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Edited Transcript of SHA.DE earnings conference call or presentation 5-Nov-19 9:00am GMT

Q3 2019 Schaeffler AG Earnings Call

HERZOGENAURACH Nov 18, 2019 (Thomson StreetEvents) -- Edited Transcript of Schaeffler AG earnings conference call or presentation Tuesday, November 5, 2019 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Dietmar Heinrich

Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs

* Klaus Rosenfeld

Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board

* Renata Casaro

Schaeffler AG - Head of IR

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Conference Call Participants

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* Christoph Laskawi

Deutsche Bank AG, Research Division - Research Analyst

* Jemma Permalloo

JP Morgan Chase & Co, Research Division - Associate

* Kai Alexander Mueller

BofA Merrill Lynch, Research Division - Associate and Analyst

* Raghav Gupta-Chaudhary

Citigroup Inc, Research Division - Analyst

* Sascha Sebastian Gommel

Jefferies LLC, Research Division - Equity Analyst

* Thomas Swift

CreditSights Ltd. - Analyst of European Industrials

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Presentation

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Operator [1]

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Dear ladies and gentlemen, welcome to the Q3 2019 results of Schaeffler Group. Please note that this call is for financial analysts and institutional investors only. (Operator Instructions)

At our research customer's request, this conference will be recorded, and a replay will be available shortly after the call on the website.

May I now hand you over to Renata Casaro, Head of IR, who will lead you through this conference. Please go ahead.

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Renata Casaro, Schaeffler AG - Head of IR [2]

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Thank you very much, operator, and thank you very much for your time today with the conference call on the Q3 results with Mr. Rosenfeld, CEO of the Schaeffler Group; and Mr. Heinrich, CFO of the Schaeffler Group.

Without further ado, I leave the floor to Mr. Rosenfeld.

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [3]

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Thank you, Renata. Ladies and gentlemen, welcome to our Q3 earnings call. I'm here together with Dietmar, and you all have the presentation in front of you. We published the results this morning, and we want to guide you through the main figures and the main information as usual.

Let me start on Page #4 with the key messages as an overview. As you see in the headline here, we are still cruising through a challenging market environment. The downturn in the market has continued, and we all know that there's still uncertainty around us. However, in this environment, we have performed quite well in Q3 2019 and have, I think with the numbers shown that we are able to sequentially, step by step, improve our earnings quality. And that is a function very much of the self-help measures that we introduced at the beginning of the year, that these self-help measures are gaining further traction.

Let me also say at this point already, we are certainly not through. And the fact that this Q3 is better than expected does not mean that we will not forcefully continue with the execution of these measures. And I will give you a little bit more background on this during my part.

Very quickly on the key numbers, I think you saw that, but let me stress the most important points. Group sales growth in Q3 by 1.2%, more or less flat on an FX-adjusted basis for the first 9 months. That means an outperformance of 460 basis points in Automotive OEM. What is clearly positive, you will see later on very much driven by the Americas and China. On the other side, we also see that our Industrial businesses are impacted by the slowdown in that sector, and we see a slightly reduced growth in that area compared to the previous quarter growth rates.

Gross margin, more or less stable compared to the previous quarters, but clearly down compared to the previous year in both Automotive divisions, go in that direction. On the other hand, we see a positive trend in Industrial. So you see that also here, we are continuing with our improvement programs.

EBIT margin, 9.1%, clearly a strong margin, driven by the Automotive OEM division. I will come back to this. I think one of the key numbers to look at is our free cash flow. You all know that we are managing this group very much for free cash flow. And we are up significantly year-on-year to EUR 362 million before cash outflows for M&A activities. Even if you deduct these, it's a strong number. And also here, you clearly see that our measures to introduce a stronger CapEx discipline and also manage our inventory more effectively have paid off.

We have also seen a one-off type of impact here that stems from a tax refund. After a long debate with foreign tax authorities, we got about EUR 30 million from a foreign tax authority back that has also impacted this. It's certainly not recurring, but it's something that we paid for in the previous years. And therefore, we clearly count it and do not adjust for that.

You also see the impact from the execution of our self-help measures if you look at the headcount numbers. We are -- as we indicated also in the last quarterly presentation, we are continually going down with headcount. End of September, we have now reached 89,000 people after nearly 92,500 end of the year 2018. There, you see that the variety of measures we have put in place are gaining traction. This is clearly not only the measures related to reducing headcount through Freiwilligenprogramm and reducing headcount by laying off some people in Germany, but there's also impact from the portfolio transactions we have executed during the year. Think about the plants that we sold here in Germany or the activities in the United Kingdom.

So you see that what we promised is starting to materialize. And I can clearly rest assure that this will continue, and this will relate to further structural savings. I think you'll all remember from the press that at the beginning of October, as indicated during our Capital Markets Day, we started a new Freiwilligenprogramm here in Germany with another 1,300 people that will now be executed into the next years.

I think that our more sequential and step-by-step approach starts to pay off. The fact that we're working very carefully with our employee representatives helps us to execute, and these voluntary severance schemes that we have been executed now clearly also has moved us on the learning curve to get things properly done.

All of that together leads me to the 6 -- key message #6. Even with a further reduced assumption for light vehicle production for the rest of the year, IHS down minus 5% to minus 6% from previously minus 4%. We are convinced that we will achieve our guidance for 2019 both on group and on divisional level.

So these are the key messages. I think I will, in the interest of time and to have more time for your questions, cut the next pages pretty short. I've already mentioned some of the most important messages.

Outperformance, Automotive, clearly a positive. We also would like to convey that the E-Mobility division is continuing growing with plus 40% in Q3. Automotive Aftermarket, another plus, have seen a sequential improvement of earnings quality, clearly driven by the Independent Aftermarket. As you know, the measures are gaining traction. And also here, with the group CapEx to sales ratio, you see that we are delivering what we promised in Q3, 6.3%, clearly within the range that we indicated.

On the other hand, I mean this is not all positive. On the negative side, you still see that the market in Europe is difficult. And let me use the opportunity here to quickly mention also the second auto gipfel yesterday in Berlin where we participated as one of the main suppliers. I think what you saw coming out of this auto gipfel was an indication that the German government is committed to support the transformation in the German car industry. The conversation there with Madam Chancellor and her ministers and the various experts from the new platform mobility and the representatives of most of the OEMs and the big suppliers was good and constructive. I think the measures that we put in place will help to push forward the E-Mobility.

For us, it's important to note that E-Mobility is not only electric vehicle, but in particular hybrid. The fact that these Umweltbonus or the subsidies for buying cars has been further increased and has been extended clearly sends a strong signal. We also appreciate the fact that the ceiling for prices of cars has been lifted upwards. So this auto summit, from our point of view, should give a positive incentive and a positive impact on the further development. It's also good that we have the labor unions at the table. And this whole idea of managing this transformation, preparing for this transformation in one of the main auto production and car markets of the world together is, from our point of view, exactly the right direction. And we are confident that, that will also help to stabilize the situation.

With this little deviation from the map here, quickly on Industrial, yes, Industrial was down in Q3, 5%. It's due to a weaker market environment; in some sectors, clearly, double-digit decline. You have seen that from competitors as well. We are watching that very carefully. It's not Schaeffler-specific but market-driven. And we also saw that we have not only focused on our auto when we think about efficiency programs but continue to focus on industrial as well to improve our margin.

Gross margin in Automotive, one of the key figures that you are following, is still subdued. And I think you saw from my explanations that the flexing of the cost base in Germany and other European automotive plants has paid off. But I also want to clearly say it has to be further intensified. We are becoming more agile. We're becoming more flexible, but there's still a way to go to make sure that, that becomes a more continuous character of our European German operations.

And still let me say that also, we have -- we still see some admin cost increases that are driven, to some extent, by our Agenda, in particular in IT. This is, to some extent, investment in the future. But I also want to make sure here that you all understand we are adamant and focused on -- also on that line of our P&L.

Quickly on the auto side. I think I have already mentioned most of the things that you see on Page 6. You see some of the numbers that you have clearly digested. The 6.9% on the -- in Q3 is clearly pointing in the right direction, but let's also make sure that we need to go through a fourth quarter that is typically a little bit weaker. And for us, it's important that this is a continuous improvement.

I just want to mention one point here, and that's the successes on the R&D cost side. As we promised, we have followed a much tougher project prioritization logic. And also with our new Head of R&D, Uwe Wagner, that clearly made a difference in particular in the Automotive OEM side. That doesn't mean that we're not continuing to invest in those areas, but it shows again that we are serious and being more selective.

Page 7 is a little bit to get the message across. So this is not only self-help measures, cost-cutting, R&D prioritization, but that we are very much focused on the new innovations. Two examples here from the show in Frankfurt where you all -- some of you participated. Matthias and myself, we have just been in Tokyo at the Tokyo Motor Show and showed our latest innovations, both for the powertrain and the chassis side. And we see great interest here from customers. That does not mean that there is immediate impact on the P&L in Q4, but the future is the most important. And as we've seen, electric mobility also on the chassis side with our Schaeffler Mover with the new acquisitions supporting that and also with our new products like the wheel hub motor, there is great interest on that side.

Let me add one more thing that you should also note. We have announced as part of our restructuring that we outlined to you at the Capital Markets Day, a separate business unit for fuel cell. That's nothing completely new for us because, since a long time, we have invested into the coating of components, and that includes bipolar plates. And we feel very good that we have a chance here to participate also in the upcoming opportunities in the hydrogen space, not only in auto, but also in industrial.

Very quickly on 8 -- Page 8. I think I mentioned also the main points here. The Independent Aftermarket has helped to stabilize the growth in Q3, clearly driven by Europe. We have pushed -- been able to push through some selected price increases that also helped. And there's here and there also positive sales mix impact. But don't forget, the market also here is still seeing some destocking from OES customers that impacted negatively, and also some of the products cost increases are to be digested.

To prepare the ground a little bit for the next year, I want to go, Page 9, a little bit more in detail when it comes to AKO or aftermarket kitting operations. Some of you already questioned that in the past. Outlined here the phasing of the impact. We are in line with expectation when it comes to the start of operations of our AKO, slightly delayed, but still okay, mid-2020.

And you -- the main message from this slide is, while we have all these benefits from the AKO with much more efficient processes and delivery service levels, there is a period of approximately 12 to 24 months overlap where we run a double warehouse structure. That needs to be there because you cannot just switch from one warehouse to another or from one kitting operation to another on 1 day. So that will impact also our cost base for quite some time. But when the AKO then is fully in place and the existing warehouses have been run down, there will be further cost improvement. But just to make sure, that will be a drain in 2021 on our performance in Aftermarket.

Industrial, I already mentioned it, Page #10, decline in certain cyclical sectors. You'll see this later on also from Dietmar. Industrial automation, one of the sectors, off-road, clearly off road, one of the lead indicators for a weak environment but also two-wheelers. So some of the sectors are clearly suffering. Again, market-driven, not so much Schaeffler-driven.

On the other hand, you see a continued strong outperformance in wind with growth rates that are far beyond what we expected. We are clearly working here at capacity limit and see that, in particular, our strong footprint in China opens opportunities that were unexpected. And I think that helps us to get to this result that you see here with the 2-digit margin.

There is cyclical swing that we need to absorb, but I think the structural drivers that we have initiated for the Industrial division are intact and will pay off in the future. Again, when we come to the next strategy Capital Markets Day, we'll also give you more insight how we want to focus and prioritize our growth areas in that division. The FIT program is running well. And clearly, the industrial colleagues are very experienced when it comes to pushing through their efficiency and also price-related measures.

On Page 11, let me cut this short. You see just some examples of what has happened. Growth with customized bearings has been strong, 2 examples from the marine application. And then also in the same sector, marine aftersales taking off with a new condition monitoring service being offered. That's just a little bit of an insight that this business -- how broad this businesses is -- this business is and how we are moving forward.

Let me finish my part, as usual, with the capital allocation page. And you see here once again the CapEx ratio. You see also the investment allocation. EUR 231 million is the number that is relevant for Q3 2019, clearly below 2018. You also see that we increased our property, plant and equipment investment in Industrial; while in Automotive, it came down. This is a function of all the capital efficiency measures of the capital that we have put in place.

Those of you that were part of the Capital Markets Day in Frankfurt remember that we are changing focus from a pure CapEx-to-sales ratio to a more reinvestment rate-driven approach. So we have agreed within the management team that we will, for the time being, invest not more than our depreciation. That starts to pay off in Q3. The number was 0.94, so clearly below 1. And that simple measure is also a good measure and tool to focus the organization. I can say that the spending discipline, Dietmar, also thanks to your hard work, has clearly improved. And we are clearly confident that even with the typical seasonal movement in Q4, we will definitely meet our 8% target or end up somewhere comfortably between the 6% and 8% for the rest of the year.

The regional mix has not really changed. So I think we are well on track here to demonstrate to you that CapEx, capital employed and also free cash flow are the key measures to turn this company around in a way that becomes again more successful.

And with this, I hand over to Dietmar.

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [4]

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Yes, Klaus, thank you very much then for handing over. Yes, good morning to everybody. And maybe let me take first of all, the opportunity to comment on today's news as far as it concerns myself. As you may have seen, I have decided not to extend my contract beyond its current expiration date, which is end of July of next year. This was not an easy decision now after almost 25 years with Schaeffler. And I really have to say, I very much enjoyed working for Schaeffler in various functions, and I identify strongly with this company.

Certainly joining the Board as CFO back in August 2 years ago has been the highlight of my career at Schaeffler. And I very much enjoyed working together with the other Board members during that period, but also it's a great pleasure in meeting with you on roadshows and in one-on-ones.

The reasons for my decision are of personal nature. And I do not want to go too much into detail, but really would like to highlight, at the very end, it's in conjunction with the family situation. I would like to be closer to my family and spend more time with them. And nevertheless, maybe giving a little bit of insight, my parents already crossed the 80s, my father-in-law as well. And as you can expect, their health is not as good as it was before. And I feel it's important now to be, yes, able to spend more time together with them, and same applies to my wife.

Nevertheless, I look forward to seeing many of you again in the coming days, weeks and months. And yes, thank you very much for this short opportunity also to explain my situation.

And now let me turn to the first 9 months and the third quarter. And I would actually like to jump directly to Page #14. And then as you can see on the sales development on a quarter-to-quarter basis, basically stable, growth 1.2% now in the third quarter, nevertheless being driven by different dynamics in the different regions.

Europe, in regards to auto OEM and industry was down, in both divisions, by around 5%. China continued with the strong development on the Industrial side with 24% growth. And also as Klaus already highlighted, in conjunction with the outperformance, Automotive was developing well for us, and the Automotive Aftermarket also picked up.

In regard to the gross profit development, going now to Page #15. We can see on one side that margin was 25.4%. It's a slight decrease compared to the same period last year. And we have a negative volume impact in there related to the Auto OEM business in Europe, as I explained, with the drop in business there. We also had positive mix impact coming from lower ramp-up costs year-on-year in the Automotive OEM area. And we have impact here from higher production costs related to personnel costs in Industrial side being caused by the reduced output. On the other side, as we explained during the Capital Markets Day, we have very much focused, and Klaus also related to this or referred to this, on flexing the costs. And this works very well, especially August and September continued to develop even more positive in that regard, so we further gained momentum.

Now moving on overall to the EBIT margin. We see the sequential improvement out of the Automotive OEM side being supported by the strong growth in Americas and China and as explained on the flexing of costs. Aftermarket also improved sequentially, and we see a stabilization of volumes and a better cost control on the Aftermarket side as well.

Now Industrial, we had a weaker margin in Q3 being by the slowdown of the growth momentum, especially Europe is a big share of our Industrial business, higher R&D costs and also admin expenses, which are related then to our FIT program. Overall, third quarter now 9.1% EBIT margin. And year-to-date, we are now 8.1%, so being in line with the guidance for the whole year.

In regard to Page #17, it's a new information that we provide over here to give you an insight in regard to the special costs. Then in the one side, restructuring, 20 - no, EUR 15 million that we posted in Q3. Then in regard to the adjustment, there have been no one-offs, and the EUR 15 million are basically caused by the program RACE and by the U.K. reorganization that we already announced in fourth quarter of last year. And there have been no one-offs.

In regard to provisions -- okay, I think we'll get back to that later. Okay. Yes. So that's in regard to the special items. Then let's go to Page 18 and go to the divisions.

Automotive OE side, you can see first of all, top line development on E-Mobility side still continues with 44% growth, very well. You can also see on the outperformance side and especially Americas and Greater China developed very well, as Klaus already mentioned, the general outperformance over there that helped very well.

And overall now, the margin, EBIT margin, 6.9%, which is, as already mentioned, a sequential improvement. Nevertheless, we have to be cautious in regard to the outlook. Q4, we continue, of course, with our measures in regard to cost discipline. But as you're aware, the year-end is always used then to prepare the factories for the new year, so we will have some additional spending on the maintenance side in the factories as well. And we do not expect such a high level of profitability in the fourth quarter.

On the Automotive Aftermarket side and switching to Page #19, we see Greater China and Asia/Pacific with different developments. Greater China, growth of 15%; Asia/Pacific with a growth of 12%. As you can see on the lower left side, our Industrial Aftermarket in the third quarter, with a growth of 3%, was going very well. On the other side, on the OES side, we still see inventory reduction on customer side, on the OEM side then and also then other Automotive customers that we are supplying. Profitability, nevertheless, with the stabilization of sales, increased to 17.2%, also being driven by a reduction on expenses with a clear focus also in regard to our marketing activities on the Aftermarket side.

Then moving to the Industrial side, Page 20. As already mentioned, Europe is weak in Q3 with minus 5%. China continues to grow in a strong way. Asia/Pacific, down. And on the lower left side, we can see still a continuation of the good development in the Industrial sector clusters wind and railway. Raw materials, still a growth, but getting less strong in that regard. And as Klaus already indicated, the more cyclical sectors already see a significant decline in the business activity now in the third quarter.

And looking to the profitability development, we still have a positive impact on the gross profit side being driven by positive price impact. We can see that our efforts to position us in regard to Industry 4.0 and robotics, with the additional spending there, are having an impact with increased R&D expenses. And on the administrative side, we have the additional expenses in conjunction with our FIT program, so that led finally to the fact that our EBIT margin is at 10.2% now in the third quarter.

And moving on then to the net income. You can actually see, compared to previous year, it decreased to a level of EUR 212 million, and main impact over there was the lower EBIT margin.

On the free cash flow side, Klaus already mentioned some impacts. Now in the third quarter, which was a strong quarter, we had a positive impact from the inventory reduction. We had a positive impact from this VAT refund, which is clearly a one-off. So overall, year-to-date, now we are at level of EUR 133 million. And we are basically with the continuation of an effective inventory management and a strict CapEx discipline, on track to achieve our guidance of around EUR 350 million to EUR 400 million, as we already explained.

And that's also what you can see on Page 23 and especially highlighting again the CapEx development, with 6.3% of sales in the third quarter, well on track. And we expect even to decrease that number for the fourth quarter. In line with the cash flow generation, then net debt developed, decreased. The gearing ratio decreased to 103%, and our leverage ratio got down now to 1.4%.

And yes, that's basically from my side. Klaus, with these things, I hand back to you.

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [5]

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Well, thank you, Dietmar. Let me use the opportunity here to make one comment on your decision. And I speak for our owners and the Chairman of the Supervisory Board as well. We clearly regret your decision. That, we respect. We know that this is your personal decision, and we understand the reasons. We have been, Dietmar, for a long time working together very closely with really great success for both of us. And it's something that I also personally accepted, but I really regret the fact that you will not be at my side then in the future.

There's still nearly 9 months to go that we will give us the opportunity to find a good successor. And I want to use the opportunity here to thank you for all your cooperation in the last weeks. Without you, we clearly would not have seen this development that we are now able to report. And please take it as a greatest sign of respect that we have for you when we now continue also in the next 8, 9 months.

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [6]

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Klaus, thank you very much for this appreciation. And yes, looking forward, we'll continue as we worked together in the past. So still a lot of work to be done.

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [7]

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Now let's continue with the final page, outlook. I think we already mentioned the key messages. I don't want to spend more time here.

You saw all the good things, and I also mentioned that there's still areas that we need to further improve. So I'm not going to read the numbers on 26 again. What counts in this complex market environment is relentless execution, and I think we have shown that this is possible.

I also want to use the opportunity here and say the -- as an overall conclusion, all our divisions have really contributed to this result. They have done a very good job in working together, and there's more to do and hopefully also more to come. Discipline counts, and it's good to see that while the divisions are focused on the top line, all our functions contributed on the cost side.

And this spirit is, from my point of view, the most important thing if you go through challenging and difficult times. Again, we are not forgetting that there is innovation necessary, but it goes in both directions. The self-help momentum has to continue, it will continue and it will open up new opportunities at the same time on the top line.

So let me finish here. Thank you for your attention and I hand back to the -- to Renata for your questions.

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Renata Casaro, Schaeffler AG - Head of IR [8]

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Yes. Dear operator, we can open the Q&A session right now.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we've received the first question, it is from Kai Mueller of Bank of America Merrill Lynch.

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

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The first one, if I may, is you said you've been much more efficient in the third quarter in terms of running your capacities alongside where demand was. And I understand you've been also reducing your sort of hourly overtime banks, basically, in order to do that. Can you give us a bit of color in terms of how much you've tapped into in terms of extra holidays and how much you can still tap into, let's say, into Q4 and into next year?

The second question is we've had some of your peers already starting to do a sort of slight look into 2020. I'm not expecting any guidance whatsoever. But I'm just trying to understand how you think about 2020 as you're preparing possibly for a further drop in volumes. So are you seeing a stabilization?

And then thirdly, just sort of a more specific one. In your Automotive OEM bridge on Page 18, you show in the others line is now a positive EUR 7 million in the quarter. I think it was minus EUR 17 million in Q2 and it's, I think, negative before in Q1 as well. Can you give us a bit of color what the swing factor really is in there?

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [3]

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Thank you, Kai. Let me take the first 2 ones. And I think if I understand your first question correctly, you are asking whether the possibilities on further adjusting by reducing holidays or overtime is exhausted, and the answer is no, it's not. There -- we have a continuous improvement process here in place. We are monitoring the plants more or less on a weekly basis, but also the indirect areas. We just had a Schließungstag again in October. That is clearly not in the September results. And again, don't get us wrong, this is a good third quarter, but there is still headwind, and we need to manage this with our eyes on the road and the hands upon the wheel. So that's what we're doing.

And there's always, also towards the end of the year, this year-end impact that needs to be handled. We definitely want to make sure, and I think Dietmar indicated this already, when it comes to working capital, also be very disciplined there and do not deviate from the course that we have taken. So there is still potential, but clearly, we have made more progress compared to the last year. And in some areas, when you think about part-time, holidays have been run to 0 under the German regime. So it's very distinct area by area.

Second, in terms of what's going to happen the next year, again, we will, as you all know, give our guidance for the next year in end of March when we come out with our numbers. We will give midterm targets on the 24th of March. When you look at the IHS numbers, I think their indication is that it's somewhere around 0. And if I can stress a little bit the around 0, with all the things that we have seen in this year, I think that's also what we think is probably a good indicator for what's coming. But it's premature. We need to watch this very carefully.

And you all know the key number for us behind that is then the question what's happening in China. China will be very interesting for the rest of this year to see what's happening there. And we want to be cautious in 2020. We all know that there is too much capacity in the system, and therefore, managing this capacity and adjusting for any potential downturn as well is critical. And that's why we have put in place the 1,300. The 1,300 program has been announced. It has been agreed with our workers' council. We're using the same instruments that we have used before, and it will give us some flexibility to adjust if necessary. This is always a good thing to have this out, and it increases our resilience if things get under pressure again.

I hand over to Dietmar for the...

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [4]

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Yes. Kai, in regard to your question, the other position in the Automotive OEM bridge, the EUR 7 million, that's basically caused by adjustment for our RACE impact then.

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Kai Alexander Mueller, BofA Merrill Lynch, Research Division - Associate and Analyst [5]

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Why was it minus EUR 17 million in the second quarter? Do you know?

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [6]

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At that time, we had other impacts in there, and adjustments have been now posted in Q3.

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Operator [7]

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The next question is from Raghav Gupta of Citigroup.

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Raghav Gupta-Chaudhary, Citigroup Inc, Research Division - Analyst [8]

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Raghav Gupta from Citi. Just firstly on free cash flow, when I look at what you've achieved year-to-date and couple that with both an improvement in Automotive margins and lower CapEx in Q4, I'd expect you to comfortably exceed the top end of your free cash flow guidance. What am I missing here, please?

Secondly on the Automotive margin, EBIT margins improved clearly versus the first half, although gross margins I noted were broadly stable. What levers have you got to improve gross margins from here? Clearly, you've got -- done a lot on the cost side, but that seems to be below the gross profit line. Just trying to understand what levers you've got to improve gross margins from here on the Automotive side.

And then finally, a quick one on the headcount reduction. You reported that 4% reduction year-over-year. How much of this is full-time employees versus fewer temporary workers?

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [9]

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Okay. Let me start with the free cash flow question. Again, we stay with our guidance. The year is not over. We, I think explained to you what the drivers of the Q3 performance are. We have seen a pretty good working capital management on the inventory side, but we've also seen a situation that -- so some may have linked also to the lower CapEx, and our payables do not give us the benefits that we had in the past. With lower sales also, clearly, there's an impact on the receivables side. But there's always year-end, and that's why we decided to stay with the EUR 350 million to EUR 400 million. There's still a way to go, and that's why we would like to leave it as it is. Let's see what the year-end is going to bring.

On the headcount side, we have -- I don't have a number at hand. But if you think about the overall reduction, a significant part comes from the sale of activities. And the temporary workers, so far we have not highlighted externally. That is part of the equation, but clearly not a major part. What we have been doing, and it goes back to this resilience argument and the flexibility argument, and let me stress this because I also stressed it at the outlook yesterday. For us, it's very important that we keep the high-qualified people and that we put the right qualification programs internally in place. We're not going to wait for the German Republic to help us on this, but we have our own program in place FIT for mechatronics where people that want to take the offer can go into training courses, can go into -- do vocational training programs and can make themselves fit for the new requirements.

So that clearly plays a role. And clearly, also having an acceptable level of part-time work is always good to be able to react if necessary. So that is not the main driver for this. It's part of this. And we are clearly looking at the whole composition of our workforce very carefully, a, not to lose the highly qualified; and b, try to be as flexible as possible in the future.

Dietmar, do you want to do the gross profit?

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Raghav Gupta-Chaudhary, Citigroup Inc, Research Division - Analyst [10]

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And can I ask a follow-up just on the free cash flow side? So for the past few years, your Q4 CapEx has been above Q3 in the order of magnitude, I think around 300 basis points of sales -- or 3% of sales, sorry. In light of your CapEx discipline strategy, what's your expectation for the fourth quarter this year? I understand the tooling point that you need to get the factories ready for next year. But just given that discipline, and you're heading that committee, what can you tell us about that, please?

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [11]

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Yes. Well, if you see the pattern of CapEx and the CapEx outflow in the last years, you always have these peaks in the fourth quarter. And if you recall, I think the first quarter presentation, we clearly agreed on a strategic target for the organization that looks at the delta between the years where we said we don't want to have this hockey stick. We want to manage more evenly and make sure that it's -- that we better continuously improve than having -- and being within the 6% to 8% range than having always this outlier in the fourth quarter. And therefore, again, we need to see how this pays off. But the team here and also the underlying leadership group is clearly incentivized on managing this against the hockey stick in the fourth quarter. That's what I can say.

We also don't want to see a situation like last year where in the fourth quarter then, there's too much spillover effect from working capital into the next year and we start with a pretty low CapEx into the next year. But as all of you know, managing CapEx and managing cash flow and working capital towards the end of the year in an uncertain environment is more an art than a science. But please take the key message with you, we will manage it more proactively, and we will be careful on CapEx allocation. That's clearly the one factor for the future that counts. And it leads also back to the whole question of return on capital employed and achieving a better Schaeffler value-added.

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Raghav Gupta-Chaudhary, Citigroup Inc, Research Division - Analyst [12]

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Okay, clear. And then on the Automotive margins, please?

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [13]

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I think, Dietmar, would you like to take over?

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [14]

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Yes, of course. So on the Automotive margin, starting first of all with the gross profit side. We have a positive mix impact in there with actually reduced ramp-up costs that contributed to the development in Q3, especially in comparison to Q2. Then the flexing of costs became even more effective in August and September and has a positive impact in there. We have some other impacts from these -- we are also integrating the numbers of our acquisition of Elmotec that was countering a little bit. But this wasn't on the gross profit side.

And when looking to the EBIT side, we have then additionally, again being derived or being a result of our RACE measures, more focus not just on the CapEx discipline, but also in regard to spending on our R&D project. And we have a significant saving in the R&D expense compared to last year. And additionally, we have a positive contribution that actually the special freight, which has been on a high level during the whole of last year, are on a significant lower level this year. So that's basically the impact there.

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Raghav Gupta-Chaudhary, Citigroup Inc, Research Division - Analyst [15]

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And I guess, Dietmar, just thinking forward, gross margins in the Auto OE division have fallen 400 basis points, right, or kind of that magnitude over the past few years. What opportunity do you see for the company to improve that going forward?

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [16]

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Yes, the opportunities are basically the RACE program that we started. Wave 1 is in its execution. We are optimizing the footprint in that regard. Two plants are basically already sold. One plant, actually, we could sell then to a third-party plant in the U.K., was closed now in October, just the final finishing work is being done. And we have 3 more factory-related activities going on where we are in close negotiation with our unions then to finalize it as well. And then we target also to establish a second phase of RACE. This is currently in the preparation. Not sure, Klaus, whether you want to add something. I think we will come out with a direction in that regard next year during the Capital Markets Day end of March.

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Operator [17]

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The next question is from Sascha Gommel of Jefferies.

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Sascha Sebastian Gommel, Jefferies LLC, Research Division - Equity Analyst [18]

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I have 3 questions as well. The first one is on your regional split, you see an acceleration in China basically across all 3 divisions. And I was wondering if you can explain a bit more what is behind that and also how we should think about that in the coming quarters.

Then my second question is a bit what one of your major customers said that they're planning to cut production, and the impression is a little bit that OEMs are rightsizing their inventories and also their production mix in the fourth quarter for the upcoming regulation in Europe. So I was wondering if you see any major shift in the production schedules in your fourth quarter.

And then very lastly, on your pension liability, it keeps coming up. And I was wondering, as part of your negotiations with the unions, if this is a demand that you have to fund a bit more of your pension or if this not a discussion at all.

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [19]

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Let me start with the last one. Again, the pension liability increase is a function of the discounting. Interest rates are low, and I think you will see this across various other companies that this clearly needs an adjustment. It has nothing to do with workers' council or employee representatives, and there's no discussion there. There is a discussion, I think I can already indicate that, how we transform our pension system starting with the Board. And that's something we're working on since quite some time now and where we will come out with a decision to adjust the system that is clearly driven by historical measures into a more modern system starting with a portion and then bringing this forward to the next level.

Again, we're not -- on the second one, we're not here to comment on OEMs. As I said at the beginning, the market environment is challenging. We -- there is no trend that is absolutely clear to everybody. And the transformation is ongoing. We are part of this transformation. It's the question of how you focus this. So we -- the best thing you can do as a big supplier is that you monitor very carefully what's going on, but you're close to our customers -- we are close to our customers. And for us, managing production capacity is, as I said, as important as increasing our order intake.

In terms of China, yes, I mean in China, you all know that we are pretty well positioned. We have the outperformance there in Automotive OEM. If you think about the Automotive Aftermarket and the 15% growth in Automotive Aftermarket China, then don't forget this is a very low base number. The really impressive number is the continued growth in Industrial. And as I said, that's very much driven by the wind business that is really rocketing there. So a sequential improvement in Automotive OEM should not come as a surprise after the very bad quarter that we had and the 2 others is also well explained.

So let's see how this stabilizes. As I said, Q4 will be decisive to see what's -- how China behaves and what also the latest decision here on the tariff debate will mean. Again, our market position in China has always been good, and that's clearly something that we will benefit from when this region of the world turns around little bit.

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Sascha Sebastian Gommel, Jefferies LLC, Research Division - Equity Analyst [20]

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Understood. Can I quickly follow up on the Q4 production schedule in Europe? So if I look at IHS, you would confirm that this is a realistic scenario and we're not missing any major shifts that you might already see on your order intake?

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [21]

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Well, I think Q4 is, if I understand this correctly, somewhere between minus 5% and minus 6% in IHS numbers. We said minus 4% for the year, and we will ask this also when it comes to the guidance that we just confirmed. I think that is not very far off. We need to see what's developing.

Again, then -- no more questions? Then I would once again come to the final point here. And I think you see the dates that we have on our calendars. Renata and Dietmar are going on a road show, London and Frankfurt. I will be on a roadshow in New York in December 4. And then when the year is finished, we, I think have a chance to talk in Frankfurt. Dietmar is continuing to do all the capital markets regular work and will also clearly be with me on the earnings release for the full year.

What I would like to highlight here before we come to the end is the 24th of March. It's not a new date. You already know it. It's our strategy Capital Market Day here in Herzogenaurach. We have promised to share with you the midterm targets. We are heavily working on this, and that's something that is clearly a very important date in our further development.

So Renata, with that, I hand back to you for the final comments and closing of the call.

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Renata Casaro, Schaeffler AG - Head of IR [22]

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I'm just checking with the operator if there are no further questions pending.

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Operator [23]

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We've received further questions. The next question is from Christoph Laskawi of Deutsche Bank.

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Christoph Laskawi, Deutsche Bank AG, Research Division - Research Analyst [24]

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The first one would be on the mix impact that you've highlighted in Auto OE. My assumption would be that it's primarily driven by project ramp-ups in China on the engine system side. Is that something that you could confirm? And do you expect the same tailwind from the mix going into Q4? Or do you expect mix to shift to some degree in the fourth quarter?

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [25]

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Yes, maybe let me get back to this, Klaus, if that's okay. The mix impact is not coming from China. It was in conjunction with the project ramp-ups in Americas and Europe in the first and second quarter, and we see now improvement on the cost situation. Our Chinese colleagues, even now with the ramp-up that we see in Q3 which led to the outperformance, are doing an excellent job in regard to managing their costs. It's really outstanding what the colleagues are doing there. So that's the situation over there.

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Christoph Laskawi, Deutsche Bank AG, Research Division - Research Analyst [26]

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And will the tailwind be the same in Q4? Or do you expect it to fade to some degree?

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [27]

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Yes. There will be support at least in that regard in Q4 coming from the mix, and we expect a positive continuation of these ramp-ups in China as well for the fourth quarter.

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Christoph Laskawi, Deutsche Bank AG, Research Division - Research Analyst [28]

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And on Europe, you've underperformed the market again in Q3. The question would be, do you expect to return to an outperformance in the near term? And could you point us towards some project ramp-ups which might help you with that in the near future?

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [29]

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As you mentioned, the performance was on a weaker level in the third quarter. And then we have some ramp-up coming up in the e-axle side, especially now with Audi e-tron picking up. So that's where we expect further volume increases on that side. But overall, the market expectation for Europe is weak. Klaus explained regarding the -- at summit with the chancellor last night, at least this gives us a little bit of hope that during the remainder of the year, the important market, Germany within Europe, then should gain some more confidence.

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [30]

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Maybe let me add a little bit on the dimension here because your question -- your observation is right, but I mean you saw that the market was down in Europe in Q3 by minus 4.8%. We are down by minus 5.6%. So I wouldn't say we massively underperformed the market. We have gone down with the market, whether it's a rounded minus 5% or a rounded upwards minus 5% is not really relevant. So just to...

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [31]

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Klaus is right, yes.

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [32]

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Don't -- I'm not disagreeing with you that Europe is an issue. But between a massive underperformance, as it sounded, and a performance with the market there, I think there's a slight difference. So I think just to correct that impression.

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [33]

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Yes. That's right, Christoph.

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Christoph Laskawi, Deutsche Bank AG, Research Division - Research Analyst [34]

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Point taken. Yes, sorry. Lastly, just a housekeeping question. On the EUR 7 million in the EBIT bridge, I couldn't really get -- it was tough to understand what was behind it. Was it RACE-related or wage-related? I just couldn't (inaudible)...

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [35]

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It's a RACE-related adjustment, yes, especially effect in conjunction with RACE that we adjusted.

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Operator [36]

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The next question is from Jemma Permalloo of JPMorgan.

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Jemma Permalloo, JP Morgan Chase & Co, Research Division - Associate [37]

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Well done on this quarter. So I've got 2 questions. Looking at ratings here, so you are a negative outlook from S&P, and you've obviously maintained your guidance for this year, including margins. Now I understand that you won't be able to give guidance for 2020, but I was just hoping for some color in terms of your commitment to maintaining an investment-grade rating going into 2020.

And then my second question, just on the FCA and Peugeot merger. So the way I see it is that with consolidation, obviously, comes pricing pressure for suppliers, and I think some of your peers have actually been vocal on this front recently. So 2 parts to my question. If you could remind us of your customer exposure to either Fiat or Peugeot, if any. And just secondly, your general thoughts on pricing going forward.

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [38]

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Okay. Let me first tackle the rating-related question. We concur with you that one of the key figures to look at is the Automotive margin, you saw an improvement now. We are, long term, clearly committed to investment-grade rating. Dietmar has, in the last quarters, done all of this work to bring this also in our financing structure. And we will -- we're in very constructive conversations with our rating agencies in years. So let's see what's happening with this outlook. What needs to happen from our side is an improvement in the margin, and that's why we're working on our self-help measures. And how the rating agencies will then decide is their decision. But for us, investment grade is clearly a long-term commitment.

In terms of consolidation, what's happening around us, Fiat and now the new version with Italia -- Italy and France, is something remains to be seen. You all know our biggest customer is VW, the VW Group. We have very strong business with the large U.S. players. We have footprints with European players. This consolidation move doesn't expose us to any undue concentration risk. We are looking forward to see what's happening there. We think that this combined group will be stronger than the single companies, and that typically gives also additional potential.

And in particular, when it comes to helping these 2 companies in optimizing their CO2 strategy and when it comes to the mix of their fleets, we want to be there. We have good relationships to both companies, and we will see what comes out of that. But I wouldn't conclude from all mergers that it always means cost pressure. I mean there are some very prominent names here that you all know that are very good in this. But again, I wouldn't like to finish this call with this notion that everything is going to be paid by the suppliers. That's definitely not the case. The whole industry knows that we can only survive together.

And CO2 efficiency, let me point this out, is one of our key strengths, whether it's E-Mobility, hybrid or the combustion engine. And that will be absolutely key in winning new business. I think we have a good chance here to benefit from this combination as well.

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Operator [39]

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The last question is from Tom Swift of CreditSights.

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Thomas Swift, CreditSights Ltd. - Analyst of European Industrials [40]

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Just a question on working capital. I saw there was an improvement this year, but it seems to be from the other assets, liabilities and provisions line. So can we get a bit of color as to what that is exactly? Because if I add up inventories, receivables and payables, it kind of nets out. That's my first question.

The second question is the growth from E-Mobility, I mean how long do you expect this cadence to continue? It's very solid, but just some color for that going forward.

And then finally, I guess this is a question slightly out of topic in terms of, can we get a ballpark estimate of -- or figure for how much cash is up at the IHO Verwaltungs sorting or even at layers above the Schaeffler AG group?

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [41]

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Let me start with the last one. Again, this is not an IHO call. I think we have always explained to you how the cooperation -- or that's how the whole system with the IHO Holding works. And therefore, please understand we're not going to -- we cannot give at this call such a figure. I think what you all know is that the IHO just issued new bonds, that the financing structure is very sound. There are all sorts of elements in the structure that can help us to sustain also a situation where there's less cash. We've also committed, and you know that I have a role in the holding as well, to a step-by-step deleveraging there. And there's no reason to believe that this has now changed. On the contrary, I think with the performance we have shown now and with our dividend policy guidance that we have given, I think it's fair to assume that there will be a dividend paid by us to the holding that is then sufficient to deliver on our promises.

And E-Mobility, how long is the cadence, that's one of the really interesting questions. We have been, if I may say so, a little bit later than others in this. But we have invested already years ago into this. It's a function of how the market develops, it's a function of what the customers do and it's a function of our own readiness. I think we have improved our own readiness quite substantially. And back to what happened yesterday in Berlin, I think there is a clear push forward also from the regulators and from the government, and we want to benefit from this. But it will not come in quarters. It will take some years. I mean these ramp-ups are long-term businesses, and that's also a good opportunity because there is no radical change in the environment here to be expected. We see it as positive. And don't forget, it's not only E-Mobility versus combustion engine. It's both. With our 30-40-30 scenario, I think we are very well positioned to benefit from the overall transformation of the industry.

And let me add, if there's anything on the IHO that you need, the IHO treasury is available and can have somebody call you if necessary. Dietmar, you want to (inaudible).

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Dietmar Heinrich, Schaeffler AG - CFO, Member of Executive Board & Member of Board of MDs [42]

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Okay. Regarding the working capital, maybe giving you a little bit of insight, we reduced on the inventory side by EUR 80 million. And on the financial supply chain side, in conjunction also with September picking up compared to the month of July, which was a vacation month, we have a slight increase in receivables. And on the other side, we strengthened, as we already explained, our measures in regard to CapEx. But also, we focused in the factories on reducing services then to the really necessary level. And in line with this, our accounts payables actually dropped. So at the very end, the working capital slightly increased in an absolute number. But we have this positive contribution. And then in that conjunction from the inventory development and at the very end, the lower CapEx, so the payout then also helped in conjunction also with the other impact that we already explained, including some onetime one-offs.

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Renata Casaro, Schaeffler AG - Head of IR [43]

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So dear operator, if there are no other questions, as I see from the system, I think we are ready to close this call. I just want to anticipate -- thank you very much to all bondholders and equity holders and also analysts on the line. We'll be on the road with Mr. Heinrich from tomorrow. And thank you very much, and goodbye.

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Klaus Rosenfeld, Schaeffler AG - CEO, Member of Board of MDs & Member of Executive Board [44]

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Thank you.

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Operator [45]

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Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may disconnect.