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Edited Transcript of OSR.DE earnings conference call or presentation 12-Nov-19 1:00pm GMT

Full Year 2019 Osram Licht AG Earnings Call

Muenchen Dec 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Osram Licht AG earnings conference call or presentation Tuesday, November 12, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Ingo Bank

OSRAM Licht AG - CFO & Member of the Managing Board

* Juliana Baron

OSRAM Licht AG - Head of IR

* Olaf Berlien

OSRAM Licht AG - CEO & Chairman of the Managing Board

* Stefan Kampmann

OSRAM Licht AG - CTO & Member of Management Board

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Conference Call Participants

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* Charlotte Friedrichs

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

* James Moore

Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research

* Jürgen Wagner

MainFirst Bank AG, Research Division - Director

* Lucie Anne Lise Carrier

Morgan Stanley, Research Division - Executive Director

* Sebastian Growe

Commerzbank AG, Research Division - Team Head of Industrials

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. I'm Haley, your Chorus Call operator. Welcome, and thank you for joining the OSRAM Licht AG Investor and Analyst Conference Call 2019. (Operator Instructions)

I would now like to turn the conference over to Juliana Baron. Please go ahead.

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Juliana Baron, OSRAM Licht AG - Head of IR [2]

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Thank you, Haley. Good morning, and good afternoon, ladies and gentlemen. Welcome to the OSRAM conference call on the Q4 and full year 2019 results. I'd also like to welcome our management board represented by Dr. Olaf Berlien, our CEO; and Ingo Bank, our CFO; as well as Dr. Kampmann, Stefan Kampmann, our CTO. As a reminder, today's call is being recorded. You can follow the webcast on our website at osram.com/ir where you will also find the slides available for download.

As with previous results conference calls, I would like to draw your attention to the safe harbor statement on Page 2 of the results presentation, as usual, described throughout this call.

It is now my pleasure to hand you over to Olaf.

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Olaf Berlien, OSRAM Licht AG - CEO & Chairman of the Managing Board [3]

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Yes. Thank you, Juliana. Ladies and gentlemen, a warm welcome also from my side to our conference call today. As usually, I will start with the presentation of the results for the fiscal year, followed by our outlook for fiscal year '20, and of course, our long-term view. Finally, we will comment on the late takeover bids by AMS and, of course, the recent opinion that we have published today. As usual, we will then have enough time to answer all your questions.

So let's make a start and look back on the past year. Fiscal year 2019 was one of the most challenging years we have experienced. We continued to confront a very tough market environment with slower demand across nearly all markets and with ongoing political and economic uncertainties. This clearly impacted our financial results for fiscal year '19, and we expect these headwinds to also continue in our Q1. For the rest of the fiscal year, we assume a more stable development. While market developments are unlikely to help us, we are focusing on our own performance. The countermeasures that we have installed are having an effect, especially in the Opto segment. And thanks to these programs, we expect a moderate revenue and earnings development in the current fiscal year.

Before we go into the financial details, let's take a brief look at OSRAM in 2019, and I move to Page #5. As of today, OSRAM is a company with sales of EUR 3.5 billion and an operating margin of almost 9%. OSRAM has a strong IP portfolio with more than 15,000 patents, and every working day 2 new ones are added. The R&D ratio is 11% of sales, and we have a team of 25,000 (sic) [23,500] inspiring colleagues. So however, we must also acknowledge that we experienced headwinds from the markets in 2019, and this has an effect at our full year results as we move to Slide #6.

Overall, we managed to achieve our targets for fiscal year '19 adjusted in March. This is due also in large part to a stronger Q4, which developed quite well. For the full year, comparable revenue fell by 13% to roughly EUR 3.5 billion, in line with our expectations. The decline was mainly caused by the weak market environment in automotive and in China.

Adjusted EBITDA before special items was impacted by lower volumes and reached EUR 307 million, which translates to a margin of 8.9%. Thanks to the strong Q4, free cash flow for the full year exceeded expectations and was positive at EUR 17 million. This was mainly due to our strong focus on net working capital reductions.

On the other hand, our net profit was affected by goodwill impairment. For the (inaudible) we do not expect global car production to pick up significantly in the near future. Due to these lower market expectations and accounting standards, we have made an impairment on the goodwill of joint venture of EUR 170 million.

Slide #7 shows you the weak market development in automotive last year. Car production continued to decline across all regions. The biggest impact was noted in China where car production fell by almost 13% year-on-year, but also Europe and NAFTA turned negative in 2019. Accordingly, IHS reduced its forecast for yearly global car production every month, as you can see from the right-hand chart.

One year ago, the IHS forecast was almost 98 million cars. 12 months and 12 forecasts later, it ended at 90 million cars. By the way, as we predicted early in the year, we clearly noticed that with our automotive customers, if you take a look at Slide #8, you can see the actual order volumes from our tier 1 key customers in 2019 compared to the order volume agreement a year ago on the left, almost all customers fell short of their agreed purchasing volumes, most of them significantly.

External factors are one part of the story, the other one relates to internal issues and that we are working on, especially streamline our processes. You know our strategic execution programs that you can see on Slide #9.

I reported that status to you in the previous quarters, and we continue to make good progress with these programs. I want to highlight the divestment of Siteco that we closed successfully at the end of September. And I want to point out our operational improvements at OS. Our Fit for the Future initiative at OS has taken effect in 2019, delivering cost savings of EUR 57 million to date, and we are continuing our efforts not only at OS. All in all, we are confident that with our performance programs, we will get back to a profitable growth.

The overall success of our performance programs is illustrated on Slide #10. At EUR 107 million, we managed to overachieve our cost-saving target for fiscal year '19 by around 20%. This was mainly due to overhead reduction and the adjustment of our footprint. All in all, we managed to reduce our head count by more than 2,300 employees. Ingo will show you that in a more detail in a few minutes and which takes me to the outlook for fiscal year '20 on Slide #12.

A look at the global business climate shows that the economic environment continues to slow down. After some improvement in spring, the ifo World Economic Climate Index fell again in the last quarter, and also the global manufacturing expectations remain at the low level, as you can see on the right, from the Global PMI Index. At the same time, the graph indicates that we might be seeing a trend reversal here. The outlook for our most important market, automotive, remains challenging.

If we take a look at Slide #13, according to IHS again, global car production for fiscal year '20 is expected to reach 88 million units. This is a minus of 2%. At minus 5%, Q1, in particular, should still be challenging. While the second half of the fiscal year there are some signs of relief, after a declining year with minus 13%, especially in China might recover, yet we remain cautious given what we have seen so far in terms of order volumes from our customers.

First discussions with key automotive clients indicate a rather flat development in the purchasing volumes for fiscal year '20 with a better second half year. Other indicators support the view that the markets may have bottomed out in 2019.

Slide #14 shows the historical development for the semiconductor market. After several quarters of decline in growth rates, the market might have found a floor in the last 2 quarters. Hence, the world semiconductor trade statistics forecast a market recovery for Q1 of calendar year 2020. But again, for Q4 '19, which is our Q1, they've also still seen negative growth. And this is in line with what our customers are telling us. For the first 4 to 6 months, we see more or less a sideways trend with a better second half of the fiscal year. This is also one reason why we remain cautious regarding our outlook for fiscal year '20.

And with this, I move to Slide #15. For fiscal year 2020, we assume a moderate revenue and margin development. We expect revenue growth for the group in the range of minus 3% to plus 3% and an adjusted EBITDA margin of 9% to 11%. Free cash flow is expected to be positive, up in the mid-double digit.

For the past fiscal year, Managing Board and Supervisory Board proposed not to pay a dividend. Ingo will explain that in a more detail later on.

Overall, we can say while the outlook for fiscal '20 remains moderate, we are convinced that the long-term trends are intact. As a reminder, on Slide 17, you can see the photonics markets we want to address with our high-tech photonic strategy. We presented it at our Capital Markets Day last year. Coming from illumination, we want to enter photonics market in the fields of sensing, visualization and treatment. As of today, these target markets are still intact.

Move to Page 18. This is exactly why we believe in our photonic strategy, and we will continue to strictly pursue it, yet we continue to deal with unstable economic and political circumstances. Therefore, we have to make some adjustments along our way to reach our strategic targets.

This means, first, we will intensify our performance programs with a focus on lean and agile structures. Second, we will run our traditional products, mainly with a focus on cash and less on EBITDA. And third, we will focus our product portfolio even more on future-orientated profitable product. And fourth, we will speed up our transition to photonic applications beyond illumination. You see, cost and product performance will be in the center on our way forward. They are the key to reaching our financial targets, illustrated on Slide 19. You know the illustration on the right from the Capital Market Day last November. However, we have to acknowledge that the markets currently are not supporting us. The market weakness in '19 and '20 leads to a postponement of our midterm financial targets by 2 years. Let me be clear, we are streaking our targets for the group with mid-single-digit to double-digit annual growth rates and an adjusted EBITDA margin of more than 15%, but we expect to see them 2 years later by '24, '25. Regarding the business units, we can confirm that OS and Digital are expected to remain in that target corridors and also the traditional business automotive. Yet due to the weaker development of the joint venture, automotive as a reporting segment is likely not to meet the margin target currently presented last year. This is something we were discussing with Continental to improve the situation. But overall, for the group, we will achieve our midterm targets.

Ladies and gentlemen, let me summarize. The market environment remains challenging, with no short-term market recovery in sight, we have to take in countermeasures to address our own performance. These measures are taking effect, and we will intensify that. With the long-term trends being intact, we strongly believe in our high-tech photonic strategy, and that it will lead us to success again.

And now I would like to hand over to Ingo.

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [4]

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Yes. Thank you, and good afternoon from my side. Thank you for joining the earnings call today. And I will start with the key financials for OSRAM continued operations on Page #21, summarized.

Fourth quarter revenue decline slowed down to some extent, in line with typical seasonality and supported through positive year-over-year growth in DI. Total OSRAM revenue was EUR 924 million, translating into a year-over-year decline of approximately 9%. Sequentially, revenue increased by 7.8%, also in line with typical seasonality.

Given the significantly lower volumes, adjusted EBITDA came in at EUR 86 million or 9.3% of revenue, however, sequentially improved to Q3 '19 with approximately 250 basis points. Compared to the same period a year ago, low volumes and underutilization of factories continued to weigh on profitability. The operating leverages both at Opto and our traditional automotive business continued to drive margin contraction.

Our performance programs delivered EUR 40 million in gross savings in Q4 '19. We exceeded our original plans for the year by generating approximately EUR 107 million in gross savings for the full fiscal year '19 as we continued to address our cost structure. Net income from continuing operations was negative with EUR 213 million in the quarter, reflecting a noncash goodwill impairment charge of EUR 171 million pertaining to our OSRAM Continental subsidiary.

Given reduced expectations regarding both, the development of the automotive global light vehicle market and the underlying profitability, we impaired the goodwill associated with the joint venture in full, in line with the corresponding accounting standards under IFRS.

Special items amounted to EUR 32 million in the quarter. For total fiscal year 2019, special items totaled EUR 131 million. Free cash flow was again positive at EUR 103 million in the quarter. The strong free cash flow performance in the second half of fiscal year 2019 helped us to deliver positive free cash flow for the full fiscal year despite the sharp earnings contraction.

Taking now a more detailed look regarding the revenue development in Q4 '19 on Slide 22. The impact of foreign exchange as well as the additions to the business portfolio of OSRAM had a positive impact on revenue growth.

When looking at our regions, EMEA further declined on the back of an ongoing lower customer demand in our automotive business, both for traditional as well as LED light sources.

In the Americas, our traditional and automotive LED OEM business declined when compared to prior year. Our Digital Systems business, as part of DI, saw revenue decline as the general lighting market in the U.S. continues to be challenging, also echoed by public statements of large U.S. lighting companies. Still, overall, revenue for OSRAM in the Americas grew with low single digits due to a strong performance of Fluence, part of the DI segment.

In APAC, business in China continued to be lower in a double-digit range when comparing to the same quarter a year ago. Sequentially, in other words, when comparing with the third quarter of '19, however, we recorded strong, nominal growth.

It appears the necessary industrial supply chain adjustments to cope with the lower market demand now have largely been completed. Yet, we remain cautious as to whether from this point forward some form of recovery will occur.

Let me now comment on the revenue development in our 3 reporting segments. Opto's revenue in the fourth quarter improved sequentially when compared to the third quarter of '19. Relative to the fourth quarter of 2018, this nevertheless still translated into a year-over-year decline of 16.6%. Lower volumes and pricing were the major drivers behind this decline with volume carrying a higher share than pricing.

Within Opto, automotive revenue declined by a double-digit range when compared to prior year. Sequentially, automotive revenue was up slightly driven by higher demand from China. EMEA and NAFTA demands were slightly below, respectively, at the same level as prior quarter. Pricing dynamics were stable and in the higher single-digit range.

In the industry and mobile segment of Opto, comparable growth was in the negative double digits, still reflecting a significant year-over-year drop in our business for multiple LED applications run through distributors. Sequentially, however, in other words, when comparing to our prior quarter '19, in '19, absolute revenue levels were stable. We believe that by now, inventory levels in the distribution chain seem have to been adjusted at normal -- at lower and normalized levels. The shift towards 3D solutions, biometric sensors for consumer applications also continued well into our fourth quarter.

In Opto's general lighting business, we continue down the path of recording quarter-over-quarter sequential revenue improvement driven by horticulture lighting but also an improved outdoor lighting performance. Compared to the same period a year ago, general lighting posted a positive double-digit year-over-year comparable growth performance.

Moving now to our reporting segment, automotive. Revenue decline was 9.9% when compared to Q4 of fiscal year 2018. Volume for the traditional business continued to be lower across all regions. The aftermarket business posted a low single-digit growth performance compared to Q4 '18 and improved its revenue level markedly on a sequential basis, in line with typical seasonality.

Revenue levels at our OSRAM Continental subsidiary, which is part of the AM reporting segment, were more or less flat sequentially.

And finally, let's take a look at DI, our third reporting segment. DI's comparable revenue growth was positive in the quarter, coming in with a 4% increase year-over-year driven by strong performance of Fluence where demand in North America continued to be strong. Our Traxon business revenue improved sequentially and was nominally at similar, absolute revenue levels when compared to the same period a year ago. Our entertainment business continued to be in positive growth territory. At the same time, however, we continue to face a challenging market environment for general lighting for our business of electronic ballots in the United States.

DS business levels in EMEA were slightly below the level when compared to the same period last fiscal year. In APAC, however, DS, digital systems, finished strongly with positive year-over-year growth in the final quarter of fiscal year 2019.

Moving on to profitability on Slide 23 now. In Q4 '19, absolute adjusted EBITDA was EUR 86 million, translating into 9.3% in margin terms, representing a sequential improvement of 250 basis points. When compared to the same period prior year, the operating leverage effect of significantly lower volumes, particularly in Opto, AM but also DS as part of DI, were the main drivers of the absolute decline in adjusted EBITDA. This holds true both at OSRAM level as well as at the segment level.

Negative price, mix and inflation impacts were successfully offset by our operational and performance savings programs. Compared to Q3 '19, Opto's profitability improved sequentially to 90% of adjusted EBITDA in Q4 '19 as the overall performance programs are delivering structural cost savings, combined with sequentially higher volumes.

Still, compared to the same quarter a year ago, lower volumes drove profitability down. Operational improvements, combined with the gross savings from the performance programs in Opto, were able to offset price erosion and inflation in the quarter, however.

The year-by-year decline in automotive's adjusted EBITDA profitability reflected lower volumes and factory utilization in its traditional light source portfolio. Part of the volume impact was also related to the ongoing efforts to reduce inventory levels to improve cash flow generation. Price erosion and inflation were compensated by productivity measures.

The OSRAM Continental subsidiary, which is part of our AM reporting segment, continued to be dilutive in the quarter, with a negative year-over-year impact of approximately EUR 7 million in absolute adjusted EBITDA.

DI's adjusted EBITDA was positive with EUR 11 million, main drivers being a strong performance at Fluence and Traxon. Overall, DI continued to offset pricing and inflation well with productivity measures. Adjusted EBITDA in corporate items for OSRAM continued operations was negative EUR 23 million.

Moving to Slide 24. Our performance programs delivered EUR 40 million of gross savings in the quarter, translating into approximately EUR 107 million in gross savings for the full fiscal year. With this strong result, we exceeded our original savings targets for fiscal year '19 of between EUR 85 million to EUR 95 million and moved into a triple-digit savings.

Out of the EUR 107 million in gross savings, EUR 55 million of gross savings were generated through our overhead cost reduction programs and EUR 53 million through our programs for our factories.

Moving to cash flow on Slide 25. Free cash flow was positive with EUR 103 million in the quarter. Improved working capital management, especially lower inventory levels in combination with lower CapEx, were the main drivers behind the positive free cash flow generation. Net debt reduced to EUR 350 million, reflecting the strong cash inflow in the fourth quarter.

When we now look back and recap the full financial year in 2019 on Slide 26, it was clearly one of the most challenging years in the more recent history of the company. First signs of slowdowns already noted in fiscal year '18 in our key markets, automotive, general lighting and consumer electronics, gathered speed in 2019 and impacted revenue and profitability of the company in a significant way.

As a result, comparable growth for the company declined by around 13%, translating into an adjusted EBITDA of about 9% for the year, in line with our revised guidance of March 2019. Key drivers for this development in fiscal year '19 were: Chinese market demand being close to 20% of the company's revenue base slowed down markedly, particularly impacting our Opto businesses but also traditional automotive light sources within our AM segment and translating into a revenue decline for OSRAM in China of 22% for fiscal year '19 when comparing it with fiscal year '18.

Global industrial supply chains moved through significant inventory adjustments, particularly for general lighting and automotive and amplified the lower market demand further. The ongoing trade dispute between the United States and China created significant uncertainty in global supply chains and negatively impacted our business in the United States, for instance, in Digital Systems being part of DI.

The OSRAM Continental joint venture as part of our AM segment was impacted from a -- by a difficult automotive market environment while building up its own infrastructure as a new company. As a result, it finished the year with a negative adjusted EBITDA of EUR 43 million and a negative free cash flow of EUR 68 million, the latter also reflecting capital expenditure needs and the initial buildup of working capital.

We increased our cost reduction measures in light of the overall deteriorating market environment and exceeded our original cost-saving targets from performance programs for the fiscal year with a total of EUR 107 million in gross savings.

Another positive development were the business results of our most recent acquisition, Fluence, which performed very strongly, particularly in the second half of fiscal year '19. And we made progress with respect to the transformation of our business portfolio by concluding the divestments of our lighting service business in the U.S. as well as our European luminaires business, Siteco, during the course of fiscal year '19.

Profitability for the year was significantly impacted by the operating leverage of substantially lower volumes when compared to fiscal year '18, as you can see on Slide 27. Lower market demand, combined with our own efforts to reduce inventory levels company-wide to focus on cash flow resulted in a lower utilization of our factories, particularly for Opto, automotive, traditional and Digital Systems, the latter being part of our DI reporting segment.

The first full year of consolidation of our OSRAM Continental subsidiary had an overall negative impact of approximately EUR 32 million when compared to prior year. In total, the joint venture adjusted EBITDA margin was dilutive for the company with approximately 1 percentage point. And as you may remember, in fiscal year '18, we recorded a gain of approximately EUR 15 million through the disposal of a noncore business.

Savings from our performance programs together with our normal operational savings from procurement and operational efficiency programs were overall able to offset price erosion and inflation. Overall price erosion was up a notch in certain parts of our business, notably in our automotive businesses. Overall, for the full year 2019, free cash flow came in positively with EUR 17 million as a result of a strong second half of cash generation, representing our strong focus on cash flow, driving improved levels of working capital.

CapEx was lower than prior year, also reflecting the change in market environment and slowdown in demand. As a result, CapEx spend totaled EUR 208 million for the year, lower overall by approximately 54% when compared to prior year. Overall special items for the full fiscal year 2019 came in at EUR 131 million.

Moving now to the outlook for our new fiscal year 2020 on Slide 28. As we are moving into fiscal year 2020, we expect the economic environment to continue to be challenging. A number of economic research institutes have recently pointed towards a further slowdown in overall world economic activity. Our 3 key markets, automotive, general lighting and consumer electronics, are not expected to be exempted from this development.

When looking into the first quarter of fiscal year '20, we certainly expect the same headwinds that we faced in fiscal year '19 also to continue. As a result, overall comparable revenue growth is expected to be roughly flat or slightly negative when compared to Q1 fiscal year '19, also reflecting the expectation of a sequential quarter 4 to quarter 1 decline in Opto and in DI, in line with typical end of calendar year seasonalities.

For the full fiscal year 2020, we expect comparable revenue growth to be in the range of between minus 3% to plus 3%. This range reflects the still existing uncertainties in overall global market developments, combined with ongoing external geopolitical developments, such as ongoing tariff discussions, the Brexit situation and the difficulties to reliably assess global economic growth prospects for fiscal year '20, particularly for China.

Against this macro backdrop, we expect our adjusted EBITDA margin to be in the range of 9% to 11%. This range is largely driven by the possible variance in our revenue growth trajectory in fiscal year '20 and the corresponding operating leverage effects. Furthermore, we expect a demand in pricing environment in our key markets, automotive and general lighting, to continue well into the new fiscal year.

The impact of the introduction of IFRS 16, which is, this time, first applied as per the 1st of October 2019 by the company, is expected to be positive with approximately 1 percentage point in adjusted EBITDA and is already reflected in the above-given range.

Free cash flow is expected to be positive possibly at mid-double digit levels, including significant cash outflows resulting from the ongoing performance programs. Special items are expected to be similar to the level of fiscal year '19.

Let me also finally point out that the guidance does not assume a hard Brexit scenario or a full-blown recession. It also excludes possible increases or scope extensions with respect to tariffs, pertaining to international good flows.

And now, Juliana, back to Olaf.

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Juliana Baron, OSRAM Licht AG - Head of IR [5]

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Okay. Olaf, if we can start with the comment on AMS.

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Olaf Berlien, OSRAM Licht AG - CEO & Chairman of the Managing Board [6]

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Yes. It's very short. At this point, I would like to finally comment on the takeover from AMS. As you know, we published this morning our joint response today. At this statement, the Supervisory Board and the Managing Board recommend the takeover bid to us from shareholders. From our viewpoint, the new offer is attractive for our shareholders, for our employees and for the company, as you can see on Slide #30.

The offer price of EUR 41 per share offers a high premium to our shareholders of 42%. This translates to an enterprise value of EUR 4.5 billion. I think it's a fair valuation of the company. It means an enterprise value multiple of 11.5 compared to the EBITDA. The new offer also contains substantial improvements for our employees, as you can see on Slide #31.

In the new business combination agreement, OSRAM and AMS have agreed on important points for the integration of OSRAM. Most important, employees at the German sites would be protected against layoffs for the transactional reasons until end of 2020. Half of the leaders of the corporate function and the large part of their teams would be located in Munich as a core headquarter. OS and AM would remain cornerstones of the combined company. The future of DI would be assessed on a joint integration team. Last but not least, the business combination agreement also ensure the continuity of OSRAM as a company, as we move to Slide #32.

AMS supports the OSRAM photonic strategy. The strong OSRAM brand is aimed to be reflected in the new group's name. And it is also planned to change AMS into a European corporation with representation of OSRAM in the Managing and Supervisory Board. To safeguard the interest of both parties, we are happy to announce that with Brigitte Ederer, we will install an independent monitor. So all in all, we can say that compared to the first offer, we have achieved substantial improvement to OSRAM and the future company.

And with this, we are now happy to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And the first question comes from the line of Sebastian Growe of Commerzbank.

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Sebastian Growe, Commerzbank AG, Research Division - Team Head of Industrials [2]

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Bridge for 2020 and at a higher level, can you just give us some ideas what you're planning by segments to get to the flat to up to EUR 100 million increase in EBITDA year-on-year? And can you particularly talk about the expectations around the Conti JV after that not-so-great performance in 2019? And I think, Olaf, you also mentioned that you will discuss that exact performance with Conti to provide us a bit more -- or give us a bit more insight of what is behind that? And may I also ask a question then for the CFO, for Ingo. Also, if you have received any compensation yet by Conti after the 2019 year? And last but not least and related to that bridge, can you also give us a better understanding what you're planning for DI, in particular? Certainly quite a bit that -- on EUR 40 million higher revenues, you are able to achieve incremental EBITDA of EUR 20 million, so what's been driving that and what's the way forward from here that would be on the bridge? Admittedly, a couple of questions than one.

And then secondly, around CapEx and free cash flow, may I ask what CapEx that you have baked into that free cash flow target of double-digit million euro amount? Because the 2% quota to sales we've seen in the second half of '19 should be fairly sustainable from my point of view.

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Olaf Berlien, OSRAM Licht AG - CEO & Chairman of the Managing Board [3]

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Okay. Thank you, Sebastian. I think in the beginning, there was a misconnection. Maybe we did not get your first question. But nevertheless, I think you had so many. I think, Ingo, maybe you'll start with the...

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [4]

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Yes. I just caught up with something like a bridge. So I guess you want to understand how we go from '19 to '20, I presume. So let me start with that maybe. So I think as you can see from the revenue guidance that our volume growth expectations for next year show a fairly mixed picture. That's still due to the limited visibility that we have.

I think I also pointed in my prepared remarks, towards a somewhat -- an elevated pricing environment that sort of we have to cater for next year. So therefore, we expect that, overall, if you look at the productivity programs and the performance programs that these will be necessary to offset, let's say, pricing and possibly inflation. And with not much volume growth, that basically means you have a chance to stabilize and possibly improve margins a bit year-over-year.

In addition, we do also expect somewhat of a more negative product mix next year as we continue to see the traditional products in our automotive business decline faster than a little bit expected, especially halogen and HID. And therefore, that weighs also on profitability. And it's offset, as I said, by mostly cost and other measures. Therefore, that's roughly the bridge overall.

If you look at the segments, I think that was your second part, we don't guide for segments. But overall, I would expect Opto to improve compared to this year, also on the basis of the cost and structural measures that we've taken there. And the new team, the management team that's in there, has, I think, seen more potential with what we could do in Opto. I do not expect an improvement in the joint venture based on the current outlook we have there. And as you said, we're in discussions with Conti how to -- see how we can improve that situation.

And in DI, it's going to be a mixed picture. I think we will see that Fluence will continue to perform well. But I think I also pointed to still a difficult market environment for DS in there. In the other markets we are in there, if you look at entertainment, et cetera, those are not markets that show significant size of growth at this point in time. So that's roughly what I would say.

In terms of compensation for Conti, yes, I mean the customer transfer has not been completed, but we get compensation from Conti for every revenue, margin that is still in their books, we get compensated. That has also been the case this year and will be the case up until the moment all of the customer contracts have been transferred eventually into the joint venture.

Then on CapEx, you should expect a similar CapEx level to '19 also in 2020.

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Sebastian Growe, Commerzbank AG, Research Division - Team Head of Industrials [5]

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For the Conti JV, the compensation and the number that you provided, the close to EUR 40 million loss, that is net of those compensations, is it rightly understood?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [6]

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Yes.

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Sebastian Growe, Commerzbank AG, Research Division - Team Head of Industrials [7]

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Okay. And cash-wise, you have also and already being compensated? Or is it still to come?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [8]

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Well, sure. I mean the compensation is accounting in cash, so there's no difference.

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Operator [9]

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The next question comes from the line of Charlotte Friedrichs of Berenberg.

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

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A few follow-ups, please. The first one would be on current trading. And is -- aside from the IHS numbers that you're basing your guidance on partly, is there anything that you can tell us in terms of sentiment at your customers, the kind of things that they tell you? What sort of visibility do they have right now? Is there anything new here?

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Olaf Berlien, OSRAM Licht AG - CEO & Chairman of the Managing Board [11]

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I would say not really new if you think -- or if you see what Infineon recommend this morning, what we have seen for their Q4, same like other, for their Q1 and for the 2020, I think we have the exact same view. We had a strong Q4. We see a little bit of slowdown for the months October, November, December, and we expect a much better second half of 2020. So we have the same view coming from the semiconductor. So it looks like that the dealers, the distributors, are starting to order in the second half of 2020, so they are much more optimistic.

If I move to automotive, the same, as I said. So we see a little bit of a sidestep for the next 3 months. And then it looks like that 2020 is getting better. So that's our order volume, and it compares to what our colleagues around the corner proposed this morning as well.

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

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Okay. Understood. Second question would be on the revenue split in the automotive division. Can you give us a bit of an idea of where we are right now? You commented traditional business is coming down. Where in the process are we currently?

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Olaf Berlien, OSRAM Licht AG - CEO & Chairman of the Managing Board [13]

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I think that's a nice question for Ingo.

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [14]

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So I'm not sure exactly what you mean, frankly speaking. In there, the -- I think what you will find is that what we've eliminated for intercompany purposes and group purposes is approximately, I believe, out of my head now, don't quote me, please, EUR 750 million. So that would give you a sense as to what is there. And I think the Conti joint venture was around EUR 230 million or so of revenue. That tells you what the rest is right now.

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Charlotte Friedrichs, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [15]

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Okay. Perfect. And within DI, the increase in profitability, were there any sort of one-offs that we should take into consideration? Or do you think -- I mean you mentioned some headwinds, but do you think profitability for DI in 2020 is reasonable or not?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [16]

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Well, I think in Q4, clearly, it's been 2 parts that drove the positive EBITDA for DI. That was Fluence on the back of very strong demand and also Traxon had a very strong quarter. And they have -- we have very high gross margins in Traxon. So therefore, you see -- immediately see the benefit if your revenue levels come up.

For next-gen DI, I think we will still face a challenging market environment around our Digital Systems or electronics ballast business, and that is supported by cost measures and restructuring measures that the business has undertaken now for quite a while and is also planning for next year. But I think if they're -- the good earnings momentum within DI, at this point in time, clearly comes from Fluence, and the rest is basically moving along not so much growth and possibly improving here and there from cost measurement.

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Operator [17]

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The next question is from Lucie Carrier of Morgan Stanley.

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Lucie Anne Lise Carrier, Morgan Stanley, Research Division - Executive Director [18]

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I just wanted to go back to the guidance for 2020, please. Because if I understand well from the comments, you kind of expect about EUR 35 million of IFRS 16 benefit in 2020. And if I kind of back out the guidance, it almost looked like you're looking at IFRS 16 for a flat EBITDA. So I was just wondering how we should think about that because I would have still expected at least cost savings to come through in 2020.

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [19]

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Lucie, yes, that's true. And the performance programs will also contribute and continue to contribute. But as I said that we expect this to be offset by pricing inflation as well as a negative mix that we see overall. So therefore, it does help stabilize that, but it does not help, at this point in time, to provide an uplift to the margin year-over-year. So still very much dependent on where volume will go next year. And therefore, we've been careful in our assessment, at this point in time, given the uncertainties and said, well, anywhere between minus 3% and plus 3% is a possibility at this point in time. So if growth comes, and as Olaf said, the first 3 to 6 months will still be -- or expected to be with headwinds that we've seen already in '19, and the second half better, then we might improve on that margin front. But without that, we at least are able to stabilize our EBITDA levels despite a somewhat more amplified pricing environment.

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Lucie Anne Lise Carrier, Morgan Stanley, Research Division - Executive Director [20]

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And just if we can maybe calibrate a bit the cost savings, which, from what I understand right now, you expected only we need to compensate the additional price pressure and the mix. You have about EUR 100 million net of cost savings on the program. Should we think that a large part of that is going to be in 2020 or is equally between 2020, 2021? How do you model that?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [21]

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Well, at this point in time, the expectation is that the big part of that will be in 2020 and then a residual in 2021. That's currently the expectation.

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Lucie Anne Lise Carrier, Morgan Stanley, Research Division - Executive Director [22]

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My second question was around the Conti JV, please. And I mean there is a significant goodwill impairment here of roughly EUR 170 million. Can you, first of all, indicate to us what was the value of the assets you had in the books, so we can kind of assess how much of it has been written down? And also for us to understand maybe a bit better, because I appreciate the weakness of the auto industry that we are seeing now. But typically, those impairment decisions are not made on kind of short-term consideration on a business. They've been more medium term to long term. So is there anything that you are seeing now in terms of demand, in terms of how the automotive market is heading to that lowers your expectation fundamentally on what this JV can deliver?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [23]

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Lucie, as I think I said in my prepared remarks, is that the goodwill has been written off in full. And the trigger was simply that we looked at the new business plan that the joint venture management team presented, reflecting overall an expectation that market demand in the automotive industry will, at least on the near term, midterm, not substantially improve and overall also showing somewhat lower profitability than we originally assumed. Those 2 basically triggered an impairment under IFRS, which we then took in full in the last quarter.

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Lucie Anne Lise Carrier, Morgan Stanley, Research Division - Executive Director [24]

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Sorry, I had missed the full written-off. But in terms of the lower forecast for the medium term, especially around profitability, where is really the variation coming from? Because again, I guess, where I struggle is, it seems that you -- by writing it off completely, it seems that you're giving us the signal that maybe this is not going to be as an interesting area as you were thinking initially when you put together the JV?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [25]

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Well, I think we have to consider 2 things, of course. One is that the original business plan was made at a time when the automotive industry was doing still relatively well. And since then -- until then, the joint venture was actually constituted some time past, and we now had a chance to relook at some of the market assessment. We also now have first insights coming from our customers in the joint venture. And overall, because the automotive market starting point from a revenue perspective for the joint venture in fiscal year '19, of course, was lower, and therefore, the trajectory in terms of growth for the joint venture plus a somewhat reduced outlook from a car production perspective over the next few years certainly made us look at different types of revenue figures than we originally had seen. And the slower ramp-up of volumes that we still see and the order intake of the joint venture is still there, so they were quite successful.

The other thing we saw is also that, let's say, the progression of, let's say, higher margin, very sophistic matrix light in the front is expected now to be somewhat slower. And as a result, the product mix is expected not to be as positive as originally planned but coming, therefore, also later. And all these 2 shifts have basically meant that, overall, we had to make a value adjustment here. But overall, the idea of the joint venture, of the combination of light sources and electronics and the sophistication that we can bring to the table and possibly also an evolution in how OEMs will think about front lighting architecture in the car in the future is absolutely still intact and also confirmed in discussions we have with customers.

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Operator [26]

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(Operator Instructions)

The next question comes from the line of James Moore of Redburn.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [27]

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I've got a few questions. Maybe I'll go one at a time. You mentioned some of the increased pricing challenge in full year '20. Would it be possible to update us on what pricing as a percentage turned out to be at the group level at Opto and even Opto auto in full year '19 and how you think that's going to change in full year '20? That's my first question.

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Olaf Berlien, OSRAM Licht AG - CEO & Chairman of the Managing Board [28]

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Ingo?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [29]

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Yes. So I think on a group level, looking at price erosion is not very meaningful because we have -- the businesses are operating in completely different pricing environments. What we saw with Opto is certainly something that is in the sort of higher single-digit range. And we expect that to be at least at that level, if not slightly higher than next year. And that's one of the comments I made earlier is about pricing.

In the traditional part of automotive, certainly in the OEM part, not the aftermarket, but the OEM part, we also have seen a little bit more pricing discussions, simply because some smaller and other competitors are now trying to also gather volume in what is overall a declining volume market from a last-man-standing perspective. So here and there, there's some expectation that the pricing will change a little bit also or somewhat going into next year in the OEM, not in the aftermarket business.

And by the way, at this point in time, our aftermarket business in overall revenue terms is already higher than the OEM business for traditional light sources. I think that's important to understand.

And then on the DI side, I think it's more meaningful to discuss that for our ballast business systems because the rest is largely project business and the like. And there, we've seen some elevated pricing levels in '18. That's sort of stayed a bit in '19. And also in 2020, we expect it not to come down, at least we don't expect it to increase but also not to come down.

And therefore, overall, if you look at what we see in the automotive business, at least, we expect, therefore, that the pricing impact will be a bit bigger than it was in 2019 for the company.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [30]

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That's very helpful. And on the savings, am I right in saying that the original target of -- or the upgraded target in the first half of total savings of over EUR 200 million is unchanged and that you brought forward the savings a bit faster in FY '19? Or is it that the overall number is now a bigger number? And if so, could you comment on that?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [31]

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Yes. Yes. The overall number is now expected to be higher. So if you take the period that we pointed to, so including '21, we now expect it to be around EUR 220 million, and no longer just EUR 200 million, simply because we accelerated savings in fiscal year '19. And hence, that was an addition, partly -- or largely Opto, that is. And therefore, if you remember what I said to Sebastian, I said that I expect Opto to improve its profitability somewhat next year. That is largely on the back of the cost measures they took.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [32]

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And the split of the digital industries -- the digital business, I get confused to it because there was a presentation on a 3 business unit structure, and you often talk about Traxon and entertainment and DS and Fluence. Would it be possible to give us some flavor for what the current revenue sizes and margin variation is of those pieces?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [33]

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I don't want to get into guidance for sort of subsegments or so. So look, from a total perspective, DS, electronic ballast is still the most important part of the segment with roughly a little bit less than half of what it overall is. The business at Fluence is developing well into almost a triple-digit type of revenue business that is. And the rest, pieces of the DI segment are also, by and large, somewhat in that sort of same neighborhood, probably a bit higher than Fluence.

And if you add that all up, roughly, you should be at the numbers that -- or at the sort of subsegment level. But please understand, James, that I don't want to start guidance on that level.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [34]

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I wasn't expecting guidance, just exactly as you gave, so that was very helpful. And on Continental, obviously, a similar number this year, but do you have an ambition for when you think it can get to breakeven?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [35]

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Yes, we do have an ambition, but that requires discussions, which we currently have in the decision bodies of the joint venture where parties from both parents are represented, so both OSRAM and Conti. And I don't want to sort of preempt those discussions as to what is -- I mean both parties are not happy with the performance of the -- the financial performance of the joint venture. And as we speak, we are discussing those improvement areas. So I can't give you a clear -- but I can repeat what I said earlier that, at this point in time, I do not expect a material improvement in the joint venture's financial performance for next fiscal year.

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James Moore, Redburn (Europe) Limited, Research Division - Partner of Capital Goods Research [36]

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Finally, if I could, it's a technology question for Opto. I don't know if it's for you or Stefan. But would it be possible to update us with the penetration for the year just finished of SSL LED versus LED and how you now think that, that's going to develop given your comments about matrix perhaps not being adopted as fast? And the second part to that is, you've talked in the past about 3D and infrared and other technologies. Would it be possible to just have a bit of an update as to how we're progressing on the high-tech end of the revenue portfolio?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [37]

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James, so we don't really have right now the fixed numbers on LED penetration. What we think, though, is that it has increased, of course, this year, a little bit more even than we expected, especially driven by China. But the next level of numbers will come out soon. There's always a little bit of a mix-up with IHS numbers on that regard. So we're not able today to give you that. But overall, our estimate is that it went up more than we expected originally, and that is driven largely by the developments in China.

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Stefan Kampmann, OSRAM Licht AG - CTO & Member of Management Board [38]

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And the second part of your question about sensing and 3D. We see an increased number of projects also equipped with the component from our company Vixar, which we acquired last year. So the expectations which we have for this field of application is supported by the projects, which we're currently discussing with our customers. So I think we are on track in that as well.

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Operator [39]

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(Operator Instructions)

The next question comes from the line of Jürgen Wagner of MainFirst.

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Jürgen Wagner, MainFirst Bank AG, Research Division - Director [40]

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I have a follow-up on pricing. In Opto, you said it is worsening, but still you are doing better than the more consumer-focused players. How long do you think your auto LED business can keep to price premium versus consumer LEDs? And the second question on the AMS takeover process. Workers representatives still oppose the AMS offer and especially Mr. Abel is very active in the German press. What is the background for his action?

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Ingo Bank, OSRAM Licht AG - CFO & Member of the Managing Board [41]

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So let me comment first on the price erosion question you had, and then Olaf will comment on AMS. So I don't think I used the word worsening. I said that pricing will be more elevated. I wouldn't call it worse because it sounds something dramatic will happen. What we just see is that at this point in time, you're working in an environment where there's too much capacity out there from -- in auto, both on the LED as well as on the traditional side. And hence, with that, the pricing power is shifting more to customers and less to suppliers. I think that's a normal economic development.

We've also seen that -- we have not seen any new entrants into the automotive front lights or exterior lighting market from that perspective. And we don't expect it to be. That's also not the indications we have from customers that they are looking for that. So from that perspective, with the normalization of demand now also moving to 2020, we will -- we think that beyond 2020, it will start normalizing a little bit again.

On the traditional side, as I said, it's a market that will continue to decline in volumes. And there, it is important that if we want to be successful from a last-man-standing perspective, we start managing this business also more towards cash and it helps us to possibly consolidate volume in a declining market and helps also with the utilization of the factories that we have. So that's how I would describe it. I don't think it's a structural issue. I think it's more related to the current -- simply the situation that we have. We've had a very strong correction in the automotive industry overall from production volumes and from inventory levels with distributors. We had a very strong correction, led by China. And as I said, our business in China is in the meantime 20% of the company's revenue. And depending on how economic developments will be, we also expect that to recover.

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Olaf Berlien, OSRAM Licht AG - CEO & Chairman of the Managing Board [42]

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Coming to your second question, I think, of course, the real background, I think you have to ask Mr. Abel, so I cannot talk about the background. But I think it maybe started with the unexpected first offer of AMS, in combination with some miscommunication at the beginning. So maybe the start was not the best one. I think in the meantime, there were a lot of discussions with the IG Metall and with AMS. I think we are on a good way. We made good progress. And I am quite sure if we would be successful or if this offer will be successful in mid of December, then we are coming in a normal range of discussion. I think that's the point. I think it's a matter of time to come to a normal situation.

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Operator [43]

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In the interest of time, we have to stop the Q&A session. And I hand back to Juliana Baron for closing comments.

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Juliana Baron, OSRAM Licht AG - Head of IR [44]

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Yes. Thank you very much for your participation. With that, we would like to close the conference call. If you have further questions, please get in contact with our Investor Relations team. Have a good day. Thank you, and goodbye.

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Operator [45]

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Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.