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Edited Transcript of PPAMF earnings conference call or presentation 1-Aug-19 4:30pm GMT

Half Year 2019 Pirelli & C SpA Earnings Call

Milan Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Pirelli & C SpA earnings conference call or presentation Thursday, August 1, 2019 at 4:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrea Livio Donato Casaluci

Pirelli & C. S.p.A. - General Manager of Operations

* Marco Tronchetti Provera

Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO

* Maurizio Sala

Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer

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Conference Call Participants

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* Gaetan Toulemonde

Deutsche Bank AG, Research Division - Research Analyst

* Henning Cosman

HSBC, Research Division - Analyst

* Kai Alexander Mueller

BofA Merrill Lynch, Research Division - Associate and Analyst

* Martino De Ambroggi

Equita SIM S.p.A., Research Division - Analyst

* Monica Bosio

Banca IMI SpA, Research Division - Research Analyst

* Sascha Gommel

Jefferies LLC, Research Division - Equity Analyst

* Thomas Besson

Kepler Cheuvreux, Research Division - Head of Automobile Sector

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to Pirelli's conference call in which the Executive Vice Chairman and CEO of Pirelli, Mr. Marco Tronchetti Provera, will present Pirelli's first half financial results as of June 30, 2019. (Operator Instructions) Moreover, a live webcast of the event and the presentation slides are available in the Investor Relations section of the Pirelli website.

I would now like to introduce Mr. Marco Tronchetti Provera. Please go ahead, sir.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [2]

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Good evening, ladies and gentlemen, thank you for joining us today. Let me start with a brief overview on the current market dynamics and how Pirelli is addressing the new challenges, both in the short and medium terms. The car industry is grappling with an external environment that continues to be uncertain, with trade tariff negotiations slowly proceeding, Brexit approaching, and a weak demand. The transition to hybrid or full electric power trend, combined with the introduction of future stricter emission regulations, are calling for higher research and development efforts and heavier investments.

The transformation of mobility supply chain, more skewed towards services, is getting more complex and requiring new skills and capabilities. As a consequence, carmakers are adopting exceptional cost measures. Temporary factory shutdown, for instance, BMW and Daimler in Europe, division of the work or pay. Nissan cutting 2,500 jobs globally by 2022, reducing their production by 10%. Ford cutting the workforce and units that will be closed in Europe. New partnership to share development and production costs. And first half car production was weaker than expected, minus 6.7%, with a worsening trend in second quarter, minus 7.5%, leading to a decline in the Original Equipment channel market demand and an increased pressure on pricing in both the Original Equipment and Replacement channels with major tire makers redirecting production originally planned for OEMs to the aftermarket.

In this context, Pirelli's choice of positioning in the High Value is bringing it to a better regime. However, we are not completely new to this downturn. In the first half, the more prolonged crisis of the Original Equipment impacted our volumes while price/mix improvement is still at the top of the industry. We were faced with a challenging pricing environment in the Standard segment and in the non-specialties High Value. We limited the impact of these headwinds on EBIT through increased efforts in our cost-cutting program, raising the full year target to EUR 70 million, equal to 1.3% on sales.

For the second half of the year, we expect larger than expected recovery of the Original Equipment, 18 inches and above tire market, driven by an increase in Prestige and Premium car production. Prestige, we expect plus 4.7% year-on-year in second half versus 2.7% in first half, and Premium, plus 3.5% in second half versus minus 2.4% in first half, while a double-digit growth in Replacement in 18 inches and above is confirmed. As a consequence, we are adjusting our full year guidance, providing a floor in case of further market deterioration. The mid-range of the guidance is EUR 5.3 billion for revenues, EUR 980 million of adjusted EBIT and EUR 370 million of net cash flow before dividends and extraordinary operations. In case of a weaker market environment, weaker than what we already described, the floor of our guidance is EUR 950 million of adjusted EBIT and EUR 350 million of net cash flow before dividends and extraordinary operations. This is the floor.

The tough car industry situation is challenging us to be even more selective, technologically advanced and efficient, requiring structural actions that we are already implementing. As we're just on a market decline, we are promptly reacting to the Original Equipment crisis. We are already setting the ground for several actions that will be better explained in the new plan. We are recalibrating our Original Equipment presence by reducing the exposure to clients and products by integrated profitability if replacement is low and not due to improve, and also increasing our presence in the new Original Equipment customers and treatment for electric cars, mostly in Asia, where profitability stands out.

In the Replacement business, we are planning to strengthen our focus on Prestige high rim sizes and specialties. These products are characterized by high technological content and less exposed to pricing pressure. We will enforce our distribution coverage, expanding partnerships and increasing our share forward.

On the cost side, we will continue the restructure of the Standard footprint and work on the complexity, furthering low plant cost and planned overhead reduction. Our new 3-year plan, to be released next November, will address the deployment of all these actions and the continuous innovation in products and services, capable of capturing future shifts in mobility consumption.

Finally, on the shareholders' agreement, the current governance has been confirmed, with ChemChina and Camfin as stable shareholders. And I will continue to have the responsibility as CEO of Pirelli up to spring 2023 and showing a succession.

Let's start now to briefly review Pirelli key performance in the first half of 2019. The top line trend was marked by strengthening in High Value, now accounting for more than 67% of total revenues and the ongoing reduction of the Standard segment.

In the quarter, once again, an outstanding price/mix improvement, plus 6.4%, around 3x versus our peers, in spite of our challenging environment. Our performance was driven by solid climb in Replacement channel due to the pull-through effect and by the ongoing product mix improvement.

In the retail market environment, we were able to limit the impact of the external headwinds on our profitability, mainly with demand, pressure on prices and increase in the cost of production factors through our internal levers, such as price/mix, efficiency and further efforts in our cost cutting program. A better financial management and one-off positive impact related to the Brazilian tax rate recognition was EUR 102 million, drove the net income increase of plus 69%. Finally, we closed the first half with a net financial position of EUR 4 billion or [EUR 4.45 billion] including the IFRS 16 impact, discounting the usual seasonality of the working capital and the dividend payments in the first and second quarter of the year, respectively.

In a couple of slides, Mr. Sala will show you how the net cash flow before extraordinary operations and dividends improved year-on-year, with a lower cash absorption than in the first half of 2018.

On the basis of the new assumptions on the market scenario and pricing environment, we are revising our full year guidance. We introduced a target range for all indicators, considering the lower end as the floor in case of further deterioration of the external scenario.

Revenues are expected to be approximately EUR 5.3 billion, with EUR 5.4 billion at the top line by the previous guidance. The delta is attributable to the new assumptions on the Original Equipment High Value sales and on the Standard business. Taking a more cautious view on LatAm and a more contained price/mix contribution. Mr. Casaluci will comment on that later.

High Value rate is confirmed at 67% of our revenues and 85% of the adjusted EBIT before start-up costs.

On profitability, we now forecast an adjusted EBIT margin between 18% and 19%, with further efforts in our cost-cutting program to limit the impact of the external headwinds. We revised our CapEx estimates to EUR 380 million or 7.2% of revenues. Finally, our leverage target is now raised to 2.33x/2.20x net debt-to-EBITDA over adjusted EBITDA without start-up costs. Due to the more contained growth in operating profit, we indicate and confirm a solid net cash flow generation for dividends and accelerating operations between EUR 350 million and EUR 380 million.

To summarize, the mid-range of the guidance is EUR 5.3 billion for revenues, EUR 980 million of adjusted EBIT and EUR 370 million of net cash flow before dividends and extraordinary operations. In case of a weaker market environment, the floor of our guidance is slightly below EUR 5.3 billion for revenues, EUR 950 million of adjusted EBIT and EUR 350 million of net cash flow before dividends and extraordinary operations.

I'll now hand it over to Mr. Casaluci, our General Manager for Operations, who will review our first half results in expense, our full year market expectation, and the operational drivers underpinning our guidance. Later on, Mr. Sala will give you an overview of net cash flow dynamics in both the first half and full year. Please begin, Mr. Casaluci.

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Andrea Livio Donato Casaluci, Pirelli & C. S.p.A. - General Manager of Operations [3]

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Thank you, Mr. Tronchetti. Good evening, ladies and gentlemen. The first half of 2019 closed with EUR 2.6 billion revenues, recording an organic growth of 1.4%, with a solid price/mix more than offsetting the volume trend. High Value volumes grew by 3.9% in the first half, the performance marked by a different trend in Replacement and the Original Equipment channel.

In Replacement, we improved our market share in the 18 inches up across regions, recording a plus 13% in the first half, which means 3.1 percentage points more than the market as a result of a pull-through effect of 83%. The overperformance was more marked in the second quarter, with Pirelli growing 14% versus 9% of the market.

In the Original Equipment business, we discounted in the first half the weakness of the premium car production in Europe and in China, minus 7.3% and minus 6.3%, respectively. The past year-over-year comparison since last year, we recorded a plus 23% growth in Original Equipment 18 inches up, mainly in Europe and in China, and Pirelli's decision to adopt a more selective policy and more oriented to value with regard to some supplies to Original Equipment to safeguard profitability.

In the Standard business, we reduced volumes by 13.9% at the lower base on a quarter-on-quarter basis. We are progressively phasing out products with lower rim diameters and profitability, given the general slowdown of the Standard market.

We recorded a solid price/mix improvement, plus 6.4% in the first half. We stand at the top of the industry. Mix was a driver of such improvement. Given the strong replacement weight, the progressive migration from Standard to High Value and the mix improvement within each segment, compared to the first quarter, the price/mix trend in the second quarter reflects a lower contribution of the migration from Standard to High Value and the worsening of the pricing environment. Many tire players are redirecting production originally intended for the Original Equipment channel to the Replacement market. This impact is more contained in High Value due to specialties that account for more than 50% of our High Value sales.

ForEx was negative, minus 0.5%, due to the volatility of exchange rates in emerging countries versus the euro, mitigated by the revaluation of the U.S. dollar and the adoption of high inflation accounting in Argentina.

Looking at profitability. Pirelli-adjusted EBIT closed at EUR 441 million for the first half, with a 16.6% margin. Internal levers contributed to containing the impacts of the external scenario: exchange rate volatility, increase in the cost of production factors, weakness in the market demand and pressure on prices.

In more detail, our industrial efficiencies are generating savings of 1.4% of sales, offsetting rising inflation costs. Price/mix and cost-cutting plan were not sufficient to fully offset the volume decline and raw material and ForEx headwind. Seeing the drop-through of the price/mix reflects the tough pricing scenario in the second quarter.

Let's now move to the performance by region. In the close of the first 6 months, with an organic sales of minus 3.2%, impacted by the full in-car production in Europe during the first half and a more challenging pricing scenario. In this volatile market, we maintained our market share in car 18 inches up, supported by our diversified homologations portfolio in the Original Equipment and the pull-through effect in the Replacement channel. Reduction of exposure to the less profitable products continued in the Standard segment.

Overall, profitability was in the mid-teens range for the region, lower than the first half of 2018 due to the previously mentioned slowdown in the Original Equipment channel.

In North America, we recorded an organic growth of 4.6%, driven by High Value sales where we improved our market share through the success of our specialty, the 18 inches and above, and our Original All Season products.

Profitability improved by more than 2 percentage points to the 20s range as a result of the higher weight of High Value sales, cost efficiencies and progressive strengthening of the U.S. dollar.

Asia Pacific remains the Pirelli region with the highest adjusted EBIT margin. The 5% organic growth in the High Value sales was mainly driven by the Replacement channel, with better market share in car tires 18 inches up, supported by the pull-through effect and the vast distribution network counting over 4,500 points of sale. The negative performance on the Original Equipment side reflects the weak demand, the tough year-on-year comparison and the selective approach to OEMs to supply. Standard organic sales were up about 2%, thanks to the recovery in the Replacement market for the 17 inches rim diameter tires.

Russia and Nordics recorded an organic growth of 2.5%. The focus on the most profitable segments and the market recovery boosted the results of the first 6 months, with an organic growth in High Value revenues of 34% compared to a decline of Standard organic sales of minus 6%. Profitability keeps improving in the region. Adjusted EBIT margin is now in the mid-teens range versus a mid-single-digit level for the same period of 2018.

South America grew organically by about 9% and was the result of a drop in volumes, about 11%, in a weak market environment, both in the Original Equipment and in the Replacement channel. A marked improvement on the price/mix, thanks to price increases in Brazil during the fourth quarter of 2018 and the strong improvement in the product mix, with a progressive reduction in sales of less profitable Standard products with lower diameters. Profitability has improved in the first half of 2019 due to continued efforts aimed at cost efficiencies and to the improvement and conversion of the mix. Price/mix is at plus 20% in the first half.

Let's now move to the market outlook for 2019. Second quarter trends are pointing to a more prolonged weakness of the Original Equipment market for 2019, with the second half recovery expected to be slower than previously estimated.

In Europe, 3 channels have brought forward many orders to the first half, so that in the second half, we might suffer lower demand from them. In China, final government car incentive schemes are supported but below the initial expectations. The early introduction of China VI lower emission system has pressured sales in June, creating another pre-buy effect that will likely hurt second half sales. Given this scenario, our new -- our view on the High Value Original Equipment is more cautious, with the market expected to be almost flat for the full year 2019. Plus [2% -- 3%] was the previous expectation.

Replacement. We confirm the soundness of demand driven by the car park shift towards the high rims. Double-digit growth is confirmed at around 10% within all High Value regions, accounting for 95% of 18 inches up global demand. In this scenario, we are reinforcing our cost-cutting program by additional EUR 20 million as a result of further actions on marketing and advertising; reducing budget on Standard regions while exploiting more digital tools on High Value; purchasing negotiation by extending the revision of contracts especially in non-core products and services, G&A and other; leveraging our new travel policy and other discretionary cost rationalization. At the same time, we are working on a more structural and extensive plan that will allow us to further optimize our cost structure and also streamlining our standard capacity. This is one of the chapters of our new business plan.

Let's finally move to the operational drivers of our guidance. On the basis of the Original Equipment market outlook before mentioned, we foresee a High Value growth between 6.5% and 8% in volumes, higher than 9%, the previous indication, outperforming the market in both channels. In the Original Equipment, we will leverage our homologations and new supply contracts in North America and Asia Pacific, becoming effective in the second half of the year. In Replacement, we will benefit from the pull-through effect, around 83%. The low part of the range reflects a potentially more prolonged weakness of the Original Equipment market, especially in China, where the demand is affected by both macroeconomic and regulatory issues.

For Standard, we forecast a double-digit decline, between 11.5% and 12%, assuming further slowdown on the Original Equipment channel, especially in Brazil and Argentina.

The combined trend of High Value and Standard will bring volumes down between minus 2.5% and minus 2%. Minus 1%, the previous indication.

Price/mix improvement is now expected at 4.5% to 5%. From 5% to 5.5% was the previous indication. Due to a different product and regional mix and the more challenging pricing environment in the Standard business and in the non-specialties High Value sits slightly negative, minus 0.5%, in line with the first half. Hence, the top line is expected at approximately EUR 5.3 billion. High Value weight over sales is confirmed at 67%, in line with the previous indication. Adjusted EBIT margin is expected in the range of 18% or 19%. Higher than 19%, the previous indication.

With lower volume and price/mix contribution, partially offset by higher cost-cutting measure, EUR 70 million, plus EUR 20 million, versus previous indication and lower raw material impact, now at minus EUR 70 million, versus the minus EUR 85 million previously indicated.

For volumes, we confirm a 40% drop-through. For price/mix, the drop-through will be in the range of 45% to 60%, where the low end reflects mainly a worsening of the price trend.

Efficiencies will more than offset the increasing cost inflation, roughly EUR 10 million of net effect. D&A and Other is almost 0 since cost cutting worth almost EUR 70 million will offset the increase of depreciation and other costs.

Finally, start-up costs are confirmed at EUR 40 million, mainly linked to additional efforts in the digital transformation program in Cyber, where the business is almost at breakeven.

And now I leave the floor to Mr. Sala.

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [4]

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Thank you, Mr. Casaluci, and good evening, ladies and gentlemen. We closed the first 6 months of 2019 with a net income of EUR 307 million or 6.7% of sales. The improvement from the first half of 2018 was driven by the higher EBIT reported, which benefits mainly from the one-off income equal to EUR 72 million, due to the recognition of tax credits in Brazil following the judgment of the Brazilian Regional Federal Court, which recognized the right to exclude the local value-added taxes from the base calculation of PIS and COFINS contributions. And this positive one-off income more than offset the lower adjusted EBIT, minus EUR 9 million, and increased nonrecurring and restructuring costs, minus EUR 15 million. And better financial income and charges, which reflected a one-off positive effect of EUR 100 million, deriving from the mentioned tax credits, lower financial charges for EUR 8 million, including the impact of IFRS 16 basis.

Tax expenses were negative for EUR 110 million. The tax rate in first half was at 26.4%, consistent with the expected tax rate for the 2019 financial year and including the impact of the Brazilian tax credit.

Excluding all the one-offs and nonrecurring items, net income adjusted amounted to EUR 256 million versus EUR 233 million in the first half of 2018.

We ended the first half with a net debt of EUR 4 billion, excluding the impact of the IFRS 16, reflecting the usual trend of the working capital in line with the seasonality of the business and the dividend payment in the second quarter.

In the first half, the net cash flow before extraordinary operations, dividend and equity transactions amounted to minus EUR 623 million, EUR 207 million less negative than last year. And this improvement is attributable to the operating cash flow, with EUR 214 million less in terms of cash absorption, mainly related to working capital, which benefited from the continued improvement of payment conditions with suppliers and the recovery actions on receivables and inventories. More specifically, on trade receivables, we align the payment terms with the main dealers in Brazil, which had temporarily been extended to the end of 2018 due to difficult market conditions. And on inventories, we reduced volumes by 4% with a 16% decline in Standard products, in line with the recovery plan announced earlier this year, with a 6% increase on High Value products to guarantee a better service level to final customers.

The stock mix improvement and ForEx impact drew a slight increase of the value in stocks versus full year 2018 but stable versus the end of the first quarter.

In the second quarter, we recorded a positive net cash flow before dividends and extraordinary items equal to EUR 73 million, twice the value of second quarter 2018.

For the full year 2019, we expect to generate a net cash flow before extraordinary operations and dividends between EUR 350 million and EUR 380 million, and this result will be achieved through the operating performance improvement; a tight control of the working capital, over the year we are taking actions on stock to reduce the incidence on sales between 20.5% to 21% based on the new revenue guidance versus almost 22% in 2018; and lower investments, EUR 380 million versus EUR 400 million previously indicated and EUR 463 million in 2018.

In the second half, we expect a positive reversal in contribution in working capital and other by around EUR 800 million, concentrating in the fourth quarter for the usual seasonality with collection of winter sales within year-end and to consider the slow season in Europe and Russia, and for the further reduction on inventories and benefiting from the expected improved results.

Pirelli's gross debt amounted to EUR 5.5 billion at the end of June 2019. With an average life of 2.7 years, more than 66% of it is now due beyond 2021. These figures include the IFRS 16 impact, while they don't include the discretionary borrowers on the extension option up to 2 years on our committed bank lines which can therefore be extended on changed economic conditions to 2022 and 2024, respectively. By considering such extension option, our EUR 1.4 billion liquidity margin allows to cover 2.5 years of forthcoming maturities. Our cost of debt on an annual basis, related to the last 12 months, stands at 2.97% from 2.95% in December 2018. The risk exposure of the net financial debt to high interest rate currencies may be possible to offset the negative effects mainly related to the exit from the perimeter of net positive accounting assets, the repricing of the debt and the make-whole option for the early repayment of the bond loan during the first half of 2018.

And now I leave the floor back to Mr. Tronchetti.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [5]

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Thank you, Mr. Sala. This ends our presentation, and we may open the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

The first question is from Kai Mueller of Bank of America.

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Kai Alexander Mueller, BofA Merrill Lynch, Research Division - Associate and Analyst [2]

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The first one is really on the OEM production time line, as obviously, the recovery (inaudible). Can you give us a little bit of color on how you see that? And have you had [it in] the OEMs that have been weaker than what you had expected? Because you said, obviously, you want to grow with some of the newer startups, especially in the EU world as well? And on the second point on pricing. You mentioned the point, especially in the European market, is that a European phenomenon, or do you see it somewhere else as well? And is that really related to OE contracts? Or is it those OE volumes going into the Replacement markets that caused somewhat more pressure in the Replacement market itself?

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Andrea Livio Donato Casaluci, Pirelli & C. S.p.A. - General Manager of Operations [3]

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So concerning the first question, on the market of the original equipment, I will give you our vision on the 18-inches up market, which is our core. In the first half -- starting from Europe. In the first half, we had a decline of roughly 3% in the market. In the second half, we do expect a market growing roughly at 7%. This is mainly due to a favorable comparison with last year because the last year, in the second half in Europe, we had a negative effect of the introduction of the WLTP regulation that influenced the seasonality of the market.

If we move on North America, we do expect a stable market, which is basically flat in the first half, and we do expect the same trend in the second half, flat or slightly negative, maximum 1% negative. While in Asia Pacific, the picture is similar to Europe. We had a negative 2% market in the first half, and we do expect a positive market in the second half in the region of 2.5%, 2.6%. And again, here, the major effect is a favorable comparison with the last year, where the car registration started to decline in the last quarter, mainly in China, and also the introduction of some new incentivization that, as I said before, less effective that was expected before.

As far as price environment, the price pressure that we perceive in the high-value regions is mainly due to the fact that the decline of the original equipment demand is creating, let me say, capacity available and the need for finding volumes and demand that is moving into the replacement channel. And as a consequence, a little bit more of pressure on the price environment as far as the replacement is concerned. But this pressure is concentrated on the Standard segment and in the high value not protected by specialties or market size or prestige, which accounts today that -- in the high-value regions, roughly half of our sales.

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Operator [4]

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The next question is from Monica Bosio of Banca IMI.

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Monica Bosio, Banca IMI SpA, Research Division - Research Analyst [5]

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The first one is on the price/mix drop-through. If I heard well, the price/mix drop-through will be in the range of 45% and 60%. Can you just highlight how much it was in the second quarter? I can imagine, close to 40%, 45%. And what can we expect in the third and then the last quarter? And as for competition and pricing pressure, can you just give us a flavor of the inventories, the original equipment level and also the replacement one? And where do -- in which regions do you mostly see the competition? And very last, given that there is competition, your price/mix assumption, I can imagine that they may derive from the mix and not from pricing. Is it correct?

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [6]

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Let me talk to Mr. Sala. One point I want to underline is that as you see that the region is recovering the original equipment in the second half related also to the comparison to last year. So this is one of the reason why we see the price/mix lowering. And now to Mr. Sala, please.

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [7]

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Thank you. For your concern the price/mix in the second quarter, the drop-through was in the region of 55%, while in the first quarter was 62%. And this came from the more pressure on price that we suffer, in particular in Europe, but concentrated on the Standard part of the business. On the high-value part, that is less subject to our business model, so the part that is not specialties from this point of view. Our guidance for the full year is -- taking into consideration the current situation of the market is in a range from 45% to 60%, in which the lower level of the drop-through of the price/mix is considering the continuous pressure on price. Thank you.

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Monica Bosio, Banca IMI SpA, Research Division - Research Analyst [8]

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It should be very high if the price/mix drop might fill to 45%, do you see -- do you think (inaudible) for the second part of the year?

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [9]

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We gave this range, so in case the pressure on price will be less negative, we will position ourselves on term of drop-through price/mix in the top part of the range.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [10]

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We have to keep in mind that the price effect is going down 100%. The drop-through is 100%. So that's the reason why 1 point of price is dropping drastically. So the effect is negative because of price.

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [11]

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If I may add also another point, the fact that in the second half of the year, we will have versus the first half of the year a negative channel mix because of the strong growth that we had in replacement in the first half that we continue in the second half. But in the second half, for the concern regionally, we will have a recover in terms of volumes for the different comparison basis of the previous year.

And the second element is that the reduction of Standard will be lower than the previous year because of the fact that last year there was a strong reduction in the volumes in Standard and in particular in South America. So we will have also a channel mix negative -- a regional mix negative from this point of view. But the drop -- the final drop-through is in the range of from 45% to 60%.

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Monica Bosio, Banca IMI SpA, Research Division - Research Analyst [12]

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Okay. That's very clear.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [13]

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Mr. Casaluci on inventories.

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Andrea Livio Donato Casaluci, Pirelli & C. S.p.A. - General Manager of Operations [14]

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Yes, thank you, Mr. Tronchetti. So as far as original, keeping the concern and, we talk about the stock of cars into the trade. No major relevant information from the U.S. and Europe, while there is good news coming from China, where after the month of June we have recorded a strong sellout and a very low production. So there was a high improvement in the car registration and we saw production -- reduction in car production. So we do expect a normalization of the stock of cars into the trade. This is due to the China VI regulation that was introduced before than expected. And so we had a discount effect on the old stock of cars produced before these new regulations.

While if you move into the replacement channel, again, we see a level of stock in some that is a bit higher than the normal and a bit higher than last year. And this is mainly due to a weak sellout summer, mainly in Europe. And now we do expect that this will go back to the normal level in a couple of months. While in winter, the stock that we measure into the trade is in low level compared to the normal situation in this period of time. So this is opening a good opportunity for the winter season.

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Operator [15]

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The next question is from Martino Ambroggi of Equita.

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Martino De Ambroggi, Equita SIM S.p.A., Research Division - Analyst [16]

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On the equipment sales by division. If I take the figures in the guidance, I realize that the high-value -- but please correct me if I'm wrong, the high-value [of the financials] should be down for the full year by 150 bps. While the standard roughly 50 bps. So first of all, if it's not correct, please stop me. But I was wondering why the impact on profitability is more evident in high-value where you have aftermarket, which is holding up and price pressure, which is more on Standard. So I would have expected a significant decline in Standard, not to [earning] rather than higher decline in profitability in high value due to the above-mentioned conditions.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [17]

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(inaudible)

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [18]

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Yes, I guess you referred to the second quarter versus the first quarter. So the lower pace of growth in the high-value of the second quarter versus the first one is mainly due to the slowdown of the regional equipment, okay? There is a limited impact of the price in this part of the range. The measure is negatively impacting. The difference of pace, of course, the high-value in the second quarter versus the first one is related to the slowdown of the original equipment, mainly in China and Europe.

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Martino De Ambroggi, Equita SIM S.p.A., Research Division - Analyst [19]

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Actually, I was referring to the full year guidance, taking the 67% high-value retail sales and 85% high-value rate on adjusted EBIT. So I derived 150 bps of lower recognized savings that are the 25% of last year. So this was my real question.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [20]

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We don't see what you are mentioning in our second half forecast because we see, let's say, a stable second half compared to last year in terms of profitability of the high value. We can see a drop in high value. What we see is the risk that we have underlined on volumes that could be -- could come mainly from the original equipment. That is what we see. But the effect you see is to be considered only related to the original equipment. And in case the standard continue to reduce -- so it's continuing the reduction more than expected. But we don't see a deterioration on high-value in the second half.

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Martino De Ambroggi, Equita SIM S.p.A., Research Division - Analyst [21]

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Okay. And on volumes, what's the saturation of the plans in the high-value? Do you have a rough indication today compared to 1 year ago, when the market was, let's say, skyrocketing compared to today?

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [22]

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If you look to the adjusted EBIT margin for -- we expect, we estimate for the full year is in the range of last year. So to achieve it, it's obvious that we stay in the same range of profitability for what concern the high value. And we put a floor on building worst-case scenario, at least in line with last year.

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Martino De Ambroggi, Equita SIM S.p.A., Research Division - Analyst [23]

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Okay. That's referring to the first question. But in terms of saturation of the plan for capacity utilization for high value, there is a big difference compared to 1 year ago?

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [24]

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Now it's fully saturated.

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Martino De Ambroggi, Equita SIM S.p.A., Research Division - Analyst [25]

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Okay. And the very last, in your floor scenario, is there a possibility to further cut in CapEx? Or CapEx cannot be touched anymore?

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [26]

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No, we consider that we have done what is necessary and what was feasible, considering also the volumes that are lower than expected. The EUR 380 million will remain the number.

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Operator [27]

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The next question is from Sascha Gommel of Jefferies.

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Sascha Gommel, Jefferies LLC, Research Division - Equity Analyst [28]

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The first one would actually be on pricing in NAFTA. I think some of your competitors are talking about price increases. So I was wondering if you can share your view on how you see pricing at the moment in NAFTA and how you see it evolving for the rest of the year.

Then my second question would be on restructuring charges, I think the initial guidance was EUR 50 million. So I was wondering if this has changed, given that you stepped up your cost-saving efforts. And then my last question would actually be on the item other input costs. Maybe you can remind us what exactly that is, and why we should assume that the impact in the second half should be lower than in the first half.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [29]

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Mr. Sala? First of all, price, NAFTA to me. For the other questions, Mr. Sala. While Mr. Sala is -- the EUR 50 million restructuring cost.

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [30]

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Exactly. Probably when you mentioned the EUR 50 million were related to the guidance on nonrecurring restructuring cost. We added in the first half EUR 50 million on action on write-off in Brazil and Italy for further restructuring action. So our current guidance for the full year is in the region of EUR 70 million for the concern restructuring cost and nonrecurring cost because we are increasing the actions to face the current situation of the industry.

For the concern, the input cost, the major difference in terms of -- in the input cost, we are including inflation for the concern labor cost, for the concern energy, for the concern transport. These are the major issues. And we are seeing a trend that will be slightly lower in terms of inflation in the second half versus the first half.

What will be definitely lower in the second half versus the first half is the headwind related to the raw material cost because in the first half, raw material were negative by almost EUR 50 million. And our guidance for the full year is a negativity of EUR 70 million. So in the second half, we will have a lower tailwind in -- versus the previous year by around EUR 50 million.

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Sascha Gommel, Jefferies LLC, Research Division - Equity Analyst [31]

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Perfect. And can I sneak one quick one? Your factoring level at the end of the quarter, how much was that roughly?

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [32]

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Stable versus the corresponding period of the previous year.

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Operator [33]

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The next question is from Gaetan Toulemonde of Deutsche Bank.

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Gaetan Toulemonde, Deutsche Bank AG, Research Division - Research Analyst [34]

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It's Gaetan Toulemonde speaking. Two questions. The first one is when I look at your volume in Standard tires, you end up with approximately minus 25% in 2 years, and even if selling price margin is low, the volume [is important, also] fixed costs. So is there a limit there if we project ourselves to next year, the following year? Do you still expect to decline by this type of magnitude in terms of volume? That's my first question.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [35]

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Mr. Casaluci?

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Andrea Livio Donato Casaluci, Pirelli & C. S.p.A. - General Manager of Operations [36]

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Yes. We have a target of a floor level of standard. We don't want to go completely out from the standard because in the standard segment, there is still a niche of value products with different technologies. I'm talking, for example, about the offseason, the winter tires even for small rim size. So we have a target by region, and we will communicate during the next plan. We are not so far in the high-value region from the target as far as Asia Pacific and North America is concerned. Otherwise, we still have opportunities to optimize in Europe.

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Gaetan Toulemonde, Deutsche Bank AG, Research Division - Research Analyst [37]

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Okay. But if I understand well, we are close to the floor in terms of volume decline, is it correct?

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Andrea Livio Donato Casaluci, Pirelli & C. S.p.A. - General Manager of Operations [38]

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Yes, of course, we are not really close to the minimum, but from the third quarter 2019 on, we do expect a reduce in the speed of declining of the standards, so no more the double-digit reduction that we saw in the last 5, 6 quarters.

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Gaetan Toulemonde, Deutsche Bank AG, Research Division - Research Analyst [39]

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Okay. That's pretty clear. I have a second question regarding the free cash flow. You gave us a number which is around EUR 350 million, EUR 370 million. I get that number pretty easily without including any positive from Latin America, negative working capital of last year where I thought that you wanted to recuperate part of it this year. Does that mean that there will be no positive working capital impact for the full year this year? Is it the way I should understand that?

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [40]

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We mentioned from EUR 350 million and EUR 380 million. And for the concern working capital, we are doing further actions on stocks. We already reduced the stocks in absolute value in terms of volume by 4%. But we are continuously reducing the stock, and we will have a further reduction of stock in September.

For the concern in working capital, we are forecasting this target growth of working capital in the region of EUR 50 million, taking in consideration that also in the other receivables we are having for the receivables that are coming from the fiscal credits that we will not generate immediately during this year. Cash, but we generate cash in the following year. So when we release in April, the (inaudible) is related to the PIS/COFINS issue, we said that the cash from this will impacting our numbers in the next 4, 5 years. So practically, this will be a credit receivable at the end of this year and we generate cash for the following year.

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Gaetan Toulemonde, Deutsche Bank AG, Research Division - Research Analyst [41]

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Okay. But some parts you don't expect to recover from Latin America, from last year, where the fourth quarter has been very negative?

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [42]

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We see already in the first half of the year, the recovery. So the cash flow traction shows that we're cleaning out what was the excess of stock in Latin America end of last year. So I think that part of the generation of the cash flow is due to this.

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Operator [43]

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The next question is from Thomas Besson with Kepler Cheuvreux.

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Thomas Besson, Kepler Cheuvreux, Research Division - Head of Automobile Sector [44]

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I'd like to continue on the specific inventories. If you look at Page 19 of your presentation, the absolute inventory figure you show is that nearly EUR 1.2 billion or nearly 2 points higher in terms of proportion of revenues in the previous year. So can you help us reconcile this with the comments you just made on the reduction of inventories by 4 points and also explain the big change we've seen in payables year-on-year that are up EUR 150 million year-on-year? That's my first question.

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [45]

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For all concerned stocks, we mentioned the reduction of stock in volume. So I mentioned a reduction of stock of 4% from the end of last year until June in total volumes, out of which minus 16% was a reduction of stock in volumes for all concerned standard, and the most important part of it happened in South America, which the reduction of stock was more than 20%, as we answered to the previous questions -- question. And an increase in high value by 6% coming from better service levels, increase of volume that we are in the case also having for this year.

For the full year, in terms of stock, we are targeting to arrive at the end of the year with further reduction to a level that is not already the level that we have in June 11. That will be in the region of 20.5%. 21% of net sales. So having recovered versus the 22% of -- in incidents, or net sales that we had at the end of last year.

For all concerned payables, we are doing, as we did in the past, all the activity with the supplier to increase our premium terms but in continuity versus the previous year. So not doing any further actions or any particular [tricky things] from this point of view. We are at good level of efficiency. We want to keep the same level of efficiency from this point of view.

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Thomas Besson, Kepler Cheuvreux, Research Division - Head of Automobile Sector [46]

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Okay. Second question please, we've seen a trend of iPhones surprising in terms of expense, Q1, Q2, between regimes and price/mix. So your volumes have improved versus the market, but your price/mix deteriorated. And your new guidance suggests that you're going to [figure out] in H2 again, reduce the price/mix. Would you say that the rapid price positioning of Pirelli has come down? Or would you say that the absolute market has come down a lot, and therefore, you have to address as well to just follow the market and not reach those volumes?

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [47]

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Yes, so as far as the price/mix of the second quarter versus the first quarter, we have roughly 2 points of difference. These are -- 2.4 point of difference are mainly driven by 2 factors. The first one is the lower reduction of Standard. So we had a lower reduction of Standard in the second quarter compared to the first quarter, and this is anticipating what I said before. And you will see in the second half, this will also contribute negatively into the price/mix. So less reduction in Standard.

The second aspect in the performance of the second quarter compared to the first one, as we said before, is the negative price effect. If we go into -- we look at the second half, we'll have 2 negative impact on the price/mix. One, as I said, is the lower reduction of Standard. And the second is the negative channel mix because we do expect a recovery of the original equipment and with a favorable comparison with the last year. And also because we are enlarging the customer base, and we will start new supplies and new contracts mainly in the U.S. and in Asia Pacific.

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Thomas Besson, Kepler Cheuvreux, Research Division - Head of Automobile Sector [48]

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Okay. I have a last question, please. Start-up costs, can you remind us how -- why you decide something -- start-up costs or more than start-up costs? Initially, it was supposed to end, and you said the businesses that are related to the start-up costs are lower at equilibrium. So should we expect 0 start-up costs in 2020? Or are we going to continue to have start-up costs in 2020, please?

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [49]

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These -- the start-up costs are in line with what we forecasted, the EUR 40 million. For next year, we expect to go down to EUR 10 million, as it was in our plan. So no news on start-up costs that's not in line with the past.

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Operator [50]

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Our next question is from Henning Cosman of HSBC.

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Henning Cosman, HSBC, Research Division - Analyst [51]

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I'm afraid I'm still a bit confused with respect to the range and floor communication that you've now introduced. I calculated an adjusted EBIT range of EUR 950 million to EUR 1.01 billion roughly. So that's a range of $60 million top to bottom of the adjusted EBIT range. And I think you said for free cash flow, you have EUR 350 million to EUR 380 million range. That's only EUR 30 million difference. So besides the change in EBIT, can you help us what moves the range in the free cash flow? And then I also wasn't sure if you suggested that the EUR 380 million compares to the EUR 980 million adjusted EBIT midpoint, whereas for the free cash flow, it seems like you meant the top end. So if you could just clarify that again, please.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [52]

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We are referring to the expected results. We put a floor just to consider the market environment, considering the worst-case scenario. All of the numbers you see, the EUR 30 million you see in terms of cash is due to the tax. So the difference you see from the EUR 60 million and EUR 30 million is just related to the tax rate. Nothing more than this.

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Henning Cosman, HSBC, Research Division - Analyst [53]

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Okay. And just to reconfirm, the EUR 380 million free cash flow corresponds to the midpoint of the adjusted EBIT range which is EUR 980 million?

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Maurizio Sala, Pirelli & C. S.p.A. - Executive VP and Chief Planning & Controlling Officer [54]

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The cash flow of EUR 380 million correspond to the level of results in the top part of the range. The floor correspond to the level of result in the bottom part of the range.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [55]

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EUR 380 million means EUR 980 million in terms of EBIT.

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Henning Cosman, HSBC, Research Division - Analyst [56]

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Okay. So midpoint, midpoint. Okay, fine. And then just to clarify on the changed net financial position over adjusted EBITDA, that appears to suggest a larger change in the net financial position than what's implied by the net financial cash flow itself. So I was just wondering if there are other moving parts in your net financial position bridge outside of the free cash flow, please.

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [57]

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No, nothing else.

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Henning Cosman, HSBC, Research Division - Analyst [58]

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So if we compare the EUR 400 million original indication for free cash flow versus EUR 380 million, that's only a EUR 20 million difference. But your -- the change in the indication for the net financial position, I think that implies just over EUR 100 million. So is that somehow rounding-related, or how would you explain that?

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [59]

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You do not consider one thing that's to be -- have been positive for everybody, the dividends.

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Operator [60]

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Gentlemen, at this time, there are no questions registered.

Would you like to make some closing remarks?

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Marco Tronchetti Provera, Pirelli & C. S.p.A. - Executive Deputy Chairman & CEO [61]

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If you have any other questions, you can call the IR, and I will conclude the today's program.

Thank you for your attendance, and have a good evening, and enjoy your summer holidays. Thank you, everybody.

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Operator [62]

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Ladies and gentlemen, thank you for joining. The conference is now over, and you may disconnect your telephones.