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Edited Transcript of MTX.DE earnings conference call or presentation 28-Apr-17 9:00am GMT

Thomson Reuters StreetEvents

Q1 2017 MTU Aero Engines AG Earnings Call

Munich Apr 30, 2017 (Thomson StreetEvents) -- Edited Transcript of MTU Aero Engines AG earnings conference call or presentation Friday, April 28, 2017 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Michael Röger

MTU Aero Engines AG - VP of IR

* Michael Schreyogg

MTU Aero Engines AG - Chief Program Officer and Member of Executive Board

* Reiner Winkler

MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board

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Conference Call Participants

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* Alexander Hauenstein

DZ Bank AG, Research Division - Analyst

* Antoine Boivin-Champeaux

Natixis S.A., Research Division - Research Analyst

* Benjamin Fidler

Deutsche Bank AG, Research Division - MD

* Christian A. Laughlin

Sanford C. Bernstein & Co., LLC., Research Division - Analyst

* Christophe Menard

Kepler Cheuvreux, Research Division - Head of Aerospace and Defense Sector

* James Edward Zaremba

Barclays PLC, Research Division - Research Analyst

* Norbert Kretlow

Commerzbank AG, Research Division - Research Analyst

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Presentation

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Operator [1]

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Welcome to the conference call on MTU Aero Engines First Quarter Results 2017. For your information, today's conference is being recorded. The speakers of today's conference call are Mr. Reiner Winkler, Chief Executive Officer; and Mr. Michael Schreyögg, Chief Program Officer.

Firstly, I will hand over to Mr. Michael Röger, Vice President, Investor Relations, for some introductory words.

Please go ahead, sir.

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Michael Röger, MTU Aero Engines AG - VP of IR [2]

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Good morning, everybody. Welcome also from my side. We will have 4 parts of this call.

Firstly, Reiner Winkler will give you some highlights of Q1. Michael Schreyögg will give you an update about GTF and more details about the business segments. Lastly, Reiner Winkler will close with our current guidance. Afterwards, we will have plenty of time for your questions.

Let me hand over to Reiner Winkler now.

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [3]

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Yes. Thank you, Michael. Hello from my side as well. Let me start with some business highlights of the first quarter 2017.

First of all, passenger traffic surprised with a very good start. In the first 2 months, we saw growth of about 7%. Continuous high load factors of 80% and historic low park rates are also supported for our industry.

These market indicators keep us confident that the positive momentum will continue in 2017. And we are currently in the middle of the GTF ramp-up, and we see our internal production facilities right on track. Our final assembly line for the A320neo engine has started operations in October last year, and we have delivered the first GTF engines assembled at MTU to Airbus. Our blisk manufacturing center in Munich is also in full operation. The facility in Hannover achieved the MRO readiness for the GTF, and we are now ready to support customers within the IAE network.

In February, we finalized the JV agreement with Lufthansa Technik to establish a new best cost MRO shop for the GTF engines.

According to our plan, this new 50-50 JV will be up and running by 2020.

A workforce of 500 employees will perform 300 shop visits per year, and total investment of around EUR 150 million will be shared equally between both partners.

High volumes and best cost environment would result in benefits for both parties. Our target is to build the most competitive MRO shop for GTF engines.

The strong growth momentum in our MRO business has continued into 2017. In the first quarter, we won new contracts of around USD 1 billion for our independent MRO business, mainly for regional and narrowbody engines. And we also secured new OEM MRO contracts, especially for the GTF engines.

In Q1, we achieved new MRO record sales in the sixth consecutive quarter.

Last but not least, we will propose a dividend of EUR 1.90 per share at our upcoming AGM on May 4. Compared to last year, this is an increase of 12% and the total dividend payment will be around EUR 100 million.

So first of all, let me give you a brief overview about the financial highlights of the first quarter.

Our group revenues increased by 15% to EUR 1.3 billion, mainly driven by strong MRO revenues.

Group EBIT increased by 20% to EUR 157 million, resulting in margin of 12.4%. Net income adjusted increased slightly higher by 21% to EUR 111 million, resulting in earnings per share of EUR 2.16 . The free cash flow at EUR 61 million shows a good start into the year 2017.

Let's now have a quick look on our U.S. dollar hedge book. We continued with our hedging with the following results. For 2017, roughly 80% is hedged at the rate of 1.18. For next year, roughly 50% is hedged at the rate of 1.13. And for 2019, roughly 20% is hedged at a rate of 1.12.

Let me now hand over to Michael for details on our OEM and MRO business segments. Michael, please?

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [4]

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Thank you, Reiner, and good morning to everybody.

As we have received quite a lot of questions about the geared turbofan engines in the last few weeks, I would like to give you an update on the current status of this program.

Since the engine took service in January last year, now over 50 A320neo aircraft equipped with geared turbofan engines have been delivered to 11 [custom] airlines.

A320neo was followed by a flawless market entry of the Bombardier CSeries, also powered by GTF engines. Up to now, 10 CSeries aircraft are in operations with 2 customers.

Until now, the GTF engines have performed over 150,000 flight hours with a dispatch reliability of much more than 99%.

The in-service performance of the GTF engine has shown a reduction of fuel burn by about 16%, which is above our expectation, and the noise footprint is reduced by 75%.

This is underpinned by the strong order book of 8,000 geared turbofan engines, which has been ordered by over 80 airline customers for more than 30 countries. And we have not seen any cancellations.

Let me give you now some facts about the issues, which we have seen since the engine took service last year. Pratt & Whitney provided combined software and hardware fixes to solve the early teething issues. The motor to start time for the GTF engines now in service is at a comparable level to a V2500 engine. The nuisance messages of the software has been solved at (inaudible) software fixes. Pratt has also achieved significant progress in the ramping up assembly production now.

Currently, there are only 2 durability issues discussed in the press, the carbon seal and the issues of the combustion chamber, which mainly occur on geared turbofan engines operated in very harsh environments.

On the carbon seal, Pratt has received certification for a more durable solution just this month. The retrofit program has already started and can be carried out on wing. Roughly 25% of the excess engine fleet has already been retrofitted and the remaining should be completed within the next 2 weeks.

For the combustor, we expect a further upgrade, which will extend the durability extensively. To avoid disruption of operation for the airline customer, during inspections and upgrades, the number of spare engines have been increased.

Pratt & Whitney reconfirmed to meet delivery target of 350 to 400 geared turbofan engines during this year.

Regarding the other GTF applications, we see very good progress in flight testing. The Embraer E 195 successfully completed its first flight on March 29, just 3 months ahead of the schedule already. It was added as fifth test aircraft to the flight -- as a fifth aircraft to the flight test program. Embraer is therefore well on track for engine to service of its fleet in 2018.

Mitsubishi is currently evaluating their flight test program and has added a fourth flight test aircraft. They are also on track for engine to service by 2020.

Let me now give you an overview about the financials of the OEM segment. The total OEM order book decreased by 4% to EUR 6.9 billion. The commercial order book decreased by 2% to USD 6.9 billion. The military order book decreased by 12% to EUR 440 million due to the execution of contract. And the total OEM revenues increased by about 2% to EUR 694 million. Commercial revenues increased by 10% to EUR 611 billion -- EUR 611 million, yes.

Within that, new engine sales in U.S. dollar was down by 10%, improved GTF deliveries could not compensate for the significant decline of -- in the [GP 7000] Series program and slightly lower V2500 deliveries.

Spare parts U.S. revenues increased by a high single digit number, which is slightly ahead of our full year expectation.

The main driver of our strong step-up growth was, again, the V2500 program.

Military revenues were down this quarter by 33% to EUR 83 million, but mainly due to phasing effects in our contracts. We continue, therefore, to expect revenues above EUR 450 million for the entire year 2017.

EBITDA adjusted increased by 18% to EUR 104 million, resulting in an EBIT margin of 15%.

Let me now switch to the financials of the commercial MRO business. The MRO contract volume increased to a new record level of USD 7.9 billion, mainly driven by campaign wins of our independent MRO business of around USD 1 billion in the first quarter.

Revenues increased by 37% to EUR 588 million, which is above our growth expectation for 2017, driven by a very strong induction growth regional and narrowbody engines in the first quarter, as well as a strong ramp-up of our lease and asset management business.

We expect lower growth rates in the following quarters as the comparison base naturally gets better. EBITDA adjusted improved by 23% to EUR 52 million resulting in an overall EBIT margin of 8.9%.

Thank you very much for your attention, and let's now hand over back to Reiner for the outlook of 2017.

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [5]

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Yes. Thank you, Michael. Based on the Q1 results, we confirm our guidance 2017, where we expect group revenues in the range of EUR 5.1 billion to EUR 5.2 billion.

Within that, we expect military business to decline by a high single-digit percent number due to lower Eurofighter engine deliveries.

New engine sales are expected to be up high single digit and spare parts should grow by mid-single digit.

For commercial MRO, we expect an increase of around 10% and consequently, the EBIT adjusted margin should remain stable in the level of around 10.5%.

Net income should grow a bit higher than EBIT, as we expect lower interest expenses.

We expect this year's free cash flow to be slightly above EUR 100 million, resulting in the cash conversion rate in a low double-digit range.

So thank you very much for your attention. And we are now ready to answer your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take the first question from Christian Laughlin from Bernstein.

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Christian A. Laughlin, Sanford C. Bernstein & Co., LLC., Research Division - Analyst [2]

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Two questions from me relating to the commercial OEM aftermarket, please. The first question is, in thinking about the main components of the aftermarket in Q1 around scope, pricing and unit growth, that is units or engines coming through the shop networks and stuff, how did the trends in Q1 look compared to what you expect for the full year, in line or any differences that you could discuss, please, that would be great. And then the second question is actually related to the MRO division. What sort of trends are you seeing -- pricing trends that you're seeing for GE engines that you're not an RRSP on so specifically, I guess, that mainly capture the CFM56 and GE90. So are you seeing any increased difficulty in the pricing environment in that? Or is it still pretty solid?

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [3]

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Chris, and it's Michael here. Maybe to start with your second question. I think, the pricing is just unchanged compared to 2016. We see a high demand. This is true but not something which -- where we really see different effect on pricing. In terms of the MRO division, on your first question, what is slightly above our expectation is the scope, really, not so much in units but also the scope, where we see more material content, which we have to build into this engine so this is a upside, which we experience now, really continue for the entire year here. I mean, you know us, we are sometimes a bit conservative on this one, but general changing trend is not something which we are expecting. I mean, we have now 5 or 6 quarters in a row where we see growing MRO business. And in the first quarter of 2017, we especially have to concentrate on this work content, is what the news. But no general change in trend.

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Operator [4]

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We will now take the next question from Ben Fidler from Deutsche Bank.

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Benjamin Fidler, Deutsche Bank AG, Research Division - MD [5]

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I have 2, maybe 3 questions, please. Firstly, on expense R&D in Q1, I see R&D expense was down around 20% year-over-year. Does that change your view of the full year? Where I think your prior full year guidance was that expense R&D will be marginally up year-over-year. Is that something you still see? Or have you -- does it change your view of saying this is just a quarterly phasing effect? The second question is on -- thanks for the update on GTF, Michael, on the detail you've given us there. I just wondered if you were able to give us a little bit more color, picture of where you're at in terms of unit cost, unit losses, the learning curve. Are you now pretty much done with the learning curve? Any data that you're able or willing to share with us on the progress and change that you've seen over the last 3 or 6 months in the average loss for engine, that would be very interesting. The third question is the face of much stronger than expected growth MRO spares relative to your full year guidance. You really haven't changed your full year guidance, to state the obvious. Is it that just your natural conservatism? Or is it reflective in any way of concerns you may have on GTF warranty provision costs associated with the retrofit program that may be higher than you earlier expected? Or am I misreading things and I shouldn't draw that conclusion about the lack of any full year guidance increase at this stage?

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [6]

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Maybe, Ben, we start with the first question regarding R&D. The full year guidance is unchanged. I mean, the first quarter was a little bit weaker than the full year guidance, it's just some phasing effects that (inaudible) from quarters, but for the full year, it's still slightly -- we expect slightly up for R&D as well for the company spend but also capitalization and consequently all through the P&L effect, so no change to the guidance. Coming to your last question, I mean, the main reason why we haven't changed now the guidance is, we have just seen 1 quarter where strong MRO performance, as Michael explained, very high material comment within the shop visits with -- let's say order book very strong, but let's update the guidance in middle of the year, but we normally don't do that after Q1. And there's nothing to do with any potential whatever payments or anything, something like that. I mean, all we expect for that has been included already in our guidance as we explained in February already. Also no change to that.

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [7]

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On production target cost, I think we explained this in the last Capital Market Day also. We have achieved now. Meanwhile our target cost levels on the geared turbofans operation is good news. We do not see the significant change or impact in our -- to our guidance. So we are absolutely in line with our plans there.

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Operator [8]

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We will now take the next question from Alexander Hauenstein from DZ Bank.

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Alexander Hauenstein, DZ Bank AG, Research Division - Analyst [9]

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I have to come back to the MRO and to GTF obviously. So on MRO, I mean, quite a stronger results you have, above the 50s. Is the level of, let's say, in the low 50s, is this the new normal EBIT contribution we might see for MRO for the coming quarters here? I think that is still the read one might have? Or is there a risk that you fall back over the course of the next couple of 2 or 3 quarters below the 50s, maybe due to lower utilization, lower content coming up in the new contracts, feeding into the results or any other effects here? Or should we think about the 50s-plus going forward? And then on the GTF deliveries, I understand there have been a few deliveries less on GTF during Q1 than initially expected. Is that correct? And if yes, will there be a catch-up effect in Q2? Or will there be a catch-up effect in Q3 or Q4? I mean, if the full year target stands still at 350 to 400 GTFs overall? I'm wondering when this potential catch-up effect is coming and -- maybe some color on that.

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [10]

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Yes, I think, on MRO, we do not see a significant risk change but really let's wait until the mid of the year to give you an improved glance on the guidance. I think it's far too early to make any speculation here, but there's just another 2 o3 3 months to go there. On the geared turbofan, there's no change. We can confirm that the 300 to -- 350 to 400 geared turbofans will be delivered this year's. Back-end loaded as always planned, so no change also in this program.

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Alexander Hauenstein, DZ Bank AG, Research Division - Analyst [11]

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So there hasn't been any kind of postponements of deliveries in Q1, so that was completely in line? Or was it a bit less than initially targeted? And if yes, will there be a catch-up in Q2?

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [12]

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So as seen in total, it was about 17 engine deliveries in Q1 and the remaining is back end loaded. I don't have the detail here, if it's 1 or 2 engines more or less but it's in -- and this margin is pretty marginal.

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Operator [13]

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We will now take the next question from Norbert Kretlow from Commerzbank.

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Norbert Kretlow, Commerzbank AG, Research Division - Research Analyst [14]

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I have one. Looking at the OEM sales, I get the impression that in particular, spares have been very strong in Q1 2017. I would assume that the growth rate in spare parts even surpassed the quite strong one in MRO. And my question would be, can you confirm this? And if so, could you give us an idea about particular drivers. I mean, you mentioned that again, the V2500s has been the major driver of spare parts growth. May be can you give us an idea about underlying trends like, for example, the historically low grounding rates you named?

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [15]

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Yes, maybe let's go through the spare parts guidance for 2017, which is basically what we can confirm here. On the V2500, we expect low- to mid-teens for the entire year, maybe first quarter was a bit better than expected or in the mid-teens range. CF6, PW2000 stable also in the first quarter, so in line with our expectations. The widebodies PW4000, GP7000s will be up by about mid-single digits compared to last year, where it was slightly up. This growth is now driven by the GP7000 spare parts. So in total, the spare parts sales, we expect to be up by about mid-single digit for the entire year. There's not a significant change to our guidance and therefore, I would recommend to go ahead and to plan also of these numbers.

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Operator [16]

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Our next question comes from Christophe Menard from Kepler Cheuvreux.

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Christophe Menard, Kepler Cheuvreux, Research Division - Head of Aerospace and Defense Sector [17]

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I have 2 questions. The first one is on the operational leverage in MRO. The margin is up 8.9% last year and 9.9%. My understanding is that this may be linked to the increase in long-term service agreement in the mix. I mean, first, is it the case or is it the case of -- you mentioned in the call lease and asset management, so just more color on that would be helpful. And if that's long-term service agreement, how has the proportion changed year-on-year, I would say? It will imply that it has increased quite significantly in your mix. The second question, it's more just to double check. Your free cash flow is good again. And is it directly linked to the fact that you have a decrease in military activity? I mean, net prepayment outflow? Or is it the combination of other factors?

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [18]

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Maybe we start with the second question on free cash flow. It's -- the second point you mentioned, so not impacted by the military business. It's mainly other factors like change in working capital and other issues. And as you know, cash flow is always much more volatile than the (inaudible). So [EUR 16] billion for the first quarter, I mean, last year, we had around EUR 90 million. For the full year, we can confirm free cash flow of about EUR 100 million or in the range [EUR 2500 million] but it's nothing to do with the military business.

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [19]

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And then on the first question on the MRO, you're right, it's actually it's a mix effect. Actually, 2 effects. The first one is that we saw significant amount of engines of a quite high material consumption, which is naturally decreasing then our margins since we [sourced] all its material. And secondly, an increasing OEM MRO business, which was ramping up, although something which we presented to you on the Capital Market Day. So the mix of the 2 elements here was driving the slightly lower margin in Q1.

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Christophe Menard, Kepler Cheuvreux, Research Division - Head of Aerospace and Defense Sector [20]

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And the question is, it the new norm for MRO margins? Or should we expect still between 9% and 10% as a margin over the next years?

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [21]

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I think, as we communicated in other forums already, to achieve an MRO margin well above 8% is a good achievement. It's a challenge sometimes. In the past, we showed margin also between 8% and 10% in our MRO business. And this is something for us, which is the norm. So not a significant change overall, but also not something where we have a difference. Quarter-by-quarter, we will see some fluctuations.

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Operator [22]

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Our next question comes from Antoine Boivin from Natixis.

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Antoine Boivin-Champeaux, Natixis S.A., Research Division - Research Analyst [23]

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I've got 3 questions, please. On the spares activity, can we -- just trying to assess the weight of V2500 long haul spares? I have an estimate of 40% 4-0, is it about right? My second question is on the MRO business JV with Lufthansa. Have you already decided on the location of this shop visit factory? And my third question is on GTF penalties, I think you had some of them in '16. Is it again the case in the Q1 '17 profit numbers?

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [24]

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Maybe we start with the V2500. It's in the range of 40%, you're right with your assumption. The location on the JV has not been decided, but really shortly decided, but it will be no surprise, I think, at the end of the day. And we got the penalties, we explained already during the full year call that we have done some provisioning in our statement and also in our guidance, but we hopefully understanding that we cannot disclose any details here because it's a contract between 2 parties and we are not allowed to give more details on that. I think [I excluded] in our guidance and it's unchanged.

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Antoine Boivin-Champeaux, Natixis S.A., Research Division - Research Analyst [25]

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Okay. And the very last question very quickly. How many GTF modules have you delivered in Q1? And how does it compare to Q4 '16?

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [26]

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(inaudible) the engines overall?

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [27]

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Just a second please. So there's about 60 last year in the Q4. And now about 70, ramp-up to 70 in Q1, so this should be around the numbers that are (inaudible). That's approximately the numbers.

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Operator [28]

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We will now take the next question from James Zaremba from Barclays.

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James Edward Zaremba, Barclays PLC, Research Division - Research Analyst [29]

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I've got a couple of questions, please. One, just on the free cash flow. And there seems to be about EUR 20 million and from net investments and financial assets. I just wondering if you could explain what that is? And then in secondly, there's very strong growth in the JV income this quarter, and I wonder if you could just explain if that would continue and also what was the driver?

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [30]

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So first question, it's mainly investments in the GTF engine lease pool. That's roughly 90% to 95% of this is EUR 20 million. And your second question? I didn't get the second question.

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [31]

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What was the second question, can you repeat it, please?

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James Edward Zaremba, Barclays PLC, Research Division - Research Analyst [32]

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The second question was to do with the stronger growth in JV income and just whether this is expected to continue? And also what was the driver in the first quarter?

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [33]

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The driver of that was the JV in China, so MTU through our JV with China Southern Airlines was the main driver. And then secondly, also some positive impact from the new leasing company for the GTF engines, so (inaudible).

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Operator [34]

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(Operator Instructions) We will now take the next question from (inaudible) from JMS Investment AG.

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Unidentified Analyst, [35]

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One question with regards to the strong MRO growth rate that you have. There were 3 more working days in Q1 due to the late easter this year. Now this is going to be reversed in Q2, so there will be 3 less working days compared to Q2 last year. What is the sensitivity of this business with regards to working days? And what will be the effect in Q2 versus Q1? That's the first question. Second one would be with regards to the depreciation, whether the rather high depreciation in Q1 is the new flag level? Or what we should expect going forward there? And the third question actually is a follow-up on the one that has been asked before. The equity results in Q1, that was very strong. It is the new flag level also going forward? So with off EUR 10 million, would say, EUR 11 million or so, maybe you could give some guidance there as well.

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [36]

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So maybe we start with the last question. I think we've just answered that question before. It was mainly driven by the strong performance of MTU Zhuhai, the 50-50 joint venture. And then new leasing company, but we cannot give a guidance on specific items in the P&L for the entire year, but these 2 issues were driving this -- these results. Second, depreciation, yes, it's increasing. And it's, I think, normal that driven behind investments we did in the last years and new programs but also for PPE and consequences the depreciation will decrease over time. And I'm not sure whether I get the last question?

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Michael Schreyogg, MTU Aero Engines AG - Chief Program Officer and Member of Executive Board [37]

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(inaudible) 3 working days. This has not (inaudible) to our business. I mean, the throughput is dependent when we get the engine, what is our performance in terms of operational lead time and when we can get the material from the internal and external supply chain again here. Therefore we're working with extremely flexible shift and working systems, which can balance such calendar effect. But this has not the real impact quarter-by-quarter on the revenue.

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Operator [38]

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As there are no further questions in the telephone queue, I would now like to turn the call back to our speakers for any additional or closing remarks. Please go ahead, gentlemen.

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Reiner Winkler, MTU Aero Engines AG - CEO, CFO, Director of Labor Relations and Member of Executive Board [39]

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Yes. Thank you very much for your attention. If you have further questions, please do not hesitate to call us. We are available. Our IR team is available today. So otherwise, I wish you a happy weekend, and see you next time. Bye-bye.

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Operator [40]

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Ladies and gentlemen, this concludes today's conference call. We want to thank Mr. Reiner Winkler and Mr. Michael Schreyogg and all the participants of this conference. You may now disconnect.