customers there. And we produce locally in one of the most modern plants at low cost. Thanks to a good trade fair performance, we were able to increase incoming orders in China by a good 45% compared to the same quarter of the previous year. The number of printing units sold increased by an impressive 25% in fiscal year '19 over the previous business year. With our investments in our core business, especially in our most important 70x100 format, we were also able to significantly increase our global market share in the past financial year. Precisely for this reason, at the beginning of 2019, we agreed a trendsetting cooperation with the Chinese Masterwork in the future market of China, especially in the growth area of packaging. Together, we want to establish a production facility that supplies our Shanghai plant with high-quality local-produced parts. The operational areas of cooperation are currently being defined. We also want to and will benefit from this in the future. My colleague, Dirk Kaliebe, will be going over the figures for the first quarter 2019/2020 in more details in a moment.

Quarterly revenues, EBITDA, excluding restructuring costs, and earnings after taxes were all below the corresponding figures for the previous year. The investment postponements and the unfavorable product mix led us to adjust our outlook for 2019/2020 as a whole downward in mid-July. Before I go into the measures to increase liquidity and secure profitability, which the Heidelberg management board immediately initiated and which are being implemented, I would like to make a brief statement to the critics who say, how do you intend to keep your sales stable in 2019/2020 compared to the previous year despite the economic issues described. First of all, the first quarter is always the traditionally weakest quarter for us, and accordingly, only provides limited information about the year as a whole. The majority of sales, and all those who have been with Heidelberg for some time know this, will be generated in the second half of the year, especially in Q4. Secondly, the good level of incoming orders in China and a significantly higher level of incoming orders in July make us confident. The high capacity utilization of our factory in China also has consequences for the net working capital since we also manufacture the parts for the orders in China in Wiesloch, and then deliver them to China, which initially leads to increased inventories.

Overall, we started the second quarter of fiscal year 2019/2020 with a significantly improved order situation. This compensated for parts of the weak first quarter, especially in the European business. The U.S. business is running at a good level anyway. Last week's interest rate cuts should provide further economic hope here. The good start to the second quarter makes us confident that we will achieve our planned fiscal year volume. Third, despite the economic downturn and the associated reluctance to invest in the equipment business, the company expects further stable expansion of the contract business to compensate for this. The increasing share of reoccurring contract business will have an increasingly stabilizing effect on our total sales. And last but not least, there are numerous voices saying the global economy will revive towards the end of the year or the beginning of 2020.

At the end of my remarks, I would like to go into more detail on the measures taken to improve earnings and liquidity. In terms of cost management, these include instruments to make working hours more flexible in the short term, such as time accounts and short-time working and structural projects to strengthen profitability in the long term. Heidelberg has also launched a program to significantly improve net working capital and free cash flow. For example, the company is reviewing many of the investments planned for this in the coming financial year. The planned investments are to be reduced accordingly by around EUR 20 million. In addition, lead times and inventory levels will be optimized and receivable management will be improved. This is intended to reduce tied-up capital by around EUR 50 million. Heidelberg is also reviewing portfolio adjustments through the sales of smaller divisions in the magnitude of some EUR 30 million, and further structural optimizations.

In total, this has defined a liquidity potential of around EUR 100 million, which we intend to raise as quickly as possible and thus, reduce our debt. You can see from my remarks that we are very confident that even in an increasingly difficult environment, we will be in a position to continue with our digital transformation, and at the same time, maintain Heidelberg's financial solidity.

I now hand over to Dirk Kaliebe for further details on our key financial figures and the outlook. Dirk, please.

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [2]

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Yes. Welcome also from my side. As my colleague Rainer has already explained, we had a weak June in Western Europe, especially in Germany. On the other hand, we can confirm a stable development in the U.S. and report a significant increase in orders in China. Overall, however, we are currently feeling that customers are becoming more cautious about their business prospects, and therefore, deals sometimes require a little bit more time. We see this in the overall decline in order intake in the first quarter, which around EUR 50 million -- which were around EUR 50 million lower than in the previous year. Nevertheless, the order backlog increased from EUR 650 million to about EUR 730 million at the end of the quarter and forms a solid basis for the expecting -- expected year-end.

Sales in first quarter were on the previous -- were on the quarter around EUR 500 million, meaning 7% short on the previous year. However, we are cautiously optimistic about the planned volume for the full year, while in July, partly compensated order intake came into our books. The lower volume and unfavorable product mix and lower capitalization of development costs had the corresponding impact on profitability. EBITDA fell to EUR 14 million, previous year, EUR 20 million, and the EBITDA margin fell from 3.7% to 2.8%. This included approximately EUR 5 million from the first-time application of IFRS 16.

EBIT, excluding the restructuring result, amounted to about minus EUR 10 million after the first quarter compared to EUR 2 million in the previous year. The structuring result of minus EUR 3 million is mainly attributable to the closure of the smaller chemical site. The earnings after tax amounted to minus EUR 31 million after 3 months, and we are thus still clearly negative. For the year as a whole, we expect to breakeven as sales increase, especially in the second half of the year. At minus EUR 4 million, cash provided by operating activity were almost balanced. The free cash flow was characterized by higher tied-up capital and net working capital -- I will come to this later -- and by our own investment in digital projects, new digital business models and the small acquisition of the software area. Accordingly, a value of minus EUR 83 million was reported for the first quarter compared to minus EUR 45 million in the previous year. Leverage as a debt ratio rose temporary to 2.1, and we expect it to fall below 2 again by the end of the financial year. The increase is also attributable to the first-time application of IFRS 16, as we now are reporting lease liabilities as just under EUR 55 million as financial liabilities.

A quick look through the segments. The deterioration in general conditions has mainly affected the new machine business in the Heidelberg Digital Technology segment. Lower sales and unfavorable product mix and lower capitalization of development costs led to a decline in earnings here, in particular. The Heidelberg Life cycle Solutions segment, on the other hand, recorded stable sales and earnings.

Let us now turn to the balance sheet. At around EUR 300 million, equity decreased by around EUR 100 million compared by the end of March. This is attributable to -- on the one hand, to the quarterly loss, but mainly to the significant lower interest rate of about 1.5% for domestic pension on the balance sheet date. The equity ratio, therefore, fell to 13% compared to 17% by the end of March. The higher capital bounded is also visible on the balance sheet. Due to the expected sales volume in the second half of the year, but also due to the ramp of the digital printing portfolio, net working capital rose to about EUR 710 million. We also -- we are also tying up somewhat more capital with ramp up of subscription model. As already mentioned, net debt rose to EUR 340 million due to the negative free cash flow. Including IFRS 16, the figure is around EUR 390 million.

In view of the development of the net working capital in recent years, we have already achieved a significant release of capital. We are currently sustainable below 30% of sales. The temporary increase to over EUR 700 million is mainly due to higher inventories in order to produce the machines for the second half of the year. However, the higher inventories of digital printing presses are also a temporary burn until they are developed to -- delivered to the customer. Unfortunately, our good capacity utilization in China production is also having a temporary impact. Since the number of printing units produced there has risen enormously, and almost half of the components still come from our German-side plants, the capital tied up during the year is increasing by a low double-digit number. Nevertheless, the plant in China is a success story, and we are working on further increasing the proportion of local purchase of product parts. In order to significantly reduce tied-up capital in the current fiscal year, we have initiated further measures to optimize inventories, lead times and receivable management. In total, we see a potential for releasing capital of around EUR 50 million compared to the point where we are today.

Coming to the financial framework, we have continuously -- we have continued to secure our capital structure over the past years. The balanced financial framework of around EUR 710 million in total, with no significant maturities until 2022, also gives us the freedom to actively drive forward new business models and targeted acquisitions. The liquidity reserves are sufficient and will continue to stabilize over the course of the year. As in the past, we will refinance or repay the maturities in good time and adjust the overall credit facility to our needs. So much for my comments for the first quarter.

We will continue to focus on the targets we announced in mid of July, and the good order situation in July makes us confident here. In the current financial year, we are continuing to aim for sales at the previous year level, and the EBITDA margin is expected to reach 6.5% to 7%. Overall, we expect to breakeven after taxes.

Let's now hand over to Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Markus Schmitt from ODDO.

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Markus Schmitt, ODDO BHF Corporate & Markets, Research Division - Fixed Income Analyst [2]

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Thanks for taking my questions, which actually are all related to liquidity and financing. So in terms of the EUR 100 million liquidity potential you mentioned, do you assume that all of this will be recognized until fiscal year-end '20? Because I think the portfolio optimization plan sounds a bit more time-consuming than the other measures. So are you in talks now already? And specifically about your inventories, I think you can get rid of the raw materials quite quickly, but how is it in terms of unfinished and finished items, if customers still away -- step back from earlier orders, if they're allowed to step away easily? I don't know. Maybe you could comment on this first question.

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [3]

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Yes. Coming to the activities, which our CEO has also mentioned obviously investment, EUR 20 million, is coming over the next 12 to 18 months as expected. Today, net working capital is expected to come in this year. We have had by the year-end of the last year, EUR 680 million, EUR 610 million, EUR 670 million, EUR 690 million. We are now trading around EUR 710 million. So the reduction of EUR 50 million is expected to be realized in this year. And obviously, the disposal of assets is depending on the process. We are underway, but we cannot, in brackets, guarantee that this will materialize in this financial year. We are trying to do our best to close the expected disposal as soon as possible. And therefore, this is not being guaranteed for this financial year.

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Markus Schmitt, ODDO BHF Corporate & Markets, Research Division - Fixed Income Analyst [4]

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Okay. And I saw that you bought about EUR 21 million in the quarter, but obviously, not via your RCF. Did you acquire new credit lines? Or does this reflect utilization of existing bilateral lines apart from the RCF? Because the debt maturity profile chart seems to be the same compared to fiscal year-end, so maybe you could clarify this.

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [5]

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We raised a little bit for real estate financing. So this additional EUR 10 million were coming on top. The rest, I don't know what you're meaning. So I would have to take the questions offline.

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Markus Schmitt, ODDO BHF Corporate & Markets, Research Division - Fixed Income Analyst [6]

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Okay. Then another question on your covenants. Do you feel a need to start, or have you started discussions with your financier banks to initiate a covenant reset already? I'm not trying to ruin your day, but the reason why I'm asking is that, that you got now to 2.1 on net leverage. So when I exclude the IFRS 16 effect because the credit agreement is assumingly calculating the leverage based on the old world, and starting from flat revenue as you have guided and EBITDA margin of 6.5%, and deducting the EUR 15 million IFRS 16 effect, then I get to leverage 2.4x. You -- I think that figure is a little bit elevated now because of the working capital and this will come down probably. But -- so if your maximum threshold is 3x or lower, I don't know actually, it does not leave much headroom. And I'm wondering if this is already on your card that a covenant reset could become necessary to have further access to your backup liquidity facility, if your performance will not be as guided in the remaining year or -- and/or if your liquidity measures won't generate liquidity as quick as you assume. So I'm curious how you see this.

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [7]

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Yes. Many thanks for this comment. You -- I ask for your understanding that we don't go into details and we don't disclose our covenants. I can just highlight that more or less since 12 years, I have managed the financial framework, and we have had more different times in the past. And together with our banking partners, we have also managed -- always managed to be in line and to be agreed upon our alliance with our banking partners. So please understand that I don't comment on the details in here, but this is since 12 years on our agenda, and we know how to manage the situation. And as you have said and confirmed and agreed, the temporary increase in net working capital will come down over the year, so this will also lock up additional capital. And you can see that this framework is stable with a net debt of EUR 330 million compared to EUR 700 million. So there's some room which we can still use going forward.

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Markus Schmitt, ODDO BHF Corporate & Markets, Research Division - Fixed Income Analyst [8]

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Okay. And then just quickly, finally, a question for Mr. Hundsdörfer. On your interview with Rhein-Neckar-Zeitung, you mentioned you now have a potential strategic partner. Can this be expected to pop up until fiscal year-end? Or will this take probably longer?

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [9]

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It is difficult to say. Of course, we'll try to find a solution as quick as possible. But this is a question of the process and who is going to be interested. So I cannot confirm that this will happen this year, but we're trying.

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Operator [10]

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We'll take our next question from Malte Schulz from Commerzbank.

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Malte Christoph Schulz, Commerzbank AG, Research Division - Equity Analyst of Industrials [11]

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Also 3 questions from my side. First of all, maybe on your China orders. How much of it is actually a trade fair special effect? And how much should we take as a general uptick in demand from China? So give us kind of an idea where we can go into on a full year basis on a kind of order level. And is it something you see particularly for this year? Or is it something as well you'll see continuing? So just to give us your feeling. And maybe also a little bit on July. Is it -- on how much -- and also on the mix maybe, a comment would be helpful. If you see a real recovery in EMEA and particularly also in Germany? Or if you see this kind of distressed order level continuing where you've -- which was also the trigger for your profit warning, obviously? That would be helpful. Then, I mean on the portfolio optimization. I mean you spoke already, I think some years ago, about like disposal, like the foundry or so. How significant did you think is the portfolio currently looking at? And is it just you just look at 1 or 2 pieces which you'd like to say -- sell? Or is it that you look at, let's say, 5, 10 pieces and you say, "Oh, yes, we will in the end probably sell 2 or 3?" Just give us an idea on how likely is that that you will close any deals in the short term. That would be helpful.

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [12]

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So let me start with the orders, and give Rainer the chance to comment on the sentiment, if this is okay? We do have a normal order intake in China, more or less around EUR 80 million in average. It's between EUR 70 million to EUR 90 million. We were in this quarter around EUR 110 million, EUR 120 million. So there was an increase whatever you compare, EUR 30 million to EUR 40 million. Now you could say this is speaking to the one-off of the China trade fair show, but we have the sentiment that China is developing on a good level. I wouldn't like to say that this is now sustainable on that volume-wise, but China is one of our biggest markets, and we have had very good sentiment. Rainer will eventually comment further on. But orders have materialized after the Chinese trade fair show. This is a comment from my side. The other thing was the divestments. Obviously, it's not [profoundly] what we are looking at. It's some 2 or 3 pieces which we have elected, and we believe that 1 or 2 can be materialized in the next -- let me say, 12 months to come. The sooner the better, but we are in the process of making this asset sellable.

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [13]

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Some comments on the situation in China. Our business in China we could say is developing very positively despite the American-Chinese trade war, and it's mostly driven by our customers serving domestic business. So without the difficulties between China and America, the business could be probably even better than that. So sooner or later, probably the issues will be resolved. So I think China is on a very good way to really sustainably become the largest market for our industry. The recovery in Central Europe, in EMEA is obvious, and we think it might be also sustainable. Because one thing is very promising, the projects are not disappearing. There are new projects coming up. Only the time to close an order, to really get the decision and the signature on the contract, that has increased. And that's why quite a few orders from June slipped into July. So it's at the end, the question of getting our customers the confidence that it makes sense to invest. Overall, I'm very confident that we will be able to secure all the orders for our plants' top line this year.

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Malte Christoph Schulz, Commerzbank AG, Research Division - Equity Analyst of Industrials [14]

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Okay. There was already -- so maybe one final question on your financing strategy. I mean your convertible is likely due come -- in full in March. Do you intend to issue any new bonds? Or is there -- do you just rely on your current facility to repay the bond?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [15]

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Well, it has to be seen once we are coming closer to the end of the year. As I said, financial framework is stable enough, it was more than EUR 700 million. Also the activities which Rainer has described with locking up EUR 100 million is an additional option. So let's wait and we have then to see what is the best way how to approach a potential maturity.

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Operator [16]

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We will now take our next question from Piotr Ossowicz from Ironshield Capital.

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Piotr Ossowicz, Ironshield Capital Management LLP - Senior Analyst [17]

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First, maybe following up on liquidity. Can you please remind us how much liquidity do you have available now? So how much RCF is currently available? And also on your slide showing the future liquidity initiatives, what do you mean exactly by this EUR 20 million from investments?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [18]

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Yes. As we have said, the financial debt excluding IFRS 16 is EUR 373 million. This has to be compared with the financial instruments and financial framework of EUR 712 million. So there's somehow EUR 380 million liquidity buffer available. Cash on our hand is EUR 150 million, and on the other hand, our CEO and myself have explained that we have opportunities to lock-up up to EUR 100 million compared to the situation that we are in today. The raising within the RCFA depends always on the actual situation on net working capital, and please understand that we don't disclose concrete numbers in the one or the other month. In general, we can just say there is sufficient headroom available, and the extra activities we have tried to explain. Hope that this clears up your question.

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Piotr Ossowicz, Ironshield Capital Management LLP - Senior Analyst [19]

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Right. So just following up on the cash. I think that historically, you had about EUR 30 million restricted or trapped cash. So can you please give us some color on where this figure is now? And regarding the RCF, I think that historically, some of it has been drawn or utilized for the levels of credit that's limiting the available-for-cash drawing. So if you could please update on this number as well.

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [20]

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Yes, I can repeat, EUR 380 million are open lines as what we can make use of, and there's EUR 100 million activities, extraordinary one. And then for the total financial framework, there's a restricted cash, in brackets, which is at the level still around EUR 30 million to EUR 40 million. This framework has not materially changed, therefore, we are feeling comfortable in the actual situation.

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Piotr Ossowicz, Ironshield Capital Management LLP - Senior Analyst [21]

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And from this EUR 380 million open line, is that all available in cash? Or that's part of what you utilize for letters of credit or bank guarantees?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [22]

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It is for the whole facilities, what we are needing. So in general, as we are given the letter of credit, we're also receiving cash on the other hand side. So in net debt, it's all coming together.

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Piotr Ossowicz, Ironshield Capital Management LLP - Senior Analyst [23]

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Okay. And on a separate note, can you please comment on how is the digital segment or digital product doing?

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [24]

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The business -- digital -- the printing is -- you asked for digital printing, right?

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Piotr Ossowicz, Ironshield Capital Management LLP - Senior Analyst [25]

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Yes. That's right.

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [26]

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The digital printing is moving forward. However, slower than originally planned or anticipated. It takes a little longer until the customers of our customers are accepting this new technology. But it's moving ahead. We had some good success in the last weeks, gaining more orders for the Primefire. So it is moving ahead as I mentioned and as I've described, just lately at a slower pace. But it's moving ahead. And the market is there. It will develop. And good news also is Heidelberg still is the leading supplier in this segment. No other manufacturer at this point is able to offer the technology we have. So there's a good opportunity to establish here, of course, not immediately, but in 1 year or 2, a significant growth potential and good profitability.

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Piotr Ossowicz, Ironshield Capital Management LLP - Senior Analyst [27]

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Right. And approximately, what is the contribution to sales or margin from digital at the moment?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [28]

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With the ramp-up of the units, we obviously will have a higher consumption out of the inks. This will then contribute to the margins. And the first time we will have to install the installed base, and therefore, the margins will increase over time once the volume which is printed on the machines will increase.

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Piotr Ossowicz, Ironshield Capital Management LLP - Senior Analyst [29]

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But at the moment, if I look at Q1 or the last 12 months, I mean is that like 5%, 10% of sales? Just to get the ballpark number.

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [30]

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It is not material for the time being.

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Operator [31]

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Our next question is from Stefan Augustin from Pareto Securities.

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Stefan Augustin, Pareto Securities, Research Division - Analyst [32]

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When I was looking at the segment or the divisional development, I was quite struck with the fact that the order intake in the Digital Technology division is relatively okay, and that we had rather the hit in the Life cycle Solutions, where we -- where you commented that the subscription contracts are still on a good run. Can you shed a little bit of light on that development? And why is it happening that way? And what the life -- let's say, the subscription orders in Q1 have been in the Life cycle Solutions division?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [33]

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Yes. We are traditionally reporting the subscription in Life cycle Solutions. And last year, we have had a higher number of contracts in the first quarter compared to this quarter. The trend in general is okay, but it takes a little bit longer to close the deals. Therefore, in comparison, the reduction was being reported in Life cycle Solutions.

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Stefan Augustin, Pareto Securities, Research Division - Analyst [34]

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Would you share an amount?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [35]

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We do have that EUR 10 million to EUR 15 million lower than expected, which would have been in the position to being reported earlier. But as the negotiations were ongoing, and we have not finalized -- signed the orders and have not secured the financing, we haven't reported this one as order intake.

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Stefan Augustin, Pareto Securities, Research Division - Analyst [36]

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Okay. If I go to the forecast, that margin for Digital Technology, you roughly put that one down by a bit more than 100 basis points. Is that more or less all country mix in the explanation?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [37]

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It is country and product mix. While we would have a lower volume in Western Europe, then the machines are not so much equipped as if we are going to other countries, and therefore, it's a product and country mix in combination.

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Operator [38]

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We will now take a question from Richard Schramm from HSBC.

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Richard Schramm, HSBC, Research Division - Analyst [39]

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Just a follow-up on the topic my colleague just touched. As you mentioned, the recurring revenues were nicely up by some 10% in absolute terms to EUR 80 million, which would be about a good part of this sales of Life cycle Solutions. However, it's interesting to see that the profitability obviously could not benefit from this. So can you shed a bit light more on the mix effects here? And what should we expect going forward? Will the coming quarters see kind of compensation for this weak start here? Or should we assume that we remain clearly below previous year's level?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [40]

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From the margin perspective, Mr. Schramm, we have confirmed for Heidelberg Life cycle Solutions percentage-wise, the margin, as we have said, so there might be a seasonality in. But all over, if we are bringing the product mix as expected, as being forecasted, we are in the range as what we have guided, and as I have already answered to Mr. Augustin, we see a different product and country mix in Digital Technology, and therefore, the margin in this division has been decreased. And this might be, in brackets, a seasonality. While if we would have an higher proportion in Western Europe going forward and a different product mix, then we have here also upside potential. I hope that this answers your question to a certain part.

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [41]

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I could add to that, that if you look at all our Life cycle contracts, subscription contracts, that they're performing well. Of course, there's still a small part of the Life cycle business. What is under pressure also in regards of margin is, of course, the traditional consumable trading business. This is under pressure in regards of sales and margins. And that's why it makes sense to turn that into contract business, which is performance-oriented.

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Richard Schramm, HSBC, Research Division - Analyst [42]

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Yes. I understand this. But nevertheless, I would have expected that an increasing portion of this recurring revenues would result in a kind of stabilization of margin development. But obviously, this is not automatically the case, so it's still a matter of the product mix which is in there, I take from your answer.

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [43]

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Yes. It's still not -- it's still just a small part of the business. And most of the -- or many of those contracts are just in the starting phase, but the ones that are operating show clearly this significantly better profitability. We will see that in the year to come as the contracts are increasingly coming into operation and the impact of the machinery component is increasing as well.

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Operator [44]

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Ladies and gentlemen, we will now take a question from Richard Phelan from Deutsche Bank.

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Richard Phelan, Deutsche Bank AG, Research Division - MD & Head of the European Credit Research [45]

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I had 3 questions, actually. The first is that -- you've touched upon this a little bit, but with the shift in the order intake that you saw, that Slide 15 demonstrates that from a regional perspective, where you've had the boost following the China trade show in April, whereas demand in Europe is falling off, right? So -- and that consequently has resulted in a drop in quarterly incoming orders. Would you expect that, that regional shift could drive a drop in profitability? Because the China market traditionally has served printers, which maybe are less complex or at least are assembled in the China facility with parts from Germany, and maybe we could expect a lower margin for the realization of the higher orders in Asia versus U.S. -- or versus Europe.

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [46]

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Richard, as we have said, we have seen the orders in the first quarter, and we have looked into the outlook for the full year. And there, we have then looked into the forecast and have then reduced the overall guidance for the full year by 1%. And this is mainly based on the product and country mix, which I've tried to comment on your 2 colleagues beforehand. Seasonality and [records], while obviously, sales and country mix might change in 3, 6 months to come, but if we look for the full year, which is where we are in, we have therefore said we will not be in the position to achieve 7.5% to 8%, therefore, have reduced it to 6.5% to 7%. I hope that this answers your question.

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Richard Phelan, Deutsche Bank AG, Research Division - MD & Head of the European Credit Research [47]

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Yes. I think so. I think that's reflected. So second question is, your new partner, Masterwork, which has now built a stake up at 8.5%. You mentioned some collaboration there with the plant -- I think, a plant in China or working more closely on the packaging side. Just would be helpful if you could elaborate a little bit further in terms of what work you intend to pursue with that partner in the region. And is there [CapEx] associated with that?

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [48]

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Yes. There are several areas of collaboration. The one, of course, is in the market. Masterwork is our OEM supplier for post-press packaging equipment. And to have a closer cooperation is very helpful in regards of also pushing this business for Heidelberg, but also for Masterwork. Second, we started a sales collaboration also in China, where our organizations help each other, because there are customers where Masterwork is in and Heidelberg not, and where Heidelberg is in and Masterwork not, so we started a program to kind of use our good relations in the one or other case to help out the partner. This is basically on the sales side. On the manufacturing and supply side, we are starting to bundle purchase volumes and achieve better conditions. And I think it's also well known that if a German company in China, even with Chinese staff, buys components and parts, pays a higher price than the Chinese companies buy them. So that will have some positive effect on top of the larger volume. And the real important thing is that we are working to establish a manufacturing joint venture together to produce quality parts for the MK assembly plant as well as for our China assembly plant. And the deal is that our Chinese partner brings the CapEx, and we bring the know-how. This is very helpful for us to get basically not only a capable supplier, but also have a share in this venture and some insight and control and also some profit sharing.

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Richard Phelan, Deutsche Bank AG, Research Division - MD & Head of the European Credit Research [49]

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Okay. So as a joint venture, where the CapEx is funded by your partner, you wouldn't expect any change there?

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [50]

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No.

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Richard Phelan, Deutsche Bank AG, Research Division - MD & Head of the European Credit Research [51]

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And this is sort of related to that, but just following on the concept of CapEx. Just to be clear, when you talk about the liquidity checks that you have, including the EUR 20 million of potential upside, is that -- you say lower investment. Is it fair to interpret that as basically a reduced CapEx in the current year of EUR 20 million, which is the driver of that freed up liquidity? And then I guess -- and related to that, can you just maybe update us with the CapEx guidance for the current fiscal year? And maybe if it's -- if you're willing to share it, 2020 and 2021 -- fiscal '20/'21?

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [52]

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So it is pushing out investment and even maybe canceling one other investment even in total, but this will not be all within this year. It's more like a 12- to 18-month view because it takes some time to push these things out. We might find more, but for now, it is EUR 20 million in the next 12 to 18 months of the investment. We just don't do right now, we push in the future.

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [53]

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You would have seen that depreciation is coming up while we have done the investment in the past, and therefore, we have EUR 70 million to EUR 80 million depreciation. This is what we are driving for the time being, Richard.

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [54]

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We still invest on the [appreciation] level, so we are not living from the substance, if you will.

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Richard Phelan, Deutsche Bank AG, Research Division - MD & Head of the European Credit Research [55]

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Okay. So for in the current fiscal year, maybe EUR 70 million to EUR 80 million of CapEx?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [56]

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No. We have had plans for this which were in the range of EUR 80 million to EUR 100 million. And as the depreciation is running between EUR 70 million to EUR 80 million, we have set a normalized level. We would have to be on the same level as depreciation, and therefore, we are now making the prioritization. And as financial commitments have been given and orders have been already drawn, we are now going through and say what can we adjust, what can we take out over time. We'll push it out, and therefore, we are saying 12 to 18 months, there's an opportunity for about EUR 20 million. And still comfortable while we still have a lot of investment in there, therefore, confident that we will achieve this one, but not short term, not in the next 2 to 3 months. That's what's the message we try to place here.

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Richard Phelan, Deutsche Bank AG, Research Division - MD & Head of the European Credit Research [57]

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Okay. So I guess where does that put the current guidance for CapEx and -- for the current fiscal year?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [58]

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Too early to make the final judgment in the year. Let's take us 3 months more down the road and then we confirm this by the next publication.

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Operator [59]

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(Operator Instructions) We now take our next question from Peter Rothenaicher from Baader Bank.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [60]

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Could you please comment on your current plans regarding your subscription contracts? Initially, I think you had, for the current year plan, approximately 70 additional contracts and 100 contracts in the years going forward. Is this still a valid assumption? Or do we have to expect here a lower number now?

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [61]

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We still have the plan to achieve those 70-plus contracts, but there might be a certain number without the machine. So we only have the supply part and the customers buy the machine. But the goal is still to achieve the 70-plus contracts, probably even more. If you remember, in the presentation, Page 3, we expanded the offering on the contract business, so we probably will not only achieve, maybe even achieve a larger volume of contract and reoccurring business. But we expanded that above and beyond the subscription model, including also customers who have already machines or who just buy and pay their machine.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [62]

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Okay. And with that, how far are you already with the ramp-up of your internal organization to drive up the subscription business?

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [63]

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We are more or less on plan to do so. Of course, that's a longer venture. We can support, of course, all the machines we have installed quite well. The performance of the customers is getting there, where we intended to be. If you will, we are 1/3 of the way we have behind us, 2/3 still ahead of us as a rough guess.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [64]

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Yes. And next question regarding subscription. How far are you with regards to getting these machines off the balance sheet? I think in some countries, you have already agreements with financing partners, but can you give us an overall view?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [65]

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The agreement with our financing partners partly have been signed. Now we are looking to the right customer, the right country and the right deal, where we can then -- where we are then in a position to externalize. So it's not a longer process, but it's being established. So we would have now to bring the puzzles together.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [66]

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Okay. And so are there some countries where you still have no partners, where you still have some machines and on the balance sheet, and this is burdening your liquidity?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [67]

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If I would say so yes. Obviously, we cannot do and start in 70 countries around the world where we are making business. So we are concentrating on the countries where we do have volume. There, we have discussed with our partners, and then we try to take best practice examples, having the right customer, the right deal, the right infrastructure and then roll it out over time, and therefore, then starting the externalization as the business is increasing.

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Peter Rothenaicher, Baader-Helvea Equity Research - Analyst [68]

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Okay. And my last question. You have mentioned some of the measures you tried to improve liquidity. Can you confirm that according to your planning, you're expecting a positive free cash flow for the current year?

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Dirk Kaliebe, Heidelberger Druckmaschinen Aktiengesellschaft - Deputy Chairman of Management Board, CFO & Head of the Financial Services Segment [69]

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We haven't given the guidance for positive free cash flow. We have said we're going to increase substantially against the previous year, and what does it mean, it depends on how -- on the level of what we are investing in the financial year. So in this regard, we ask for your understanding that the free cash flow guidance was not being guided specific with a number for the full year, and we are coming closer to it by the next quarterly figures.

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Operator [70]

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(Operator Instructions) We will now move to a follow-on question from Stefan Augustin from Pareto Securities.

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Stefan Augustin, Pareto Securities, Research Division - Analyst [71]

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It's actually a question on the investments in the Primefire and Labelfire, so the digital equipment. You commented that this is roughly taking off half of your R&D expenses. So in a case where you -- I know that you don't want this, but in the case when you would need to abandon this completely, how much of the costs could you save? And how much would occur anyway?

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [72]

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First of all, this is not going to happening because the technology is getting grip, and it has the potential to be -- even at some point, to become disruptive. The main reason where everybody in our world said offset cannot be replaced in total by digital printing, was the quality issue. And if you look what today our Primefire and Labelfire can deliver in the regards of quality, it is as good or even better than offset printing. That will make this technology to last. The challenges we have, of course, is to get the performance of the machine and the cost of the ink into line, but this is technically possible, and it's a question of putting it in place. So it will definitely come. We see already a very positive development. It's just that the ramp-up of the market introduction is slower than we have anticipated, but it is ramping up. We just closed, in the last weeks, some very nice orders for Primefire and there are more just before closing, so it is happening as we speak.

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Operator [73]

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(Operator Instructions) And ladies and gentlemen, just to advise, we have no further questions in the queue. So at this time, I'll turn the conference back to our host, Mr. Hundsdörfer, for any additional or closing remarks. Thank you.

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Rainer Hundsdörfer, Heidelberger Druckmaschinen Aktiengesellschaft - Chairman of Management Board, CEO & Chief HR Officer [74]

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Thank you very much. Ladies and gentlemen, thank you for your interest in Heidelberg. I believe we could make clear that Heidelberg is well on the way to establish the strategy and the long-term profitable Heidelberg. We are well set to cope with a not-so-favorable economy, and we will not only not have to sacrifice our strategy, this situation confirms that this is the right strategy for Heidelberg to make the business more robust, more profitable and turn it into growth again in the future. Thank you very much. Enjoy your summer. Thank you.