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Edited Transcript of ZIL2.DE earnings conference call or presentation 7-Aug-19 12:00pm GMT

Half Year 2019 Elringklinger AG Earnings Call

Dettingen/Erms Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of ElringKlinger AG earnings conference call or presentation Wednesday, August 7, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Stefan Wolf

ElringKlinger AG - Chairman of the Management Board & CEO

* Thomas Jessulat

ElringKlinger AG - CFO & Member of Management Board

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Conference Call Participants

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* Akshat Kacker

JP Morgan Chase & Co, Research Division - Analyst

* Christoph Laskawi

Deutsche Bank AG, Research Division - Research Analyst

* Frank Biller

Landesbank Baden-Wurttemberg, Research Division - Investment Analyst

* Henning Cosman

HSBC, Research Division - Analyst

* Marc-René Tonn

Warburg Research GmbH - Senior Analyst

* Tim Schuldt

Pareto Securities, Research Division - Research Analyst

* Yasmin Steilen

Commerzbank AG, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Dear ladies and gentlemen, welcome to the Analyst Conference Q2 2019 of ElringKlinger Group. At our customer's request, this conference will be recorded. (Operator Instructions)

May I now hand you over to Dr. Stefan Wolf, CEO, who will lead you through this conference? Please go ahead, sir.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [2]

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Well, thank you. Hello, ladies and gentlemen, a very warm welcome to our conference call on our Q2 figures 2019. The agenda is as follows. As it is normally in our conference calls, I will start with a quick overview of the markets and the important headlines of the second quarter of ElringKlinger. Then my colleague, our CFO Thomas Jessulat, will then walk you through the financial figures of Q2. Afterwards I will close with the outlook and then of course at the end, as normal, you have the opportunity to ask questions.

Well, let me start with some remarks to the second quarter. For the second quarter, we noticed the following headlines with respect to our business. First of all, top line grew slightly by 0.8%, but decreased organically by 0.3%. This represents an outperformance of the global automotive production by more than 5 percentage points.

Order backlog remains on a robust level and grew by 2.4% to EUR 1.063 billion, compared to previous year's second quarter. EBIT margin pre PPA came in at 2.5%. As expected, the high cost basis in North America, also especially high material prices and of course the very weak market developments in Asia and Europe have an impact on the EBIT. And my colleague, Mr. Jessulat, will explain the effect in more detail later to you.

Operating free cash flow improved considerably to EUR 98.6 million in Q2 due to our very disciplined CapEx spending and our consequent working capital management and also, of course, the saving programs that we have in implemented. In addition, we were able to reduce net debt significantly in the second quarter 2019.

From an operational point of view, we are currently in the ramp-up phase of our new plant, U.S. plant in Fort Wayne in Indiana. In view of the challenging conditions which weigh on the global auto market, we have initiated comprehensive additional cost-saving measures in the first half of 2019. The first positive effects on earnings have been seen already in the second quarter. Also we expect the majority to be reflected in the second half of 2019, so that means until the end of the year from now.

Furthermore, we are leveraging synergies and bundling forces to improve productivity in our production locations in North America. Our action plan is being driven forward at pace. For example, exceptional freight movements as the sorting costs have already been reduced, but there is still room for improvement.

We confirm today the outlook for the full year 2019, despite increasing challenges in the market. We will limit the impact of the market weakness on EBIT pre PPA, especially through our strict cost reduction program that we have implemented within the entire group; again, operating improvements, especially in NAFTA, and also some in Switzerland and positive one-off effects, especially caused by a sale of real estate.

Well, let's have a first look on the market development of the second quarter. Global trade conflicts and the slowdown of the economic cycle have negatively impacted the automotive markets over the course of the year so far. Therefore, leading research institutes have revised production forecast figures, as you can see now on Slide #3 that we show in our presentation for the regions China, North America and Europe. Based on the production volumes of the light vehicles that's passenger cars and light commercial vehicles, global markets decreased by around 5% in the second quarter.

In China, which is a very important market for the automotive industry, trade conflicts and tariffs are hitting the biggest automotive markets quite a bit, leading to a drop of production figures by 13% which is a lot. Potential government measures to support the industry have not been published yet. For ElringKlinger, a market downturn in such an important market like China directly impacts the earnings figures quite a bit. As once again, China is a very, very important market for us.

In North America, we saw the market down by 3% while the SUV demand keeps up the pace and model launches drive results for European OEMs. The overall market was also affected by the above-mentioned trade conflicts between the U.S. and China, especially in the second quarter. As in previous quarters, ElringKlinger outperformed the market in the second quarter significantly and continues to operate on a high group cost level.

In the European Union, we saw a decrease of 6%, partly still due to the ongoing uncertainty regarding new drive concepts and bans imposed on diesel-powered vehicles, partly due to the weak economy. This development is reflected in lower sales, in less earnings and in the moderate order intake too. So overall, it is a very difficult situation in our industry.

Well, after those preliminary remarks, let me hand over to my colleague, Mr. Jessulat, our CFO, for the explanation of the quarterly figures.

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [3]

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Yes, thank you, Dr. Wolf. Ladies and gentlemen, a warm welcome also from my side. I would like to comment the financial results for the second quarter starting on Slide #5. As already mentioned, the market slowdown is reflected in our current order book situation. Order intake decreased to EUR 420 million in the second quarter and adjusted for currency effects that represents a decline of 7.8%.

The order backlog rose to EUR 1.063 billion, a plus of 2.4% respectively, 1.5% when adjusted for foreign exchange effects. Despite the challenging market conditions, we generated slight sales growth in the second quarter of 2019. Q2 sales amounted to EUR 434 million after EUR 431 million in the second quarter of 2018 and foreign exchange effects drove sales by 1%, there was particular reasons by the U.S. dollar. All in all, we saw a slight organic decline of 0.3%.

As you can see in our global sales split as shown on slide #6, we saw again a very strong growth in North America. After a strong first quarter, the sales share in this region increased in the second quarter again significantly to 29% (sic) [27%] compared to Q2 2018 and therefore outperforming the production vehicle development in North America by 3%. In fact, North America was the only region within the ElringKlinger Group showing positive sales growth in the second quarter of 2019. In all other regions, revenues came down versus the previous year's quarter with respect to the difficult market conditions.

Regarding our business divisions, we realized increasing sales in our strategic future growth areas, the structural lightweighting and the E-Mobility divisions. The structural lightweight products and E-Mobility components achieved strong growth rates. Thus, the Lightweighting/Elastomer division, our biggest business unit, further increased its sales share in Q2 to now 29%. E-Mobility could also on a low level push its sales share to around 2%. Sales in the other classical business areas such as shielding technology as well as cylinder-head and specialty gaskets, decreased due to the underlying market slowdown.

Slide #8 presents the earnings figures for the second quarter and EBIT pre PPA reached EUR 10.7 million and the EBIT margin pre-PPA stood at 2.5%. Let me outline the main drivers for this development. On the negative side, we have noticed a market downturn in the second quarter which affected all 3 major regions. Whereas we still see strong growth in North America, we have recognized earnings impacts from the sales decline in Europe and Asia Pacific and in particular in China. This impact amounts to EUR 8 million in those 2 regions.

As already announced in the Q1 call, countervailing and antidumping duties have affected earnings, mainly in the first but also to a remaining amount in the second quarter. All in all, after a negative impact of EUR 5 million in Q1 2019, duties and tariffs decreased earnings by EUR 1 million in the second quarter. And this is a result of our immediate action upon the duties, we have relocated U.S. demand for aluminum to suppliers outside of China, so that in the second half of 2019 we won't see an impact anymore. Let me also remind you that the tariffs on steel and aluminum, which came into effect in June 2018 in the U.S., are still in place. High raw material prices burdened our earnings by EUR 4 million. Prices for plastic granules, aluminum and steel are still on a very high level.

Although markets in North America are declining too, we still see an extraordinary demand for our products. This continuing high demand results in high follow-on costs which have been addressed by effective countermeasures. We could, for example, reduce extra costs for special freights and sorting measures. On the positive side, the negative earnings effects have been countered by current cost-cutting measures within the group, such as the targeted reduction in overtime. The cost-cutting program contributed around EUR 3 million to the second quarter's EBIT. The position others includes impacts from, among others, higher personnel costs, R&D capitalization and a decrease in plant, property and equipment.

To sum up the earnings situation, the net income attributable to shareholders of ElringKlinger fell to minus EUR 8.6 million in the second quarter, especially the currency gains of EUR 0.7 million fell sharply both compared with the first quarter of 2019 with plus EUR 9 million and with the second quarter of 2018 with plus EUR 8.6 million. The higher tax rate in the second quarter of 2019 was attributable primarily to losses incurred by subsidiaries for which deferred tax assets could not be recognized. Overall, the earnings per share stood at minus EUR 0.14 in the second quarter 2019, after plus a EUR 0.13 in the second quarter 2018.

Let me now turn to Slide #9, showing the performance of our segments. As we have already discussed the main issues of the OE business above, I will now focus on the remaining segments. In regard to Aftermarket, geopolitical tensions in key sales markets such as North Africa, resulted in a slight decline in Q2 sales. Revenues stood at EUR 41 million and furthermore we made progress in tapping into the Aftermarket business in Asia and North America. EBIT came in at EUR 6.7 million, representing an EBIT margin of 16.4% and the slight dip in EBIT margin is reasoned by the lower sales level and the costs associated with a market entry in North America and in Asia.

In regard to Engineered Plastics, the Engineered Plastics segment saw a sales decrease of minus 4.3% and especially the mechanical engineering and automotive industry declined significantly in the reporting period. Sales decreased to EUR 29 million. The lower production capacity utilization, higher personnel costs and the persistently high price for fluoropolymers impacted EBIT quite a bit. It fell to EUR 1.7 million in the second quarter, which compares to EUR 5.1 million in the second quarter of 2018. EBIT margin stood at 5.9% in Q2.

We now come to Slide #10. Net working capital decreased considerably to EUR 499 million and compared to the end of 2018 this represents a decrease of EUR 68 million. The decrease is a result of the strict working capital program and has been driven by currency effects amounting to plus EUR 3 million. Inventories improved by EUR 11 million also due to higher raw material prices and declined tool-related stock referring to numerous ramp-ups in the reporting quarter, such as in Fort Wayne and in Kecskemet in Hungary. Trade receivables optimized by EUR 30 million and last but not least, trade payables extended by EUR 33 million.

In addition, we followed a disciplined CapEx approach which was down by roughly EUR 20 million compared to previous year's Q2. So CapEx ratio in Q2 was at 4.8%, well in line with our target of any figure below 9%. So all in all, operating free cash flow improved considerably to EUR 98.6 million. And having said this, we are all well on track to achieve our full year target of a positive figure.

As we have mentioned, we have implemented a comprehensive program to optimize group's cash flow figures. Generally spoken, the cash flow generated in Q2 was the result of it. We now use a broad range of instruments to improve the group's cash flow and reduce debt level. The first positive effects can be seen in Q2 figures where we scaled back the net financial debt by almost 10%, excluding IFRS 16 effects, compared to December 2018. And apart from our disciplined CapEx approach, we have implemented focused measures to improve earnings. This includes the group-wide cost-reduction program, the optimization of the performance in Switzerland and North America as well as the expected paybacks of duties.

As already shown in Q2, extended payment terms for trade payables, reduced level of trade receivables and optimized inventories will lead to a reduction of new working capital. All 3 building blocks will improve operating free cash flow in the short and medium term. Compared to December 2018, we were able to bring down net financial debt by EUR 24 million or 3%, excluding IFRS 16 effects, by EUR 69 million or 9.5%. This positive trend is primarily attributable to the working capital reduction.

Regarding our debt structure, you can clearly see the positive effect of our syndicated loan with a volume of EUR 350 million over a minimum term of 5 years. It improved our maturity structure and after 60% of long-term financial debt by the end of 2018, the share of long-term debt increased now to 75%. EUR 591 million are now due in 2020 or later.

So far from my side, I will now hand back to Dr. Wolf for the outlook and some final remarks.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [4]

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Thank you, Mr. Jessulat, for the detailed explanations of the figures. Well, let me outline the more near-term future and the outlook for 2019. At our analyst conference in March and also in the Q1 call with you, we have already included the graph on Slide #14, which you see now, which shows that the forecast of the global auto production has been revised downwards each month. Especially the economic forecast for China, the biggest car market in the world and also very important for ElringKlinger, has been revised considerably in the meantime. The originally expected significant market recovery will probably not materialize.

Looking at the development of the main markets, we expect the following. Looking at North America, here we might see a slight decrease of around 1% to 3%. The demand for SUVs and light trucks is still in line with our expectations. But the demand for passenger cars is remarkably down. In addition, the trade conflict may harm growth rates further.

Europe, looking at Europe, the economic environment is weak and the uncertainties are persisting. We still have no clear view on the Brexit. Overall, we also might see a decrease of around 1% to 3% in this region.

In China, the very important market as I mentioned before, trade conflicts will further hit the economy. Hence, government stimulus in the second half could be a countermeasure. Overall, we expect a decline of 4% to 6% in China for the year 2019.

Looking at South America, this is coming from a very low level and we see that there are some improvements, a slight improvement; a slight plus. And the development in Brazil is pretty good, but it's as I said before, coming from a low level and a very, very small market. In light of the new market insights, we revised our original market expectations. We now expect a market downturn of 2% to 4%.

Of course the current earnings situation is not satisfying for us. That's pretty clear. We expect a positive impact on earnings in the second half year of 2019 due to several reasons. First of all, the incremental cost increases due to wage and material price increases will not persist in the second half year of 2019. Likewise, the burden by antidumping and countervailing duties, due to the immediate countermeasures that we have taken, will be down. Additionally, we expect reimbursements of duties that we paid as well as we have applied for special permits.

At our plant in North America, we expect a further cost reduction. At our Swiss location, we will bring down the fixed cost base by the end of the year 2019. We have scheduled a real estate sale for the second half of 2019 with a single-digit million euro income. In addition, of course we have tightened our cost-saving measures, which are directed to improve the earning situation in the short term. For example, we are bringing down the personnel costs by reducing the overtime of our workforce, by suspending the annual employee bonus, also by internationally scaling back leasing workforce and by putting in place a hiring freeze in the traditional business area. And I also want to mention that we of the management board have informed the supervisory board that we do not want to have our (inaudible) increase that was due in February this year, according to our contract. So we are deleting that. We also carefully manage, of course, material costs and we also reduce any discretionary cost as far as possible.

If you just look to Slide 17 now in the presentation, market conditions are likely to remain challenging for the automotive industry, with key markets in China and North America and Europe. What we see here in the full year is a downturn. We expect to maintain a top line development above the level of global vehicle production organically by 2 to 4 percentage points. And as I mentioned before, we see that globally the car production is going down. And overall as a result of the various factors that I have outlined before, we still expect to achieve an EBIT margin of around 4% to 5% before purchase price allocation. This assumes, of course, that no further significant externalities emerge as a drag on earnings and that markets do not weaken any further than already anticipated. So if things stay like you see them today, we are pretty confident that we reach our guidance that we have given you already in the beginning of the year.

Last but not least, you see now on this slide, the next slide, our expectations for further indicators for 2019 and the midterm. And that all remains unchanged, as we have shown it already in our conference call for the first quarter.

Well, ladies and gentlemen, thank you very much for your attention. Thank you for listening to us. Times have been easier than right now. But we are very confident that we will get through that and that our measures that we have taken will be seen in the results of the ElringKlinger Group in the quarters to come. So thank you very much and we are ready to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Christoph Laskawi, Deutsche Bank.

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Christoph Laskawi, Deutsche Bank AG, Research Division - Research Analyst [2]

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I would have a couple and like to go one by one, if that's okay with you. The first one would be on the free cash flow. It's a big improvement in Q2. But the question really is how sustainable that is, looking at all the working capital items. Could you give an indication on the receivable side, for example? Did you use factoring? And if you did, to what extent? Just a rough euro million amount will be well appreciated. The same for the payable side, which was quite a decent improvement; did you use reverse factoring or any other measures except from just stretching payment terms with your suppliers? And on top of that, on free cash flow and working capital; should we expect this to be a one-off thing in Q2 or should we expect working capital to be an inflow in the coming quarters or for the next year when you work on the improvements?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [3]

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Like we have indicated earlier, we are getting way more aggressive on improvements on the working capital sides. And this is on the one side, we have to say some structural elements, contracts with suppliers on the inventory side which cannot be seen so much as of yet. We are also, I think, making some improvements and this will be seen in the quarters to come. And on the receivables side, from an organic perspective, a very aggressive behavior from our side in terms of collection and several measures that we have taken in general, which is a full set of amounts that contribute to the cash flow out of working capital.

So I would not agree with you that it is just 1 or 2 individual points. It's a subset of more items again that contributed to that. From a working capital perspective going forward, I would expect some more to come. Of course, it's not something that is sustainable in the long term. But my expectation is that we could further improve here in the following quarters, whereby we'll see I think a little bit on the receivables side towards Q3 and Q4. And I would expect also some more improvement here on the inventory side. And I hope that answers your question.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [4]

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Maybe one additional remark with regards to payables, we have been for many, many years different to what is normal in our industry. We always have been very good (inaudible) payers to our suppliers. So sometimes we paid the invoice already when it was not due. That's not correct, but it gives you an indication. And I think what we did now is that we went to, let's say, normal situations with regard to our suppliers. We of course stretch the payments terms, but we did not overstretch them. We just did what almost everybody does in our industry.

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Christoph Laskawi, Deutsche Bank AG, Research Division - Research Analyst [5]

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Two follow-ups on that, so do you use factoring now to a large degree? And are you willing to share an amount to which you've used it? And on the payables side, paying early usually gives you some sort of discount. With paying late that is obviously gone. So should we expect some gross margin dilution from paying later, but the free cash flow improvement on the other hand, or is there no (inaudible) effect whatsoever?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [6]

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On the question #1, again this is part of a set of different measures. I would not want to point to one. To question #2, in regard to the payables, the conversion that we do here is not with a negative impact on margins. It takes into account pricing as well and this is essentially the reason why this process takes a while in terms of activity from the sourcing department.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [7]

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And one thing to make very clear, of course this is not a one-time thing. Our clear goal is to keep the free cash flow sustainably on a high level.

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Christoph Laskawi, Deutsche Bank AG, Research Division - Research Analyst [8]

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Understood. The second set of questions or the section question will be on your guidance. I think I struggle to reconcile really how you can reach it with essentially the need of doubling the underlying margin in the second half. Stripping out the one-offs that you mentioned on the real estate sale and also on the tariffs, you would need an underlying improvement versus H1 of around EUR 20 million.

Could you just help us bridging the gap there and you already elaborated on some items. But given the market volatility is not really improving, all the suppliers are essentially looking for minus 4% to minus 5% production decline for the full year and no support from external factors. Could you just help us bridging the gap there? That would be much appreciated.

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [9]

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Yes. Bridge, in my opinion would be sale of real estate as part of the bridge to the end of the year with a high single-digit amount that I would expect from today's perspective. I would expect a mid-single-digit amount in terms of reimbursement of duties and tariffs. I would expect low double-digit amount from our activities around cost reductions, where we have addressed, let's say, a broad range of measures. And the rest is from organic EBIT.

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Christoph Laskawi, Deutsche Bank AG, Research Division - Research Analyst [10]

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And then do you see underlying improvements? Because usually Q3 and Q4 are weaker anyway. And if you expect only a low double-digit amount for the cost reduction, it probably doesn't get you to the lower end of the margin range, right?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [11]

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Well, when you see the level of capacity constraints looking back, then in the regions where we have had and in some areas still have those topics, there is going to be an effect that we expect in the second half in regard to further organic improvement coming out of the relief we got in the capacity situation. So essentially I would agree with what you say. There would need to be an underlying improvement of organic EBIT as part of it.

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Christoph Laskawi, Deutsche Bank AG, Research Division - Research Analyst [12]

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Okay. And can you reach that if the market comes out at minus 5% to minus 6%?

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [13]

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Our expectation is minus 2% to minus 4%.

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Operator [14]

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The next question is from Henning Cosman, HSBC.

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Henning Cosman, HSBC, Research Division - Analyst [15]

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So I was also going to ask about factoring, but I understand that if I can just clarify that you're effectively confirming that factoring is a part of the improvement, but you're not willing to quantify that. Is that correct?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [16]

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No, essentially we are not going very much into detail in regard to individual instruments that we are using. And part of it is organic and part of it is specific measures in order to achieve a sustainable level. Because the sustainability is what we need in order to drive down the net debt level of the group. So this is as far as I would go in terms of explanation. But again, it's a different set of topics that you cannot point just to one very large item.

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Henning Cosman, HSBC, Research Division - Analyst [17]

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Okay, understood. On your FX results which shows quite a strong swing, can you remind us if you're doing anything to balance that and not have such violence swings going forward and what exactly is driving that between quarters?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [18]

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I do. We have in place currency instruments in regard to exposure euro to the U.S. dollar and euro to Swiss francs. I wouldn't call it wide swings, because as you can see here in terms of the currency gain and the currency losses, we are pretty balanced here. And the balanced situation you can see here overall, where we have -- let me see. We have approximately 9-point-something million here in terms of currency gains, and approximately the same amount in terms of currency losses. So we have very little net exposure, which can be seen here.

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Henning Cosman, HSBC, Research Division - Analyst [19]

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Right. On the EBIT margin, you're obviously still guiding for the successive improvement beyond 2019. If we strip out the high-single-digit gain from real estate to let's just say to get you to the bottom end of the guidance, we're talking more about a level of around 3.5% underlying margin, maybe a little bit below that. So in a way, we're now guiding successive improvement from a lower base. Can we just talk a little bit around what you're thinking in sort of 2020-2021, what the new normal is that you want to achieve when some of these more temporary issues have been resolved? And considering the kind of new product mix, maybe more sort of more expensive products as compared to just a few euros, where it was in the past possible to achieve very high margins. What's a kind of new normal level that we can think of for 2020-21?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [20]

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Margin level, I would not want to talk about that as of yet. But in terms of the difference in the offset of the one-off to 2019, I have to remind you that we have pretty much backend loaded activity in Switzerland in regard to reduction of the space we are using, we have been occupying. And this consolidation is going to be happening at the end of the year. And then we already see some improvement and will see more improvement in NAFTA. And in regard to weaker market conditions, I see a good change here that we have some improvement of the bottom line coming out of the reduction of the losses in the loss-making companies. But in regard to margins, I would not want to talk about that as of yet, based on the limited visibility that I have and based on the just usual that guidance-wise we only talk about that next year.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [21]

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Just to amend, I think if you look on Slide 17, it's pretty clear. It says for 2019 EBIT margin pre PPA approximately 4% to 5% and midterm it says EBIT margin pre PPA successive improvement. I think that's a pretty clear statement. So don't expect that this EBIT margin pre PPA successive improvement that we give you today a figure.

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Henning Cosman, HSBC, Research Division - Analyst [22]

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Okay. I understand. Can I just ask as a final one, with respect to your 2% to 4% market outlook, it's obviously quite controversial with everybody else being pretty well aligned around the either 4% or 5% mark. Can I just ask if you have a strongly controversial view on one of the markets specifically, where you think it's going to be a lot better than the market institutes and most of your competitors are expecting?

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [23]

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No, there are so many figures out there. You can find almost everything. But one thing that for me is very important is being a member of the board of the VDA, the Association of Car Manufacturers and Suppliers in Germany. They have pretty good databases and they have pretty good estimations. And I'm on this board now since 8 years. Their estimations were always pretty good. And we look at a lot of different figures and a lot of different institutes. But for me, the figures of the VDA have a strong impact on our expectations.

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Henning Cosman, HSBC, Research Division - Analyst [24]

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I'm not aware of the VDA forecast. Are they going for minus 2% to minus 4% as well?

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [25]

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In total, with all the other data that we have, but with a strong impact of the VDA, this is what we expect.

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Operator [26]

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The next question is from Marc-Rene Tonn, Warburg Research.

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Marc-René Tonn, Warburg Research GmbH - Senior Analyst [27]

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Also, a couple of questions from my side, firstly, we've heard today from Continental that they are basically preparing for a quicker and presumably a bit even more pronounced decrease in demand for combustion engine technology, by doing restructuring in their power train business. Perhaps something where you could shed some light on how you see things currently developing, given you're still, let's say, a substantial share of dependency on the combustion engine. That would basically be the first question, whether you see any need now to make structural amendments to your production footprint or how you see the current development.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [28]

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Well, first of all, I'm absolutely convinced that we will see combustion engines for the next 15 to 20 years. If you look at our product portfolio, we have a certain capacity that is available to supply the industry with our classical parts. If we just look at the gasket business, highly consolidated and there will be from all our competitors, there will be no investments in this classical business area. So this is going to lead to the fact that the customers become in this area more and more dependent on us. Because if they want to build a combustion engine in the future, they need our parts. And the capacity to produce those parts as suppliers will be more limited in the future, because of that effect that I just outlined that a lot of our competitors do not invest anymore. Of course we invest, but we underproportionately invest to what we do in our new business area that means the fuel cell and the battery technology.

But still we keep our production in this classical business on a very high level, so that in a lot of cases what we see already, customers have no choice anymore. We see already some positive price development in our classical product portfolio based on this effect and that is part of our strategy. So I think to say that everything is over with the combustion engine would be the complete wrong view and would be completely wrong to follow this strategy. Of course we have to invest a lot in our new business in the fuel cell technology and the battery technology. And we have very good projects here. We have already orders on hand for series production with very interesting companies in China, but also with some start-ups here and in the U.S., so that we really drive the business in the future. But also we will see some margin improvements coming from our classical business due to the facts that I just described.

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Marc-René Tonn, Warburg Research GmbH - Senior Analyst [29]

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And you see no, let's say, change to your let's say more cautious CapEx assumptions or??

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [30]

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Once again? Once again?

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Marc-René Tonn, Warburg Research GmbH - Senior Analyst [31]

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Still you do not see any, let's say, need to now change, that you wanted to be a bit more cautious on CapEx spending because you now have to big quicker on building or to expanding the E-Mobility business? That's all in line with the previous spending.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [32]

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As of today, I would say, yes. But you never know. If we get, let's say, a very interesting order for series production for a very interesting project in the E-Mobility sector that means the fuel cell or battery technology, then of course that would generate very good earnings. Of course we would think about investing there. Everything is in the flow right now in this part of our business, not only at our company, in our sector in all. But again, one thing, don't forget that there will still be a good possibility to earn good money in the classical product portfolio in the future, because we will have combustion engines in large numbers for the next 10 years at least.

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Marc-René Tonn, Warburg Research GmbH - Senior Analyst [33]

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Perfect. Then the second question, perhaps coming back to Engineered Plastics, I think I've just missed that. We have seen this very steep decline in margin. Are you expecting that to recover quickly back to the, let's say, mid-teens level which we have seen there historically, or is it something which is there to stay for longer, the more depressed earnings level?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [34]

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I think we have to make an assessment in term of how sustainable weak sales are going to be in that area. But for now, I would see it as a dip. And I think it needs some further assessment here in customer behavior. It could be that we are entering a weaker period, but that essentially is depending on the markets. But right now it's fairly weak.

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Operator [35]

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The next question is from Tim Schuldt, Pareto.

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Tim Schuldt, Pareto Securities, Research Division - Research Analyst [36]

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I would have a question with regard to your new financing. I know that you haven't told us in the past which covenants you have. I would just be interested in what is the risk if you would miss your guidance for the year. How much headroom do you have and what would be the result, if you would break any of your covenants?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [37]

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As of today, I don't have a concern. But this is as far as I would go in terms of answering your question. I'm not concerned at that end, and I think we are heading forward with the scenarios that I have in mind, I'm not concerned.

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Tim Schuldt, Pareto Securities, Research Division - Research Analyst [38]

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You're not concerned based on your assumptions or also for different scenarios which are not your main case, but which might also be possible? I mean there has been the mention by one of my colleagues earlier that a lot of other suppliers have a much more negative market scenario. In the end the question is, will your covenants also hold, let's say, if this more negative market scenario would come into effect?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [39]

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I probably could not say for every scenario. But for the likely scenarios, ElringKlinger I think we should be okay.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [40]

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And also you have to see, I explained that a lot of times before, market scenario of course is important and has some impact on us. But we have years in the past where the markets grows by 0 and we grew by 8%, because we had a lot of new projects that went into series production. Even if a market decreases, you can as a supplier, you can increase your sales remarkably if you gain market share. If, let's say, a competitor has lost a project, 3 or 4 years ago you took over this project and it goes into series production today. So there are so many impacts, different impacts on that that a pure look at the market scenario is not really helpful.

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Tim Schuldt, Pareto Securities, Research Division - Research Analyst [41]

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Well, that's true. But you're guiding for an outperformance versus the market. So let's say the outperformance is obviously depending on not only the market as a whole, but also the development of the models which you're supplying into. But generally speaking, if the market would be 2% weaker, then you might still outperform by the same amount, but probably your revenue would also be around 2% lower than originally expected.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [42]

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Yes, but our assumption today is that the market decreases by 2% to 4% and that we outperform the market by 2% to 4%. This is the basis for our expectations. And this is also reflected in our figures that we see at the year-end.

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Tim Schuldt, Pareto Securities, Research Division - Research Analyst [43]

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Yes, I understood that. But the question is, because people are questioning if this scenario for the market might not be too optimistic. Obviously investors are interested to know what happens if your scenario turns out to be too positive, and if let's say the more general scenario of other companies comes to what happens then. But I have understood that you're optimistic not only for your guidance scenario, but also for other likely scenarios that you see no problem with your covenants this year.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [44]

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That's true, yes. And you have to see that we have a lot of, let's say, projects or a lot of parts that we have to supply into series production related to SUVs, especially if you look at the U.S., we have a lot of parts that go into the F150 of Ford, which runs really well. And other suppliers, they have also business with Ford, but they more or less supply parts to the vans that are really down. So the trend is clearly to the SUVs all over the world.

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Operator [45]

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The next question is from Frank Biller, LBW.

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Frank Biller, Landesbank Baden-Wurttemberg, Research Division - Investment Analyst [46]

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Actually, it's 2. The one is on E-Mobility. There was a sales revenue of EUR 8.4 million in the second quarter, so doubling of sales. A slight loss you mentioned in your report, how big was the loss here? Was it in the range of low-single-digit range or was it even higher? And when do you expect breakeven here in the E-Mobility business, having in mind that E-Mobility is gaining speed? And the other question is on the tax rate which was very high. So you gave as a reason your losses in foreign countries which are non-tax deductible. So which countries were affected here? Was it Asia or was it also Americas?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [47]

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Yes, on the first question here is the low-single-digit loss and the second question it's mostly Americas.

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Operator [48]

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The next question is from Yasmin Steilen, Commerzbank.

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Yasmin Steilen, Commerzbank AG, Research Division - Equity Analyst [49]

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Actually, I have only one left. You have significantly increased the capitalized development cost in the second quarter. So basically, [4 4] is year-over-year. Can you explain the triggers for the increase? So have you gained new customers or orders? And if so, in which product and segments are we talking about? And what is the run rate we should expect going forward? Or to put in the other way around, what level of capitalized development cost is reflected in your EBIT margin guidance?

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [50]

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Yes, so R&D expenses year-to-date is EUR 47.9 million and capitalization pre-IFRS 15, I would say the way we have looked at it in the past is EUR 5.2 million which represents 11% capitalization rate. If we now include contract assets as per IFRS 15, then this amount goes to EUR 8.2 million and the capitalization rate is 17%, 1-7 percent. On earlier calls I mentioned that I would expect a range somewhere between 10% and 20% and this is also the rate going forward in my expectation. We have guided always a 5% to 6% in terms of the R&D ratio. We are moving a little bit higher, based on the activities here. But I think now we are a number between 5.5% and 6%, so we are a little bit higher, but still well within the guided amount.

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Operator [51]

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The next question is from Akshat Kacker, JPMorgan.

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Akshat Kacker, JP Morgan Chase & Co, Research Division - Analyst [52]

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Two please, one, you've seen amazing growth in plastic housing modules in the Lightweighting division over the last few years and you continue to see growth in NAFTA. Can you discuss your discussions at this point with OEMs and what is the opportunity that you generally see in that market with the general structural trends that we are seeing? Second, can you just give us a broad sense in terms of a number, in terms of percentage of sales or how much do you expect net working capital improvement this year and structurally what are you targeting?

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [53]

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Well, let me say something to the first question. Yes, we have seen a strong increase in the lightweight parts that also based on of course the (inaudible), and front interior and some other parts that we developed here in this business unit. And yes, I don't really understand what you mean by discussions with the customers. We present new products. We present them solutions how they can reduce the weight in the car. They appreciate that and then we start a development project. What do you mean by discussions with the customers?

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Akshat Kacker, JP Morgan Chase & Co, Research Division - Analyst [54]

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No, the question was are you seeing more progress and more discussions on that front? Is the uptake much stronger than what you had expected on the positive side?

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [55]

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I didn't understand it. Once again, please.

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Akshat Kacker, JP Morgan Chase & Co, Research Division - Analyst [56]

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Just discussing generally, are customers willing to take on more lightweighting technology that you see to emission standards around the world?

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [57]

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Yes, of course. But that is something that is ongoing since the last 10 years. We started with this business with plastic housing parts with cam covers, oil pans and all those covers that are combined with our sealing products with our special gaskets, we started 15 years ago. And it was always the intention that's why we implemented this business unit and why we developed more and more products, lightweight products. Because since 20 years, the main issue for our customers is to reduce the weight in the car. It helps if it is a car with a combustion engine, it helps to reduce the fuel consumption and that means a reduction of CO2 emissions. And if you look at a pure electrical car, be it fuel cell or be it a battery electrical car, it enlarges the range that you can drive with the car. So this is a major topic for our customers since 20 years.

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Thomas Jessulat, ElringKlinger AG - CFO & Member of Management Board [58]

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Question number two on the working capital, the first step that's important for me to get below the 30%. This we have accomplished and I would stick here with the outlook that we have given that on an annual basis, we want to get to a successive improvement year-over-year. So there is some short-term possibilities that we have and there is some long term, like I explained before in regard to contracts with suppliers and other items here, and therefore we want to be below this year's level in 2020, following the guidance that we have given you.

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Operator [59]

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(Operator Instructions) We have currently no further questions. I hand back to the speakers.

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Stefan Wolf, ElringKlinger AG - Chairman of the Management Board & CEO [60]

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Okay. Thank you very much for joining us and for posing your questions. We are working on improvements. We are confident that we achieve what we have told you today in our guidance. And we are more than happy to talk to you again in our conference call Q3, which is I assume in the beginning of November. And so thank you for joining us and have a good rest of the week. Thank you very much.

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Operator [61]

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