Edited Transcript of CON.DE earnings conference call or presentation 7-May-20 1:00pm GMT

Slide 4 is summarizing the current situation, starting with Automotive and Powertrain. With the market rebound in China having been very positive so far, our Chinese colleagues have been hard to work to normalize our production activities there, which now sits above 80%. We expect that sales there to reach prior year levels in May. And with the gradual lifting of restrictions in Europe and restarts by our customers, our European facilities are now more than 30% ramped up. In contrast, production in North America is commencing in synchronization with our customer requirements 2, 3 weeks later.

In terms of the supply chain, the ramp-up of activities in China and now Europe have so far been resilient. The volumes requested by our customers could and can be provided. However, with Europe continuing to ramp and the important North American restarts upcoming, we remain focused on ensuring supply chain integrity for critical components such as electronics and in specific regions, such as Southern Europe and Mexico.

Regarding R&D, we are not yet seeing that our customers are delaying major launches at present. And with the customer focus on our products for electrification and digitalization remain resilient even under current conditions, we are confident in the strength of our business prospects for the near and mid-term. However, based on this, there is only limited potential in the near term to reduce our R&D expenses.

Relative to Automotive and Powertrain, the market and volume improvement is progressing faster on the Tire side of the business. In China, production activities and replacement tire sales are already back to 2019 levels. Our recovery in China has been helped in particular by our strong presence in online channels, which we have built over the past years, with almost 1/3 now of our replacement tire sales in China conducted online.

In Europe, after the strong decline of the first weeks of April, we are seeing increasing consumer activity, both in the now reopened stores and online. And almost all of our tire plants have been restarted to serve the demand recovery.

In the U.S., tire production remains mostly idle. However, we expect a similar positive development of the replacement tire market as soon as the outlets are allowed to reopen and we restart our production.

In ContiTech, production in the Automotive OE business is currently at low levels, in line with customer demand. The non-OE part of the business was strong in Q1 and currently is running much better at more than 75%. However, certain business, including industrial, fluid and conveyor belt, are beginning to see signs of weakness from customers in energy-related markets due to low oil and other raw material prices, and the recovery might not be as strong as in the OE business.

With the environment expected to remain difficult for this and the next quarters, we remain very much focused on the priorities that we outlined back on April 1. Top of our list is and will always be the health and safety of our people. We have established protocols at all our facilities from offices to production plants that utilize the best practices throughout the Continental world, especially from China.

To ensure an adequate supply of personal protective equipment, we are repurposing some of our production capacity to produce masks for our own use. The second priority is sustaining our financial position through cost reduction and cash discipline, actually the main focus of our activities. I will cover this on the next slide. Managing the ramp-up of the supply chain is another important area of focus.

In addition, 2 important strategic initiatives remain firmly on our radar. The first initiative is the spin-off of Vitesco Technologies. Though we announced last week that we will be postponing the spin-off due to the current market environment, we continue to make arrangements to prepare Vitesco for a swift implementation of its spin-off as soon as market conditions and visibility improve. At the same time, we are balancing with the near-term needs, such as cost savings and the postponement of investments.

The second initiative is our ongoing structural program. Announced measures remain on track even under current circumstances. With regards to additional measures, we have decided to hold off announcement for the time being with one reason being the political environment. However, we are fully aware that any further measures must now consider the significant likelihood that end demand for cars may remain dampened not only in 2020 but also in the coming years. Thus, we are now considering an even more challenging mid-term market development in our planning and assess how it may impact specific products, technology and regions.

One potential consequence is that our current mitigation actions may be a basis for more permanent changes. Areas under review include longer-lasting measures to improve our cost structure and portfolio as well and sustainable reduction in capital expenditures. We expect to be able to provide you a more concrete picture later this year.

Continuing on to Slide 5, the examples of our current workforce costs and cash management measures. Since the shutdowns began, we have been actively managing our workforce. As shown on the chart on the left, as of the end of April, around 60% of our employees are involved in reduced time arrangement such as short-time work in Germany, unpaid leave or working time reduction. As our activities gradually ramp up again, the number of employees in reduced time schemes will decrease, but we will remain flexible with these agility measures to adapt to the dynamic situation.

The other major dimension is cost as this is closely tied to labor costs and programs such as short-time work that only came into effect in late March and early April. The effect on fixed costs in Q1 was minimal. Since then, we have put in tight — put in tight management controls on expenses, including travel, marketing and administration. Also, R&D processes and priorities are being substantially adapted to reduce costs without affecting scheduled commitments with customer projects. As one example, we are temporarily limiting our R&D on level 3 area’s activities for the time being. We expect these and other cost controls to continue for the foreseeable future and target at least 5% reduction in fixed costs for the remainder of the year.

We have also proactively implemented numerous cash management measures. Already in the first quarter, we were able to achieve a significant reduction in capital expenditures with spending down 26% year-over-year. It’s our goal to achieve at least 20% a decline in CapEx through the rest of the year by realigning cancellations or at least temporary postponements of investments wherever possible.

We also are actively optimizing working capital. In terms of inventories, elevated tire stocks from retail projects that started in March have been mitigated by production shutdowns, putting us in a position to have a lower year-on-year inventory figures in Tires in Q2. Strict working capital management also helps us lower receivables, more than payables versus the year ago period. Going forward, we will remain disciplined to closely align working capital with market development.

Continuing to the next subject. Slide 6 provides an overview of the cash flow in Q1. Though EBIT in Q1 was lower than in the prior year period, there was also a lower level of cash outflow for working capital, lower spending and inflows from the SAS joint venture divestiture. Putting these together results in a free cash flow generation in Q1, excluding like always acquisitions and carve-out effects of EUR 59 million, an improvement of over EUR 600 million versus the prior year. Financing cash flow was minus EUR 750 million due to the repayment of the EUR 600 million bond on February 5.

This leads me to the liquidity bridge shown on Slide 7. Considering the cash flow development I just showed and FX effect, cash on hand declined by EUR 815 million from year-end 2019 to EUR 2.5 billion at the end of March. Together with unutilized committed credit lines of EUR 4.3 billion, our total available liquidity was over EUR 6.8 billion at the end of Q1. Compared, again, the only near-term bond repayment of EUR 750 million in September, our balance sheet remains in a solid position. As a reminder, neither the credit lines nor other financial indebtedness are subject to financial covenants or rating triggers.

So this concludes the first part of the presentation, and I will now move on to a review of our Q1 performance and starting with Slide 8. Reported sales came in at EUR 9.8 billion, on the upper end of the bandwidth we provided on April 1. Excluding exchange rate effects of EUR 10 million and changes in the scope of consolidation, organic growth was minus 10.9%. Adjusted EBIT declined year-on-year by 51% due to lower volumes and increased depreciation and amortization expenses. The resulting adjusted EBIT margin was 4.4%. Special effects totaled EUR 51 million, predominantly related to restructuring as well as carve-out effects on the negative side and the sale of the SAS joint venture on the positive side. These factors weighed on net income after taxes, which came in at EUR 292 million as well as trailing ROCE, which came in at minus 2.6%. As already discussed, free cash flow, excluding acquisitions and carve-out effects, came in at EUR 59 million, a considerable improvement over Q1 2019.

Let me now move on to the performance by group sector, starting on Slide 9. The new reporting structure shown here has been in effect since the start of the year. As mentioned, group organic sales were down by 10.9%. This was mainly driven by Asia, which was down in reported terms by 23% and Germany, which was down 12% in reported terms. The organic sales decline was the predominant reason behind the year-on-year decline in the group adjusted EBIT margin from 8.1% to 4.4%.

With organic growth of minus 11.5%, Automotive showed a high outperformance of 1,350 basis points above global vehicle production. This figure was even higher for Powertrain at 1,600 basis points. This is, to a large extent, attributable to our regional mix since we are more exposed to Europe and North America, which together accounts for roughly 70% of revenues in both Automotive and Powertrain. Some inventory buildup at the OEM level may have occurred as well in Q1. These effects are not expected to continue in Q2.

Operating leverage using adjusted sales and adjusted EBIT in Automotive achieved 39%; Powertrain, 38%; and Rubber, 32%. For the group, it was 38%. Recall that the first quarter last year had a onetime benefit from the release of provisions for variable compensation. Excluding this effect, group operating leverage would have been around 36%.

I continue with a closer look at the individual business areas, starting on Slide 10 with Autonomous Mobility and Safety. AMS sales came in at just under EUR 2 billion, with organic growth at minus 11.6%. Weaker demand in China and Europe were the main reasons for the sales decline. Moreover, we had a deconsolidation effect of negative EUR 124 million from our Chinese HBS joint venture. Instead of being fully consolidated as before, the contributions of this 50-50 joint venture are now consolidated as equity.

However, our stake in the joint venture remains unchanged. In terms of products, ADAS contributed positively with solid volume growth for radar sensors. Driven by negative volume growth, the adjusted EBIT margin decreased by 380 basis points versus the year ago quarter. Operating leverage was at 38%.

With customers delaying their sourcing decisions due to market uncertainties, AMS recorded a respectable order intake of EUR 1.2 billion in Q1. The biggest order wins were related to electronics for active and passive safety applications.

VNI, Vehicle Networking and Information is covered on Slide 11. Organic growth at VNI was minus 11.4%, driven by lower volumes across all business units. Demand was particularly weak in the Chinese market. The year-on-year margin decline of 140 basis points is tied to lower sales. R&D increased mainly due to the final phase of 2 significant customer projects. On top of that, we experienced negative FX effect derived from electronics purchasing. These factors resulted in an elevated operating leverage of only 40%.

In VNI, we have solid order intake of EUR 2.7 billion, including more than EUR 1 billion of orders from multiple OEs for connectivity systems solutions.

I will now cover rubber technologies, starting with tires on Slide 12. Organic growth in the Tire business area was minus 12.2% versus the year-ago period. In line with the markets, we saw double-digit sales decline in OE and replacement for both PLT as well as CV. Volumes in Q1 came in at minus 11.7%, driven by negative OE demand as well as lower replacement volumes. Price/mix was at minus 0.5%, a positive mix effect from a higher share of UHP tires could not compensate for negative pricing primarily related to OE. FX and consolidation effects were minor.

Lower volumes were the main reason behind a 410-basis-point decline in adjusted EBIT margin to 10.6%. There also was a slight raw material tailwind, but this was partially offset by inventory valuation effects. The margin was negatively affected by underutilization and ramp-down costs in March. We expect another cost burden associated with ramp-ups to occur in Q2.

Moving on to ContiTech, Slide 13. The downturn in vehicle production led to a decrease in organic sales in the OE business of 12%, while industrial and aftermarket was only down 4% like-for-like. Combined, organic growth was negative 8.1%.

Please note that Q1 2020 reported sales also includes EUR 84 million from the Cooper AVS and Merlett acquisitions. Despite these headwinds, the margin increased year-on-year by 60 basis points to 8.1%. The profitability impact from negative volumes was more than compensated by the positive effect of the margin enhancement measures, which we already discussed in previous calls. Operating leverage, therefore, was thus only 1%. Further plant margin enhancement actions will be implemented in this and in coming quarters.

Last but not least, let me cover the business area Powertrain, Slide 14. Sales of EUR 1.8 billion were organically 9.1% below last year’s figure. The decline was mainly driven by lower demand for ECUs and hydraulic and mechanical components. In contrast, demand for emission control systems was stable. The electrification technology business unit, formerly known as HEV, experienced robust growth for its electrification product, most notably for the EMR3 E-Achsantrieb. This helped ET achieved sales almost 60% higher than in the prior year.

The adjusted EBIT margin of 0.7% was down 320 basis points from Q1 2019. The volume decline was partially mitigated by cost savings, especially labor costs, as the number of employees in Powertrain declined year-over-year by 8%. Operating leverage was at 38%. Excluding ET, the adjusted EBIT margin for Powertrain would have been 5.8%, and operating leverage would have been around 30%.

Order intake of EUR 1 billion was held back by delaying sourcing decisions from major electronics and HEV projects. On the positive side, we saw healthy order book growth for emissions control, including a multimillion order for EMICAT, Vitesco’s innovative exhaust gas after-treatment solution, which has demonstrated capability to lower NOx emissions from diesel vehicles by at least 40%.

And this leads me to the conclusion of today’s presentation, a short summary shown on Slide 15. Group organic growth was down 10.9% in Q1, which was better than the underlying markets. Our operating leverage at a group level of 38% was satisfactory, given that most of our mitigation measures were only put in place towards the end of the quarter. These actions will help us weather the unprecedented negative market situation in the current quarter.

Looking forward, the health and safety of our employees naturally remains a high priority. Our main focus in the short term is maintaining our solid financial position through strict cost and cash discipline and the successful ramp-up of global supply chains. The mid-term focus is on the Vitesco spin-off, the implementation of our ongoing structural program and the definition of further measures, considering a potentially more challenging post-corona market environment.

With this, I would like to end today’s presentation and open the line to your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We’ve received the first question from Tom Narayan of RBC.

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Gautam Narayan, RBC Capital Markets, Research Division – Assistant VP [2]

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Tom Narayan, RBC. So in your prepared remarks, you noted that there was some OEM inventory buildup that happened in Q1, that is not expected to continue in Q2. This likely contributed to the strong outperformance you saw in the quarter. Should we expect some underperformance perhaps though in Q2? Presumably, the OEMS now have components not yet assembled. Also, where was this inventory buildup specifically? I would think just-in-time components might not be in this, but perhaps some of your electronics or technology products requiring longer lead times.

My next question is could you discuss the raw material impacts at Tires, particularly with respect to Q2? And finally, can you discuss the long-term impacts that the COVID crisis could have on your autonomous endeavors? Presumably, this could impact share transport negatively, but arguably, you could still do autonomous in private car form.

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [3]

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To start with the inventory buildup, we have seen it on 2 dimensions. One was just an overall inventory buildup of finished cars, which we observed in the U.S. I think there was a 5% inventory increase from February to March, which is probably something where we had a level of effects, which might — and this is your following question, which might impact then the ramp-up phase because this buildup in inventories at the ramp-up phase will probably be used. So this is a smaller effect, which we might see in Q2 when the ramp-up is finally starting, but it should not be too big.

For the rest, we have — we — I mean we don’t know one by one, but we suppose there was some inventory buildup specifically at electronic components. And our OE customers, probably more in Europe than in other areas of the world, which actually we appreciate not only because sales in Q1 were partly supported, but because those are the components which might be the most difficult one to make sure an orderly ramp-up, and the order supply chain can be guaranteed. And if we have a little bit of more reserves at the customers in this regard, this is, I think, only positive.

For the raw material in Tires effect in Q2, I don’t want to specify a number. It is still valid, but this is more, obviously, for a total year number than the quarterly effect, which is as well influenced by P&L effects of this. That $10 reduction in oil price for us had a EUR 50 million cost — positive cost effect. And this number, which we, I think, discussed sometimes as well in these calls is a number, which is still true. And this could, for the total year, be a gross effect, which we have always open question how much of that finally is passed over to the consumer via price changes.

The long-term impact of autonomous driving, I think it is too early to discuss any structural changes in autonomous driving. As a result of this coronavirus topic. At the moment, we are concentrating on cost reductions, short-term cost reductions. We don’t see — we don’t have any discussions with customers right now in these first 4 months of this crisis about a structural change in their product offerings over the next years. We don’t observe that actual programs are going to be changed, giving an indication in any of this direction. And when we talk about delays of orders coming in from our customers, then we don’t see this again as structural, but it seems to be only that the orders are somewhat delayed either because of the sourcing decision because of other priorities are delayed or because there seems to be an intention to probably delay the one or other ramp-up instead of 2022 somewhat later. But nothing of it is giving any sense of intention to — specifically on autonomous driving, having a structural change in the product offering.

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Operator [4]

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The next question is from Thomas Besson of Kepler Cheuvreux.

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Thomas Besson, Kepler Cheuvreux, Research Division – Head of Automobile Sector [5]

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Thomas Besson, Kepler Cheuvreux. I also have 3 questions, please. First, I’d like to start with the free cash flow ambition and the reasoning behind paying a dividend. What do you think about paying a dividend from here? I understand you’re not giving guidance for the time being, but you’re suggesting you’re doing a lot to generate positive free cash flow. Could you confirm that and comment on the possible payment of the dividend in 2021?

The second question, probably more difficult. You announced a plan to reduce your workforce this decade, which seems outdated, as you’ve mentioned. Your workforce is almost at the same level 6 months ago, while global light vehicle production could be substantially below what we had imagined a few weeks ago for 2020, 2022. Could you comment about the right level of your workforce to bring down operating leverage?

And final question. Can you remind us your exposure to SUVs and pickups versus passenger cars in the NAFTA region?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [6]

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Free cash flow ambition. I understood this was more a question towards dividend payments expected in 2020 and ’21. For 2020, there will be the invitation for Annual Shareholder Meeting second week of July. It will be in June, mid of June. And our Supervisory Board, in the end, will make a recommendation for the dividend payment. And actually, I cannot comment more on that at the moment.

The second topic, the workforce reduction, I did not fully understand the question. Let me just see if in the room it was understood. Well, we are, at the moment, working and using all these short-term measures, which the legislations around the world are offering, which is short-term work — which is short-term working in Germany and other similar instruments in other countries.

We are completely on track with our restructuring measures, which we booked again, part of restructuring in the first quarter showing that additional agreements could be made. And these agreements will be affected throughout the year and will lead to a further workforce reduction. We — I mean I indirectly mentioned that we are as well considering to add to the program, which we are having. We had already announced this before. We are now even taking into account, obviously, potentially different market conditions. Add to that, this is right now not the right time to announce this as we are specifically in Germany’s discussion as we are receiving short-time work aid from the state, but definitely there have to be announcement to further proceed on this way in the course of the year, as I mentioned.

Our share of the SUVs and pickups in the U.S. is below the market average. Our share is lower of SUVs and pickups in the market shares.

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Operator [7]

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Then we’ll go to the next question that is from Henning Cosman of HSBC.

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Henning Cosman, HSBC, Research Division – Analyst [8]

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It’s Henning from HSBC. Wolfgang, I heard you on Bloomberg television earlier today. And I hope I understood you right when you said it’s going to take you a few more weeks rather than a few more months before you know when you’re going back to normal and what normal means.

So I was hoping you could just elaborate on that a little bit and help me understand what makes you realize how quickly and to which level you can go back to in the next few weeks?

Again, I hope I understood you right, but — and I’m just wondering what gives you the confidence that this short time frame over the next few weeks is good enough to understand more the direction of trouble? That’s the first question, please.

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [9]

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I’m not sure that was the intention of what I said, or I’m sure this was not the intention. The message was more that at the moment, we are even having problems to basically predict the next 2 weeks of our sales volume. And the message was more, it will at least take longer, at least some weeks before we get some more clarity on this, and it will take probably even longer to get an idea about the year 2020 and specifically year ’21, ’22. There are many important drivers there. There is the question of potentially incentive programs in some world regions. There is always the question and the risk of the coronavirus having a second impact, and I think it remains to be seen.

So I don’t want to give the confidence that Conti there is in any other position than anybody else. It remains to be seen how the markets develop. It is even hard to predict when we finally have a knowledge of how the markets are going to develop.

We work with scenarios, as I guess you are doing. And obviously, we notice the scenarios and the most probable outcome, which IHS is seeing. And this might be one scenario. We are working as well with numbers above and below that for this year. And actually, we don’t feel in a position to put any of these scenarios with very high significant probability versus the others as a basis for a guidance.

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Henning Cosman, HSBC, Research Division – Analyst [10]

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Okay. I understand. And the second question, I was hoping we could talk a little bit about the structural margin potential of the new Automotive divisions. Of course, the old restructuring plan or the margin enhancement programs, they were such that you would generate these savings by 2023. And I imagine this was to bring the structural margin potential back to 8% to 10%.

I was hoping you could maybe confirm that or talk a bit about what you’re seeing in the current order book and that, that is indeed the level that you’re shooting for by 2023. Of course, under considering that you need to bring the workforce, as you just described, and the fixed cost in a position to be able to achieve that.

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [11]

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I can confirm that this is our intention. I think the message was as well that this EUR 500 million might not be sufficient, and this is why we are in consideration and in quite concrete plans to add to this, which at the moment, has to be reconsidered, with the market knowledge of the next years to come. Again, we just discussed it. A little bit too early to note it. But the intention is still there, and this is our base for everything, which we are discussing about cost restructuring, cost reductions and as well order intakes, which has to assure as well that these numbers can be achieved.

Now this was the right understanding. This was our intention. This is our intention. Just the framework conditions are most probably changing, and there is a probability. But again, I don’t know yet. There is a probability that the volume numbers in 2023 might look different in our assumptions in half a year from now than we saw them only 3 months ago.

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Henning Cosman, HSBC, Research Division – Analyst [12]

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Okay. Great. And just finally, if I may, on the degree of outperformance in Q1 and underperformance — potential underperformance or degree of outperformance in Q2, I suppose there was also a strong element of regional mix to the outperformance because of the weight of the China revenue. So between what you described as a small potential reversal effect in Q2 from the stocking or over-ordering and the unwind of the regional mix, do you see a risk that you could underperform the global light vehicle production in the second quarter?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [13]

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The manufacturing, in the end, was regional, you’re rightly saying. And the 2 big regions now have 75%, Europe and the U.S. together 75% of our sales was. Their impact now on us is significantly stronger than our 13% sales share in China. And yes, the positive effect, which we have seen in Q1 might partly reverse in Q2 because we have this stronger effect of Europe and the U.S. Now if you take mathematics, I mean, this should not be a 1:1. Plus on the one hand side should not be the minus on the one hand side, but there would — should be some effect on that.

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Operator [14]

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The next question is from Gabriel Adler of Citigroup.

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Gabriel M. Adler, Citigroup Inc, Research Division – Assistant VP & Senior Associate [15]

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Gabriel from Citigroup. I’d like to start with the Tire division. And on Tire pricing, you mentioned the negative pricing was mainly related to OE where contracts are typically indexed to raw material prices. Could you expand on your pricing strategy for when we exit the crisis? Do you see an opportunity to win market share when demand recovers and that you’re preparing a promotion strategy for this to win market share?

And my second question is just around the supply chain. Because previously, you’ve spoken about securing the auto supply chain is one of the biggest risks of the current crisis. Could you update us on the health of the supply chain, in particular, that of Tier 2 and 3 auto suppliers and also your tire dealership network?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [16]

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Well, Tire pricing, actually we saw in Q1, we saw — if I look at the replacement tire markets, we saw stable pricing. This is true for Europe. This is true for the U.S., and this is true for China. We saw, in China, bigger shift in the distribution channels. The roughly 1/4 of online sales in the past moved to 1/3 of online sales, so significantly increased, obvious reason for that. But again, this for us is not decremental for our margin as Continental AG’s pricing is a little bit more aggressive. But on the other hand side, the overall cost to serve that channel for us is compensating — the lower cost is compensating for this somewhat more aggressive margin.

So from the pricing side, Q1, markets were running okay. And now we don’t have any indication that the following quarters should see stronger deviations from this Q1. But I mean, as already in some questions I answered, the visibility is limited. And at the moment, we are lucky to see, we are actually happy to see that in China, in April, it looks like we are at 100 — more than 100% to prior year even in retail sales. So people really seem to come back to the stores and get the tires. And if I just look here at Germany, you have now, if you want to go to our retail channel for goods and change your tires to summer tires, you have to wait 4 weeks.

So people are really running to the stores. And again, this is positive. If this is continuing, like we are now experiencing it for a couple of days in Europe and for some weeks in China, this should be a development, which is positive on pricing as it shows that demand is there and volumes are there.

Supply chain, Automotive, we are feeling — we are confident. I’d say we are confident that after — in China, we and the overall industry, but we managed to supply everything which our customers wanted, and this will continue in Q2.

The always most tricky parts are the electronics, partly as well due to ramp-up situations in Malaysia and other Asian countries where there are still lockdowns, which make it more difficult, but we feel in a good position to make sure that our customers get what they want. Managed up to now, there is no short-term shortage on the horizon at all at the moment.

And I think with all the efforts, big efforts which are done there to secure this, we should get out of this coronavirus crisis, hopefully, and most probably, from our point of view, with any disruption in the supply chain from Continental and as it looks as well from others.

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Operator [17]

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The next question is from Sascha Gommel of Jeffries.

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

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It’s Sascha from Jefferies. Also a few question from my side. And the first one would actually be on the spin-off from Vitesco. I’m curious what’s the reason to call it off now and rather put it at the vote at the AGM and then like tactically decide to spin it off. Because now my understanding is you would need to either call an EGM or wait for the next AGM to proceed. Is that correct?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [19]

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Yes, this is correct. And the main reason behind it is twofold. One, I mean, this is a young organization, not so experienced organization to put them on their own in an environment, which is extremely volatile. And as many risks in dealing with short-term, mid-term actions, I think, is something which we could not do. There are — starting from the managers, I mean, many people are in quite new in their position, organizational buildup, newly processes and newly — this is fine. If there is a more or less stable environment. In such an environment, this would be too risky. And secondly, very pragmatic financing cost at the moment for something like Vitesco would be significantly higher now than they had been only 6 or 7 weeks ago.

And as we expect that markets finally will normalize and it shouldn’t take too long, I think there is no reason to now agree to conditions, which probably are, I would say, significantly better or just back to normal before the corona crisis in some point in time.

And these were the 2 reasons why we said — well, I mean, the easier thing is probably even just to say we go for it, and we do it, and we put it on the market and let them cope with their financing and other costs in the future or now say, “Well, we stop it. We delay it.” Knowing that we have a history in this topic, which has already some turns. I mean what we said. Well, unfortunately, this one, we have to take this turn again. With the intention, as you rightly said, we will do it as soon as the market is ready for it, if the market is more — has more visibility. And then it is either an extraordinary Annual Shareholder Meeting, which we have to ask for or we would use the next Annual Shareholder Meeting. I think it’s set for April next year.

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

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Okay. And then my second question would actually be on your SG&A and R&D cost. SG&A has been flat year-on-year and R&D even higher despite, I think, EUR 1.2 billion lower sales of the group. I know some of it is driven by the carve-out. But maybe you can share some thoughts around Q2 and beyond Q2, how you can flexibilize the cost kind of below your gross profits?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [21]

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Well, CapEx was down 20% already in Q1. We expect to continue on this for the rest of the year. Now delaying the spin-off, by the way, should have the one other positive effect on CapEx could add to this 20% target. Obviously, it’s only delayed and is then something, which we will see next year but could support this year’s cash flow of the group. I think the other question was part of what’s to R&D.

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Sascha Sebastian Gommel, Jefferies LLC, Research Division – Equity Analyst [22]

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SG&A actually. Because R&D, I guess, is driven by the OEMs, more or less, but SG&A has been more or less flat year-on-year. And I was wondering, given that revenue is down so much, how you can flexibilize that going forward?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [23]

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Well, SG&A, partly driven by spin-off cost. Preparation for the spin-off, which, by the way, these preparations, we will continue to make sure that we are ready to spin off as soon as the market is there. And for the other SG&A cost, if you are referring to the Q1 report, we have had — in 2019, we have had a warranty release, which is now the other way around. And we have restructuring costs partly in that number. And this makes it looking that to be a stronger increase than it is if you adjust for those factors, it’s basically the sideway development.

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Sascha Sebastian Gommel, Jefferies LLC, Research Division – Equity Analyst [24]

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Okay. Perfect. And then my last question would be on the lessons learned from the China ramp-up. When you look at your production now versus before COVID, do you have a big impact on productivity or extra costs from the change of the production setup in either of the divisions?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [25]

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There is some, which is due to, in some cases, not many, so — but in some cases, change processes because just of health situations. It should not have an impact, which, in the end, is noticeably negatively affecting the group profitability.

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Operator [26]

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The next question is from Victoria Greer of Morgan Stanley.

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Victoria Anne Greer, Morgan Stanley, Research Division – VP [27]

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Just a few for me, please. Firstly, could you talk us through what changed between the — your first pre-announcement of the Q1 numbers and the second? Just to give us a sense really for how quickly things are moving around.

And then linked to that, could you talk a bit about the conversation that you’re having with OEMs right now on the restart? Clearly, you would usually have 6 weeks of call-offs, and that’s very good planning visibility for you. How are you dealing with what must be a much more fluid situation with the OEMs? You said in the end, the next couple of weeks are quite difficult to plan for. So could you talk us through what measures you’re taking there?

And then you’ve also obviously mentioned the drop-through in Q1. Should we think about that kind of high 30s level for the remainder of the year? Or should we allow for a little bit more benefit from the 5% fixed cost reduction that you’ve talked about?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [28]

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Well, the first announcement, which we did and then had to basically correct on the better side with the second announcement, the reason is quite simple. We were — beginning of April, we had 3 weeks behind us where the — basically, the numbers I got from our organization on a daily basis for each day and on a weekly basis, each week was always a little bit less than that — what they had expected the week before. So we were in a downturn, which actually the group did not have the experience wherein such an amount, suddenly, basically complete demand breaking down.

When I saw the numbers on the day before and we discussed what should we do as a preannouncement, we went on the more careful side because I said after this experience over the last weeks, there is a chance that these numbers, which we are seeing now will be downward revised in the next days from our people reporting. And this is why we went to this lower number. Actually, had I taken the numbers which we had on our table, this was quite close already to what we saw. So it was starting to stabilize already there. We were not fully trusting of the reporting. Sorry for that but…

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Victoria Anne Greer, Morgan Stanley, Research Division – VP [29]

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No, that’s really clear. And that’s kind of my question, right, because the whole thing on our side is kind of an unprecedented thing to think about you shutting down so quickly. So that’s very helpful.

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [30]

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The conversations on the restart, you know how we would never talk negatively about our customers, but it is not so easy to have an idea what we call out over the next 7 days or next 14 days will be as we have feeling that all of our customers just want to make sure that their supply chain is significantly filled.

And many of them seem to feel that it is more assured when they give us a little bit more optimistic numbers of the call-offs and what finally appears. And so it’s a very fluid number, which we are working with at the moment. And it is far from anything which I could give you as an indication how the sales in the next 4 weeks will be.

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Victoria Anne Greer, Morgan Stanley, Research Division – VP [31]

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And so — so from your perspective, I guess, thinking about people coming off short-term work and so on, it just means that you have to be very cautious about doing that. But also, I think the short-term work can be quite flexible as well, right? You can ask people even to come in for one more day.

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [32]

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It can be. That is right. And yes, we have to be — we have to keep maximum flexibility on the load of the factories and on each single product.

Third question was on the drop-through. We saw the 38% leverage in Q1. For the total year, I would assume something around 35%. Expect though that the Q2 is still a challenge because this will be the massive lockdown in the U.S. and Europe. This is, I think, in our history, probably an unprecedented reduction in sales as well. You saw the expectation which we have for the world car production. We won’t be too far away from that. And there, probably the leverage might be somewhat under stress before. Then in Q3 and Q4, it will be easier because then we come from a lower base and ramp up and go up to a higher base.

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Operator [33]

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The last question is from Tim Rokossa of Deutsche Bank.

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Tim Rokossa, Deutsche Bank AG, Research Division – Research Analyst [34]

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I would also have 3 questions, please. The first one is I hear you on the fixed cost cut, and I also hear you that you probably extend layoffs. But you were already quite busy going into this crisis with your strategic positioning, the restructuring plans, simply also the ongoing business, now you have the crisis on top, and it’s probably fair to say that the restructuring needs have amplified from here. When do you realistically have time to focus on cost cuts again and really strategically repositioning this group? That would be the first question, please.

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [35]

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Well, as I mentioned, we are continuing with all the discussions about the restructuring measures, which we have announced, which we call the transformation C program. And as this is done on a local basis, in the local production sites or the local region, only supported and backed up from central, there is time to discuss it, and there are the capacities to do so. And we have unchanged our program in place from the group to check what is done, what has to be done until when, and we are in time with all these negotiations and all these procedures.

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Tim Rokossa, Deutsche Bank AG, Research Division – Research Analyst [36]

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So you believe that realistically, this year, we will have a point in time where you come to us and talk to us about your targets, and then we will also start to see the first impact?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [37]

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This is our intention, yes.

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Tim Rokossa, Deutsche Bank AG, Research Division – Research Analyst [38]

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Okay. Then my second question, you spoke about an indication for the earnings, and we also spoke about an indication for the CapEx side. We didn’t really touch too much on working capital, the other major element in the very important free cash flow question. You say you will manage this tightly. Can you end the year with a tailwind from working capital realistically?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [39]

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If you give me the number of volume, which we see in December and January, I mean, this is the main indicator for our working cap side. I probably give the answer this way. Our intention and what we are doing now and what we are focusing on is now to keep the working capital quota on the same level, which we have seen in good years, plus a certain additional target in there.

But we want to make sure that at the end of each month and basically day, but each month and for you important at the end of each quarter, we achieve on the sales last — of the last month of this quarter and the sales of the next month following the quarter, which is obviously for the inventory is important, that there, we are on the same level and the same quarters, which we have had before.

So if you would — if you would ask me for a forecast for the working capital for this year, I mean, the first thing we have to provide is basically the sales level, which we achieved around the end of the year. And if then you apply the same working capital quota, which we have achieved in 2019, I think this is a very good indication, and this is our target.

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Tim Rokossa, Deutsche Bank AG, Research Division – Research Analyst [40]

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That’s very clear. And then as a final question, when I look at your outlook for the quarter, specifically about the replacement Tire outlook in Q2, is this the indication that you are getting now that some of the wider dealers are open anyway? You could have done some service before that. But is this the indication you’re getting from your European dealer network that it’s going to be sizably worse year-on-year than Q1?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [41]

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Sorry. Could you repeat that? This was just — we did not get it here.

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Tim Rokossa, Deutsche Bank AG, Research Division – Research Analyst [42]

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No problem. Is the indication that you are getting from your dealer network that Q2 replacement tire demand in Europe will be sizably worse year-on-year than it was the case in Q1? Or is that just your assumption based on the economic conditions that you assume?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [43]

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Well, we have the situation that in Q2, the big regions for us, Europe and North America, had this lockdown for the retail stores in April. And now this is in the U.S. and North America, it’s even partly in May. And only then this is going to be relieved. So this is the big chunk of our business in Tires in these 2 regions has the strong lockdown effect, which we saw in China in the Q1.

Positively is that there is obviously a strong recovery. As I mentioned, I don’t want to overstate it, but at least in the first days here in Europe, and we see it in the first weeks in China, the first half recovery back to precrisis levels. Obviously, Q2 still will have this strong burden of the first month of Q2, definitely April, where, in many cases, there were just no sales or only online sales, which is always the smaller part of the whole channel. But then it could well be that May and June are already recovering nicely. Is this answering your question?

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Tim Rokossa, Deutsche Bank AG, Research Division – Research Analyst [44]

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Yes, it does. Just on that side then do you — in many industries, there’s no pent-up demand. In Tires, I kind of would see a catch-up effect possibly because people in Western European countries at least change their tires typically after Easter. Is that something that you do see right now? So could we see a potentially very strong rush from retail customers into tires?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [45]

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Well, we have just a couple of days after the lockdown, so this is too early to say. Fair enough, we have to take into account that people were driving less in April in Europe. So there should be — just by usage of tires, there should not be a strong catch-up effect. People did not drive to work back and forth. They did not go on Easter vacation. So I don’t know. I wouldn’t go that far. Just take as a message. It seems to recover fast. And actually, I would like to have a more detailed analysis. So I’m not in a position to deliver this at the moment.

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Operator [46]

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

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Kai Alexander Mueller, BofA Merrill Lynch, Research Division – Associate and Analyst [47]

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Maybe the first one, actually on — following up from Tim on your Tire market. You’ve obviously said that you continue to have ramp-up costs in the coming quarters from your 2 plants in Asia and the U.S. Is that still the plan that they go online and start producing? Or have you changed any sort of plans in terms of the size that you’re starting to run there?

And then the second question is really on some of the pricing in the automotive division. Obviously, the volumes are significantly below what you were expecting and what you plan for and what you’ve agreed with, with the customers. We’ve heard in the media, VW has been quite outspoken that suppliers are asking for price increases. Is that something we are seeing across the board? Are you part of that? Or is it right now not the time to ask for better pricing to compensate for the lower volumes?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [48]

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Kai, this was a misunderstanding on this. When I used the word ramp-up, what I wanted to point to is that the actual existing production sites had to be ramped down. In Europe, our Korbach factory, which you know our factories in Eastern Europe, as it was in the first quarter in China in Hefei. And now they have to be ramped up again. And this process of basically closing down the production side, the old tire factories at a certain point of time were sitting idle and are now ramping up. This was the ramp-up cost, which I was referring to. So the efficiency in the first weeks of the production of our big tire plants worldwide is below the normal level, just because of this effect, ramp down, ramp up, go from basically 100 down to 0 and then move up back up to 100.

Secondly, pricing, it is unchanged too that we have clauses in our contracts with our customers, which allow for discussion about the pricing if intended volumes are not met, but this is never on a quarterly basis. It is always on the basis of sometimes lifetime of a product or it is on the basis of a certain defined number of years. And for us, regarding this contractual situation, at the moment, it is not the time to go to the OEs and ask for price increases because this time it’s only there when lifetime sales are closed or when a certain number of years can be added up and these numbers are not achieved.

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Kai Alexander Mueller, BofA Merrill Lynch, Research Division – Associate and Analyst [49]

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Okay. And maybe on the latest comments by the government. Obviously, there was a summit earlier this week regarding potential incentive programs. Is there something you can share? Or is something that has been shared also with the suppliers, how you get — how you prepare yourself and what do you think the likelihood is that we see something this summer?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [50]

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Well, we had — this was a discussion where the VDA, the German association of suppliers and OEs were discussing with the chancellery and other stakeholders involved. The discussion — the demand from the automotive industry, overall, the request was to put incentives in place similar to what we have seen in 2009 in Germany, where I think we have this EUR 6,000 was the number, which we had, which significantly increased the volumes and helped for a sharp ramp-up back to a more normal situation. And this was the request of VDA.

Now there was discussion starting where, obviously, other people said, well, it has to be more targeted towards certain emission reductions or certain technology, does it have to be combined with you only get this incentive if you give back an old car with better technology emission ratios and so on. And the outcome finally was that there was not one main trade in the discussion that it will be another meeting in about 4 weeks where a design of such a program should be outlined, including the interest of the different stakeholders of this topic.

This is probably not the best outcome in such a discussion because we all know when people are getting aware and the German population is aware of this discussion, it is not too much supportive for selling cars in the next days. People tend to wait, and we hope that there might be an incentive program. So remains to be seen. Hopefully, the discussion is finalized very soon with then the one other incentive for Germany. As by the way, we see as well the one other incentive in China, which helps there to get the automotive industry ramped up.

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Operator [51]

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The last question is from Pierre-Yves Quemener of MainFirst.

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Pierre-Yves Quemener, MainFirst Bank AG, Research Division – Director [52]

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Two questions left for me, please. I appreciate that the dividend decision is in the hand of the Supervisory Board. But has the views of the management board changed in any way regarding the dividend proposal? Would you today show more moderation in the view of the current difficult environment for the dividends that would be paid in 2020? First question, please.

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [53]

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The Executive Board has given its recommendation in December, 13th of December, and now leaves it in the hands of the Supervisory Board, where, as you know, there is a representative even — 46% of our shares are even represented in our Supervisory Board.

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Pierre-Yves Quemener, MainFirst Bank AG, Research Division – Director [54]

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Okay. Second question, more specifically on ContiTech, please. The efficiencies that have kicked in, in the first quarter were probably in the magnitude of EUR 25 million to EUR 30 million at the EBIT level. Please correct me if I’m wrong, for my assumptions. Do you expect the same kind of magnitude of tailwind in the coming quarters for ContiTech?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [55]

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This is in line with our expectation of this cost reduction program, which we initiated 15 to 18 months ago. And as we said, the outcome is to be expected in 2020 and ’21, and this is what we see now. And then it was, as I mentioned, helped by strong industry business.

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Pierre-Yves Quemener, MainFirst Bank AG, Research Division – Director [56]

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Okay. Last one, if I may. Do I understand correctly that you will update investors and the community on the cost-cutting plan for the whole group in 2020, not in 2021, in your new fixed cost initiative, et cetera?

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Wolfgang Schäfer, Continental Aktiengesellschaft – CFO & Member of the Executive Board [57]

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Yes, this is what we intend. You rightly understood that. This is what we intend. And the only thing we have as main unknown at the moment is how the markets are going to be and how much we probably have to add to achieve, as we discussed before, these margin targets for the Automotive group and for Vitesco, Powertrain and for the Rubber group. Yes.

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Operator [58]

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There are no further questions. I would like to hand back to you.

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Bernard Wang, Continental Aktiengesellschaft – Head of IR [59]

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Thank you, operator. And thank you, everyone, for participating in today’s call. As always, the IR team is available if you have any remaining questions. And goodbye, and most importantly, please stay safe and healthy. Have a good day.

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Operator [60]

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