Volkswagen's (VLKAY) Q2 2016 Results - Earnings Call Transcript

| About: Volkswagen AG (VLKAY)

Volkswagen AG ADR (OTCPK:VLKAY) Q2 2016 Earnings Conference Call July 28, 2016 8:30 AM ET

Executives

Oliver Larkin - Senior Manager of Investor Relations

Frank Witter - Finance and Controlling

Fred Kappler - Head of Group Sales

Analysts

Tyndall - Citi

Arndt Ellinghorst - Evercore

Stuart Pearson - Exane BNP

Horst Schneider - HSBC

Patrick Hummel - UBS

Harold Hendricks - Morgan Stanley

Kristina Church - Barclays

Charles Winston - Redburn

Daniel Schwarz - MainFirst

Jose Asumendi - JPMorgan

Sascha Gommel - Commerzbank

Frank Biller - LBBW

Tim Rokossa - Deutsche Bank

Michael Punzet - DZ Bank AG

Christoph Rauwald - Bloomberg

William Boston - Wall Street Journal

Christiaan Hetzner - Automotive News Europe

Operator

Good day, ladies and gentlemen, and welcome to Volkswagen AG Live Audio Webcast and Conference Call on the Results January to June 2016. For your information, today’s conference is being recorded.

At this time, I would like to turn the conference over to Oliver Larkin, Head of Group Investor Relations for Volkswagen AG. Please go ahead, sir.

Oliver Larkin

Okay, thank you. And ladies and gentlemen, welcome to Volkswagen’s conference call on the results for the period January to June, based on the Adhoc release we published last week on 20 July and the interim report we published this morning.

For today’s conference call I’m joined once again by Frank Witter, member of the Board of Management, Volkswagen AG, responsible for finance and controlling and Fred Kappler, Head of Group Sales, Volkswagen AG. You can follow today’s webcast via our website, where you will also find the charts available for you to download.

Following the presentation, we will take questions first from analysts and later from journalists.

Let me now hand you over to Frank.

Frank Witter

Thank you, Oliver. And warm welcome to all participants of this call. The Volkswagen group delivered a solid performance in the first half of 2016. Despite the challenging market environment and ongoing impact from the diesel issues, our deliveries to customer which include the Chinese joint venture increased by 1.5% versus the previous year to 5.1 million units.

Our sales revenue of €108 billion just short of the comparable first half 2015 number has continued to be characterized on the one hand by an improvement in Western and Central Europe. On the other hand, we have seen a continued retraction in South America particularly in Brazil as well as in Russia.

Developments in our Financial Services business and a better mix were positive drivers, while foreign exchange developments burdened our revenues.

Operating profit before special items increased in the first half of the year robustly to €7.5 billion up 7.5% compared to the same period of 2015 corresponding to an operating margin of 7% and demonstrating the strength of our underlying business.

Special items now totaled €2.2 billion for the first six months leading to an operating profit after special items of €5.3 billion. We will of course give further detail on those items later in my presentation.

The Chinese market grew substantially in the first half, in part due to the ongoing benefit from the lowering of purchase taxes for cars below 1.6 liters. The challenging competitive environment as well as the relative weakness of the renminbi to the euro impacted the proportional operating profit from the Chinese joint ventures in the first six months, which amounted to €2.4 billion.

The full at-equity result, mainly driven by the Chinese joint venture came in below the comparable period for the previous year - in the previous year at €1.7 billion. Automotive net liquidity ended the second quarter strongly at €29 billion ensuring a secure platform to manage our future liquidity needs.

The receipt of the major portion of dividends from our Chinese joint ventures of around €2 billion was an important driver here as well the proceeds from the sale of LeasePlan in the first quarter.

In summary, despite challenging market conditions, we remain fully on-track and are sticking to our earnings guidance for 2016. We will discuss the financial results in detail in a few moments after Fred has taken you through the market context and our sales performance.

Fred Kappler

Ladies and gentlemen, I also would like to extend a warm welcome to our conference call day. The presented chart shows the half-year growth of the world car market and Volkswagen Group deliveries to customers of our passenger car brand compared to the same period of last year.

The global car market continued to grow at a moderate pace in the first six months. Key drivers of this positive development were Western Europe, China and the United States. Nevertheless, the continuing economic and political instability in Brazil and Russia still significantly burdened the overall car market.

Despite the challenging circumstances, the Volkswagen Group remained on its growth path in the second quarter 2016 and thus increased the pace compared with the first quarter. The Volkswagen passenger car brands achieved in the second quarter at sales volume on the same level as in the first quarter of this year, while our brands Audi, Skoda and Porsche continued on the growth path.

All-in-all, for the first half, the Volkswagen Group grew car deliveries to customers by 1% throughout the world over the corresponding period of the previous year. Overall, this demonstrates that our business model with a broad portfolio for attractive brands and products combined, with a strong financial services business is proving its value for our customers.

Let me now comment on the performance of the Volkswagen Group in direct comparison to the car market development around the world during the first six months of this year. In the North American market in particular, in the United States, pick-ups and SUVs continued to be in high demand.

While Audi and Porsche recorded growth in this region, deliveries for the Volkswagen passenger car brand fell, due to a limited participation to the SUV market growth, the discontinuation of sales of diesel models and a decline in the fleet business. Overall, the deliveries of the Volkswagen Group were below the previous year.

In Western Europe, the passenger car market grew versus the same period of the previous year. This growth was partly driven by the positive development of the small SUV segment. Despite of the diesel issues, the Volkswagen Group car deliveries to customers increased during the first half of the year.

Central and Eastern Europe presented the mixed picture, while markets of Central Europe such as Poland and the Czech Republic remained on the growth path, Russia continued to feel the effect of the weak economy. In contrast, to the overall negative market trends in this region, the Volkswagen Group increased its sales in the first half.

The steady growth in the Asia-Pacific region since the beginning of the year continued. The main impetus came from China, where on the one hand takes reduction for vehicles with engine no larger than 1.6 liters contributed to this growth but also budget price entry-models, especially into SUV segment grew strongly.

In the first half of 2016, the Volkswagen Group also posted considerable growth on the levels of the market. The general market condition in South America remained strained and demand deteriorated further. This trend is mainly a result of the tense economic and political situation in Brazil.

The revenues of the Volkswagen Group were also affected by falling demand and could not match the prior year level.

The following chart shows the year-to-date performance of our Volkswagen Group brand. End of period to June, 5.1 million passenger cars and commercial vehicles were delivered by the Volkswagen Group worldwide, representing an overall increase of 1.5% over the corresponding period the previous year.

The Volkswagen passenger cars brand handed over 2.9 million vehicles to customers in the first six months of 2016, almost matching the prior year level. We were particularly pleased with the development of sales in Eastern Europe and in Asia-Pacific especially achieving the best half-year results in China.

Despite a continued stable development of the brand in the second quarter, the trend in South America and the already mentioned situation in United States reduced growth. Furthermore in Western Europe, the situation of the diesel issue had in some markets a slight effect on sales and resulted in the level of 1% below the previous year in this region.

With around 953,000 units, Audi increased its sales since January by around 6%, growing in all main regions. Worldwide, especially in the new models, Audi A4 and Audi Q7 pushed the sales performance.

Skoda increased deliveries by almost 5% of good momentum in China, in Germany and India, home market Czech Republic. In particular, the new Superb is enjoying high customer demand. In the first six months of the year, SEAT deliveries of 217,000 vehicles remained at the previous year’s level also recorded an increase of over 3% to 118,000 deliveries to customers.

Growth during the first half of this year was mainly driven by the models Cayman and Boxster. Year-to-date Volkswagen commercial vehicles delivered 239,000 vehicles to customers worldwide, a growth of 7%. An essential contribution to this sales result was a renewed T-Series with its Transporter, Caravelle, Multivan and California derivatives.

In terms of trucks, the total market above six tonnes increased slightly due to high demand in Western Europe and China. Nevertheless, the adverse situation in South America and Russia, and also in the Middle East continued to burden the truck market as a whole.

MAN handed over 49,000 trucks and buses to customers. Despite an increase in sales in Western, Central and Eastern Europe, the unfavorable development in South America and Middle East have led to a decline in deliveries by 1%.

Scania sales results grew by 9% to 40,000 units due to high demand in Western as well as Central and Eastern Europe. The order books at MAN and Scania of the first half-year remains stable at the previous year’s levels despite difficult overall conditions.

Sales in power engineering by MAN decreased by around 8% and reached approximately €1.7 billion. Overall, we expect that the deliveries of the Volkswagen Group in 2016 will be slightly above the last year.

Last but not least, let me now introduce to you a few model highlights which have been extremely well received after the market launch of this quarter and for which we have high expectations.

From this month onwards, the new made-for and made-in India, Volkswagen Ameo is available, the first sub 4-meter sedan by the brand. The Ameo is equipped with several segment first features and offers the best of technology and safety standards packaged at an attractive price.

Launched in June, the new Audi Q7 e-tron Quattro is as sporty as it is comfortable and at the same time particularly efficient. In all-electric mode, it has a range of up to 56 kilometers while producing zero emission. This is world’s first plug-in hybrid with a V6 TDi engine and Quattro drive. In every field of technology, it showcases Audi’s high-tech competence.

The brand new Ateca by SEAT is the perfect car for everyday urban life as is outstanding off-road capability. SEAT’s first SUV launched last month offers best-in-class functionality thanks to its boot capacity, comfort orientated interior space and innovative assistance systems for safety and for comfort.

Porsche introduced in April, the latest generation of its mid-engine Roadster and Coupe featuring more power, greater fuel efficiency and further improved handling. The centerpiece of the Boxster and Cayman is the newly developed turbo-charged flat 4-cylinder engine combined, with a more striking and athletic appearance as well as high-end features.

Oliver Larkin

Thank you, Fred. Now, let’s turn back to Frank for a look at our financial performance in more detail.

Frank Witter

Thank you. And I will start with our Group performance before moving on to discuss our brands in more detail.

For the first six months of 2016, sales revenue for the Volkswagen Group at €108 billion came in marginally below the comparable period of 2015. Better mix and a good performance from our financial services activities with a main positive contributors. Despite difficult market conditions in South America, our truck business continued its positive development. The continuing currency headwinds had a negative impact of €3.2 billion.

Operating profit before special items for the group was up 7.5% to €7.5 billion. Considering the substantial foreign exchange headwind of about €1 billion off the hedging, this is a solid result helped by good mix development.

The operating margin before special items of 7% was above the range of our full-year guidance, also driven by seasonal effects as the second quarter is typically our strongest, should be noted that tough challenges remain.

Special items of €2.2 billion reduced. We reported operating profit to €5.3 billion. Within our financial results, the earnings for entities consolidated at equity mainly the Chinese joint ventures came in at €1.7 billion. The Chinese market grew substantially in the first half of this year in part due to the lowering of purchase taxes for cars below 1.6 liter as Fred just commented.

However, the challenging competitive environment and the FX development impacted the reported earnings so that the Chinese portion of operating profit in the first six months amounted to around €2.4 billion, 14% below the comparable period of last year.

The other financial results came in negative at around €2.2 billion. This resulted from the present value effect by applying lower interest rates on even higher provisions. Further effects came from the recognition of negative fair values of derivative financial instruments and some other items. Group profit before tax of €4.8 billion equaled at 4.5% return on sales.

Moving on to the detailed analysis of the group’s operating result performance for the first six months. Over this period, the position volume mix prices in the passenger car segment reported a plus of around €1.1 billion with mix as a key driver.

Negative exchange rate effects of around €1 billion driven by the currency development in countries such as Argentina, Brazil, the U.K., South Africa, Russia, Mexico and Turkey had an adverse effect on the operating results.

Product cost savings showed further good momentum with the performance of around €1 billion mainly as a result of our efficiency programs, the hard work from our purchasing teams and the tool-kit rollout. You can be rest assured that we continue to fight for every euro.

Fixed cost and start-up cost rose at a lower rate by around €0.8 billion. As the year progresses, fixed cost will continue to grow while product cost savings I expect to at least compensate for the impact.

Earnings in our commercial vehicles division rose by €0.2 billion on the back of the good sales performance particularly in Europe. Our power engineering division came in flat compared to last year. While earnings roughly, higher by €0.1 billion, our financial services division maintained its good performance. In total, operating profit was €7.5 billion for the first six months before special items.

The increase in special items to €2.2 billion for the first six months related mainly to legal risks, predominantly in North America. The increase in the provision for known risks relating to the worldwide diesel issue in the first half was €1.6 billion, while that’s the total diesel provision now amounts to €17.8 billion.

A new provision relating to the Scania anti-trust proceedings of €400 million has been booked for the second quarter. Scania has fully cooperated with the European Commission. However, Scania contests the Commission’s view and will exercise its rights of defense in the ongoing investigation.

Also included in special items are undefined charges relating to the Takata airbag issue and the restructuring of truck activities in South America, which together come to around €0.2 billion.

Turning to the brands in more detail. The operating profit before special items of the Volkswagen passenger car brand decreased compared to the prior year. The challenging North American market and ongoing difficult market conditions in Russia and South America, negative exchange rates, lower volumes and higher distribution costs as a result of the diesel issue had a negative impact.

These effects were partially offset by the positive effects of our efficiency program. Nevertheless, the second quarter improved significantly to €0.8 billion, giving a total of €0.9 billion for the first half of 2016.

With regards to the full-year expectation, many challenges remain for the second half of the year. We continue however to aim for an operating margin for the full-year of 2%.

Audi’s operating profit before special items came in at €2.7 billion, slightly below the comparable period. The unfavorable exchange rate environment as well as the high competitive intensity in certain segments in regions had a negative impact. The operating result was also burdened by the high outlays for the models and technologies as well as the expansion of its international production footprint.

The operating results at Skoda centered around €0.7 billion, significantly 31% up year-on-year. The excellent result which continued to progress seen in the first quarter was mainly driven by positive mix effects, optimized product costs as well as a good market acceptance of the new Superb, Octavia and Fabia.

SEAT results also improved on the back of successful new products. Bentley reported a loss mainly due to challenging market conditions and negative exchange rate effects. As the worldwide rollout of the outstanding Bentayga starts to come through, we expect to see an earnings improvement.

Porsche delivered an increased operating profit of around €1.8 billion, an improvement of around 8% driven in particular by continued sales growth.

The operating result of Volkswagen commercial vehicles increased mainly due to a better mix as the popularity of the Multivan and Transporter and the Caddy.

Increased sales revenue particularly in Europe coupled with an improvement in mix, more than compensated for lower sales in South America, Russia and Turkey, leading to an increase in operating profit at Scania.

Since January 1, we now report MAN’s business area separately within our brand analysis. So, let’s start with the MAN commercial vehicles. The earnings were negatively affected by the higher exposure to the collapsed Brazilian market. Despite this, earnings improved significantly as European sales continued to grow. MAN power engineering earnings were down on the prior year due to lower revenues.

The other line contains mainly internal postings especially the elimination of intra-group transactions. These items can very strongly over the quarters, also due to currency as can be seen looking back over the recent years.

The significant variance between the first half of this year compared to the prior year was mainly due to currency effects which boosted the intra-group eliminations in 2015.

Volkswagen Financial Services had another strong quarter and grew earnings once again to around €1 billion while the full financial services division reported earnings of €1.2 billion.

Turning now to the cash flow in the automotive division. Operating cash flow from the division over the first six months was below the prior year at €9.7 billion. The decrease was mainly driven by the lower dividend from our Chinese joint ventures and higher tax payments.

CapEx was slightly lower in absolute terms over the first six months at €4.5 billion, while the CapEx ratio remained flat at 4.9%. At €2.6 billion, capitalized development costs were above the prior year by 19%. This was due to our continued focus on the development of more environmentally friendly vehicles, effects from important volume products that are coming to market in the upcoming months and the shift products to electrified power trains.

In summary, supported by the sale of our interest in LeasePlan as we reported on the last earnings call and the partial receipt of dividends from China, net cash flow for the first six months came in at positive €5.1 billion.

Net liquidity in the automotive division stood at a strong €29 billion at the end of June. This gives us a secure platform to manage our future liquidity needs and in particular enables us to manage the upcoming outflows due as a consequence of the diesel issue. These outflows are expected to occur between the autumn of this year and 2018.

We continue to maintain a solid and robust balance sheet that will enable us to face successfully the challenges in the months ahead.

So, turning to my last slide, with our outlook for 2016. We expect that on the whole, deliveries to customers of the Volkswagen Group in 2016 will be slightly above the level of the previous year supported by growing volume in China. However, challenging market conditions will persist.

In addition to the diesel issue, the highly competitive environment as well as interest rate and exchange rate volatility as well as fluctuations in raw material prices all pose challenges.

We anticipate further positive effects from the efficiency programs implemented by all brands and from the modular tool-kits. Depending on the economic conditions particularly in South America and Russia, including the exchange rate development and in light of the diesel issue, we continue to expect the full-year 2016 sales revenue for the Volkswagen Group to be down as much as 5% from the prior year’s figure.

We also continue to maintain our outlook for the underlying operating business before special items where we expect an operating return on sales for the group of between 5% and 6% in 2016.

We have now added guidance for earnings after special items. We are expecting a clearly positive operating return on sales for the Group after special items. However, this will be outside of the corridor for earnings before special items.

Ladies and gentlemen, in closing, allow me to remark that despite the diesel issue and the difficult market conditions, we have achieved a solid result. However, it should not be forgotten that in order to be able to absorb the significant burden on the diesel issue, huge further efforts are still required.

Nevertheless the Group result for the first half of this year provides a solid foundation and that together strategy 2025 can build on so that we can achieve our aim of becoming a world-leading provider of sustainable mobility.

Oliver Larkin

Thank you, Frank. We will now take questions from investors and analysts. And as always we’ll keep time towards the end for questions from journalists. So, operator, please over to you.

Question-and-Answer Session

Operator

[Operator Instructions]. And we can take our first question from Mike Tyndall from Citi. Please go ahead caller. Your line is open.

Mike Tyndall

Yes, hi there. It’s Mike Tyndall from Citi. A couple of questions if I may. Can we start with the incremental provision €1.6 billion for the diesel issue? I’m presuming some of that is the reversal of the FX tailwind you saw in Q1, but what I’m curious to know is you gave us a split when you gave us the first 16.2 in terms of the various components.

Can you give us that if we assume that there’s €1 billion incremental, I’m curious to know is that related to sales activities, is it related to the settlements, where is that money allocated to? And I guess that leads on to my second question which is around pricing.

Looking at the EBIT walk, it certainly looks like you had a significant tailwind in Q2 from pricing. Obviously, there’s mix in there as well. I’m just wondering to what degree that’s sustainable, how can you keep your dealers happy and be firm on pricing. I’m curious to know how that dynamic works going forward. Thanks.

Oliver Larkin

Okay, Mike. I think Frank will start with you, if that’s okay with the diesel question and we’ll switch over to Fred for the question on pricing.

Frank Witter

Yes, let’s start with the diesel issue. As we said it earlier we continuously evaluate the risks to our business and so that we certainly reviewed again the total situation. You are right to assume that some of the currency gains which amounted to roughly €570 million in the first quarter have been reversed around about €300 million so that we continue to have an effect of roughly €260 million on currency provisions - currency related affect here in the total amount.

The main driver for the increase relates to legal risks as we said, predominantly related to North America but not all of that. You will understand that we are not able to comment in more detail on the facts and figures behind that in order to not to compromise our position.

Fred Kappler

Okay. Coming to the second part of the question, pricing. Is there any tailwind from pricing, yes, we were able to have slight price increase as we could implement slight price increases in some markets like in Europe that was positive. On the other hand, we have a certain increase in the sales incentives driven by the market development, for example, Europe there is a tendency in the total market for higher incentives and of course North America we had to have certain increase in order to defend our market position over there. This is of course in the context with the diesel.

And so in total, if you combine prices and sales incentives, we have a stable situation. But whether this is an opportunity, whether we have let’s say positive development for pricing activity in the second half, it’s too early to say. We have to look how the market is developing. And on the other hand, we have also to look about some developments which are in the context of the Brexit or whether we have, how the developments are in the crisis markets like in Brazil and Russia, definitely there are no pricing potentials over there.

Mike Tyndall

Okay, thank you very much.

Oliver Larkin

Okay, thank you Fred. And the next caller please.

Operator

Yes, our next question now is from Arndt Ellinghorst.

Arndt Ellinghorst

Yes, good afternoon everyone. It’s Arndt Ellinghorst from Evercore. And two quick ones please. Firstly, when do you expect to present the full turnaround plan, and will you meet your budgeting route in order to finalize your target for that?

And then secondly, could you please clarify the 7% to 8% Group EBIT margin target that you presented a couple of weeks ago. The market was a bit confused whether this was a target for a normalized level of profitability that you target to achieve or whether it was the 2025 target? And if it’s more a normalized earnings level, could you give us some color by when you would expect to first be in that corridor? Thank you.

Oliver Larkin

Okay, thank you Arndt.

Frank Witter

Yes, hi Arndt. The 7% to 8% operating margin target relate obviously to our strategy 2025. As we have already said, we are planning to provide more details including brand level during the latter half of this year. So, we continue to stick to that time plan.

With respect to the full turnaround plan, I assume Arndt that you relate to brand Volkswagen passenger cars. And it’s no secret that here for an extended period now in detail discussion with the unions and the labor representatives on our future pact.

I’m not going to fall into this trap to comment on a project as critical like this while it is in process. You can rest assured that we all focus heavily on it so it’s not only the colleagues from the brand board but it’s the entire board. And it is an essential part necessary in order to meet the Group targets as we always said. So, as quickly as possible but it is a complex and ambitious process and project. Thanks.

Arndt Ellinghorst

Okay, I get that. Frank just to clarify, the 7% to 8%, is that a normalized level or will you first reach that in 2025?

Frank Witter

As we said, the milestones will also be of what we are going to communicate at the later part. Logically the answer is as quickly as possible. But give us the time to operationalize the targets on a brand level. Certainly when you have an extreme market environment, nobody achieves these strategic targets. So there is some normalization assumed but the bridge and the individual milestones will be part of what we communicate later.

Arndt Ellinghorst

All right, thank you.

Oliver Larkin

Okay, thank you. Operator, the next caller please.

Operator

And now our next question from Stuart Pearson, Exane BNP.

Stuart Pearson

Good afternoon. This is Stuart Pearson from Exane. First question is on China obviously relatively solid operating results, at least versus Q1. But the drop from the equity income weaker, so could you just comment on that financial results in the China JV, whether - what was going on there, whether there was a one-off or something we should expect to continue that would be helpful?

And then the second question just on residual values of particularly the VW brand, maybe you could just comment on how they’re developing both in the U.S. and Europe and both on new cars, particularly the residuals of the new cars you are selling today but also residual values of those cars in Europe affected or will be affected by the diesel vehicle, whether you’ve seen any particular moves there? That would be helpful. Thank you.

Frank Witter

Sure, hi, Stuart. Yes, as you rightly stated, in China, we achieved a strong proportion of operating profit of €1.2 billion in Q2. This was truly better than last year’s Q2. But what has happened is that the result from at equity accounted investment decreased by nearly €500 million.

So, what should be in general stated is that the equity result does not necessarily follow the operating result in the same manner. The result of our Chinese JVs, which is consolidated equity and our financial results, is influenced by the financial result and the tax rate. And it is really hard and sometimes impossible to compare on quarter-to-quarter basis because you have special items, particularly related to the financial result and tax payments for tax rate development.

And in addition, we are missing in the equity result from the sale of LeasePlan on a Group level. So, that is in summary the answer to China JV development. But let me also confirm that we very much appreciate the strong performance on an operating level in Q2.

Yes, I truly appreciate your question on residual values because there was also some press coverage that we have significant - that we would have significant losses and have a very grim outlook.

At various occasions, we confirmed to you that the true used car performance in all European markets continues to be strong. What I mean by that is, the moment we dispose cars, the prices are pretty much in line with the markets and with previous experience. So we don’t have residual value problem related to diesel in any one market.

The only exception where we are currently dealing with is the United States. Diesels on a stop sale, which means that there is basically no used car travel on diesel cars. We see little bit of a spill-over effect in the United States on gasoline. But everything is fully covered. And therefore we are quite comfortable.

So, the reserves which we started to put on the books and to incremental cushion which was picked up in the press related to scenarios which we were running in the fourth quarter last year so, right after the diesel issue, with the uncertainly not to know how the used car markets would react. So this is purely provisioning and conservatism which you I think very much appreciate from us over time.

But it has nothing to do with the true used car market performance which continues to be very strong particularly in the European markets. And what I describe for America is certainly over all the markets, the used car prices in the years are bit under pressure that’s true for everybody that you have a little bit incremental but nothing that I would describe to be us rendering.

So that is pretty much the situation. And we appreciate that fact because it’s very important for the used car business going forward and solid foundation. And it’s certainly something we monitor very carefully. We also explained to you guys at various occasion that we didn’t go crazy on incentives because incentives have a particular negative impact on residual values and we care about them because that is very important for particular brand Volkswagen the way it’s perceived by its customers.

Stuart Pearson

Thank you.

Oliver Larkin

Okay. And the next caller please.

Operator

Thank you. And now our next question from Horst Schneider. Go ahead caller.

Horst Schneider

Yes, thanks for taking my question. It’s Horst from HSBC. First of all, I want to ask a question on your guidance, because you keep that unchanged, but in terms of deliveries to customers you increased it a little bit, since you expect now slight increase in deliveries to customers. And I want to ask if you want to make the statement also for the units at ex-China.

So, if you strip out China, can you increase on a full year basis also in the rest of the world in your unit sales, and especially in H2? And then in that context, I want to ask what is the seasonality of the, EBIT this year. So, ifs the H2 EBIT should be above H1 or you expect it below H1?

And the second question that I have relates to the one-offs again, because you’re saying in your H1 report that you booked impairment losses in the amount of €600 million in H1, and I think that amounts for Q2 €500 million, I want to know if these impairment losses are included in the special items that you’re also providing or is it an issue that comes on top of that? Thank you.

Oliver Larkin

Okay, Horst, couple of questions. And first one about volumes, ex-China, and we want to touch on EBIT seasonality, first half, second half, and we’ll take a look at the impairments of €600 that you mentioned and whether these are held in special items. So I think we’ll start with Fred with the volume question.

Fred Kappler

Yes, our outlook for this year globally is that we are now in a position to forecast a slight increase. Of course mainly driven by the developments in China and in Western Europe, positive results to certain extent is Eastern Europe. Outside of China we have still the problem markets like Brazil. We have a weak development in Russia. We have the uncertainty about the effects of Brexit. And just recently we have to look very carefully to the developments in Turkey, Turkey is an important market to us.

Therefore I think we’re not in a position to forecast for the deliveries overseas outside China and increase for this year. Here we have to be very, very cautious about the developments during the next months.

So, globally yes, we think we will go for slight increase outside China, we cannot confirm that at this moment.

Horst Schneider

But you don’t see any Brexit impact right now or any negative Brexit impacts, right?

Fred Kappler

No. For the time being the business is stable in the U.K. and also there are no effects of the current business on the continent. But we have to look how the effects will be during the coming months. We have an effect already on the currency side.

Horst Schneider

Okay. Thank you.

Frank Witter

Yes, Horst. The second question for me let me start with the easiest one. The impairment losses on those intangible assets properly planned in inventory are included in special items as it pertains to the diesel issue.

The second question is regarding the seasonality. Traditionally the Q2 is for most of all our brands the strongest quarter. So, we continue to assume that H1 has been more positive than H2. I certainly will admit that versus 7% operating margin for the first half that is a very strong foundation. And we will certainly review future guidance.

But at this point of time, we believe particularly in light of lot of ramp up costs and new models to be launched, Brexit, which has been touched on continued challenges in Brazil, Russia and Turkey. We feel comfortable with the current guidance and confirming it. But rightly challenged with 7%, we are certainly at a good starting point for the second half. But we continue to have open eyes on the environment we are working in.

Horst Schneider

Okay, thank you.

Oliver Larkin

Thank you, Horst. And we will take the next question now please.

Operator

And now our next question from Patrick Hummel, UBS.

Patrick Hummel

Yes, thank you for taking my questions. Regarding the outlook for the second half, can we have a bit more color on your latest thinking on FX, just looking at the screens, the emerging market currencies actually from a spot rate point of view suggest there should be a tailwind in the second half of the year? I’m just curious to hear your latest thoughts on that.

And second, you indicated that the fixed costs are going to continue to increase also in the second half. I was just wondering when will we see the first quarter, where we will not have any further increase because you hear almost every day some news of costs and new efficiency measures, what’s going on within the organization as you confirm everything on the move and no stone is left unturned. So I was wondering when we will see more meaningful positive results from all those efforts in the fixed cost line. Thank you.

Oliver Larkin

Okay, thank you Patrick. We’ll go straight to Frank.

Frank Witter

Yes, let me start with the fixed cost issue. We are targeting our fixed cost. We are committed not only by certainly the efficiency programs I was relating to. Certainly the future pact as it pertains to brand Volkswagen passenger cars, it certainly has also some critical elements related to fixed cost in there. But we should not forget that certainly also in the time to come, the depreciation of activated assets is certainly something we are going to deal with.

For us, the minimum target is that the product cost savings and improvements are at least also in the future offsetting if not exceeding the fixed cost increase. Regarding your inherent question, when we will not have a fixed cost increase, I certainly would hope for but there is no point in time I’m currently able, particularly not without any firm commitments under the future pact discussions that - there is nothing I can currently commit to.

The exchange rate effects of around €1 billion which have been booked are driven by currencies which continue to be very volatile. I mean, Turkey is particularly difficult one. We are still trying to understand what Brexit is going to be to the point euro relationship, South African Rand, Brazilian Real and Argentinean Pesos.

What we’ve seen is that the second quarter had a higher impact on FX than the first. But we are more positive for the second half of the year but it really hard, particularly for those currencies to properly predict.

Patrick Hummel

Okay, thank you.

Oliver Larkin

Okay. Let’s take the next question now please.

Operator

And now our next question from Harold Hendricks, Morgan Stanley.

Harold Hendricks

Hi, good afternoon. Harold Hendricks, Morgan Stanley. Two questions please. Firstly, just on the provisioning, and I heard some of the conversation there just now, but the fact that provisions went up less than the actual charge in the quarter, can you give us any sense of whether there has been any utilization in the quarter or maybe even enumerate for us what the utilization on the provision might have been, which I think is an important number for us.

And then that goes directly to the free cash flow, where I’ve got a number of clients asking, excluding the disposals and the China dividend, the free cash flow in the first half was just €900 million, relative to the - obviously very significant improvement in profitability. How do we see the development of free cash flow from here, because you must agree that that €900 million is not sufficient for a Company of your size and your current profitability?

Oliver Larkin

Okay, Harold, thank you. We’ll start off then with a comment on utilization of provisions. And then we’ll talk about the cash flow in the first half.

Fred Kappler

Yes, sorry. We had so far no major utilization of the provisions booked. And as I indicated, the outflow would probably start in autumn and will go through 2018. With respect to the free cash flow, we continue to have lot of emphasis on the free cash flow. We obviously saw an improvement of our net cash flow which was negative if you exclude the LeasePlan disposal from the first quarter during that first quarter. So we will continue to push since particular given the environment we are in that a strong cash flow is essential for the period we are going through.

So, we expect a positive net cash flow for 2016. But due to the diesel issue it will be considerably below previous year.

Harold Hendricks

Okay. Thanks very much. And then just if I can ask one more on financial services, Ford has just come out and has made some comments regarding interest margins, as well as credit losses and lease residual impacts on their Financial Services business in the second quarter. That’s been a significant concern of mine.

Can you talk a little bit more about what has been another outstanding quarter in terms of profitability in your Financial Services business and whether you believe that that is consistent and whether you see any risks on the horizon relative to those record levels of earnings?

Fred Kappler

We expect pretty much result for the full year in-line with previous year. We have solid policies in place, we have quality portfolios and that gives us quite some comfort that we have ongoing success with our Financial Services division.

The only area which we are currently particularly concerned is the United States as I already elaborated, as it pertains to residual values. This is a special situation. But overall we are quite comfortable with the development of the Financial Services division.

Harold Hendricks

Okay. Thank you very much.

Oliver Larkin

Thank you, Harold. And we’ll take the next question please.

Operator

Thank you very much. Our next question now from Kristina Church in Barclays.

Kristina Church

Hi, thanks for taking my questions. I had one question relating to the strong Skoda margin and I know you said part of this was related to improvements in efficiency savings and quality products.

I was wondering whether you could elaborate a little bit more and therefore if we were trying to take the read across for the VW brand, the efforts that you’ve made in MQB, how much further improvement we could expect from that? I know you’ve talked about the net of efficiency savings and product costs versus fixed cost. But if you could just dive into the Skoda brand a bit more.

And then my second question relates to - there was a rise in capitalization rates in the quarter. Is that something we can expect to stay high going forward or can you give any further indication on that? Thank you.

Frank Witter

Yes, thanks. The MQB for us continues to be a very important part of our, of today’s but also our future strategy. We explained a couple of times that we are still in the process of rolling the MQB out. We have the brands at different rollout levels, the ones that’s the highest percentage of cars being on the MQB is Skoda.

By the end of this year that might be almost 50% of the product for brand Volkswagen beyond the range of 30%. Given the strong performance of Skoda that is certainly something we also relate to a certain extent to the MQB.

An interesting point which you might share with me is the fact that the former Head of Research and Development of brand Skoda is now the R&D Head for brand Volkswagen. So he brings a huge amount of expertise and to cost focus into the brand. I think we discussed at various occasions, this is clearly needed. And therefore we’re also supporting those initiatives by people who have the experience of building great cars with reasonable investment and expenditures.

And obviously for us, if we look at Skoda’s performance right now with the margin in Q2 of almost 10%. This is certainly a blueprint we would like to have more copies of.

Oliver Larkin

Thank you, Frank. Thank you, Kristina. And we’ll move on to the next caller please.

Operator

Thank you. And now our next question from Charles Winston, Redburn.

Charles Winston

Yes, hi, it’s Charles from Redburn, thanks for taking my questions. Looking at sort of what was the driver of this result. You had said earlier that price and incentives unless each other off, volumes broadly flat. So, this is very strong €900 million volume price mix, it was basically a mix driven results, big step up from the first quarter.

Can you just give us a bit more breakdown what, was that regional issue, was that out-performance of Porsche and Audi? Perhaps give us some sort of idea of where that’s come from therefore what the sustainability of that growth is? Is it one-time or it was the beginning of a trend that will pick up as all of these new models you launch comes through?

Secondly, could you just tell us the percentage of your, or remind us the percentage of your China sales that are exposed to the tax incentives, in other words, in theory when those incentives end? If they do, how much you’re exposed to that.

And finally, can I just go back to the FX question and perhaps just ask it more directly. At current spot rates, if there is no change to spot from where we sit today, what would be the impact of FX in the second half? Thank you very much.

Frank Witter

Yes, let me start with the question of mix, which is the biggest positive contributor in our EBIT-bridge for the first six months. It relates to all three issues, regions, models but also options. To a certain extent it is truly hard to predict because particularly when it comes to the options, it’s a customer’s decision. But it is dedicated part of our strategy in the marketplace.

So, I would assume that we have continued successful strategy but this is certainly something which is always to be proven in the marketplace. We have also in that area starting with the balancing act between pricing and incentives, which we continue to have.

We tried to improve certainly if you take a deeper dive into the cost of sales, you will see on a quarter-to-quarter basis we tried to take the gas - the feet off the pedal, on the incentive side but very carefully in order to continue to do what we promised from day one after the diesel issue that we tried to do the balancing act between volume maintaining market share or even sometimes not but not going overboard and crazy on the incentives. And this is to us certainly something which we have - which we continue to have challenging market environment particular for brand Volkswagen outside China.

So, it has continued to be a part of - the mix is expected to continue to contribute positively but to what extent is certainly hard to predict.

On the FX side, we’re going to we need to take a look because obviously we have all the hedging in the books. And maybe we need to come back to you on that particular question. I just wanted to also make sure I might have misdated the effect of the €1 billion.

In Q1 we had an effect of minus €0.8 billion and Q2 was better, it was only minus €0.2 billion. But as I said, we expect H2 to be better. But to what extent is certainly pretty volatile given the particular currencies we are talking about.

Oliver Larkin

Thank you. And Charles, could I just check with you, what your question was, on the tax in China. Are you referring to the volume of cars below 1.6 liter or was it?

Charles Winston

Sorry, yes. No, no, absolutely, just in terms of what proportion of your total sales are below the 1.6 liter and therefore are you able to derivate an incentive?

Oliver Larkin

Okay, thank you. Fred then.

Fred Kappler

Okay. Of course this is a major part of our business. Cars with an engine of 1.6 liter and below, approximately two third of our complete sales in China are covered by these engine capacities. And of course they have, they are affected by the tax activities in China.

Charles Winston

Great. Thank you.

Oliver Larkin

Okay, Charles, thank you. And we’ll take the next caller please, operator.

Operator

And now our next question from Daniel Schwarz, MainFirst.

Daniel Schwarz

Yes, thank you. Daniel Schwarz, MainFirst Bank. I have two questions, one follow-up question on the earlier question on MQB. If you would just take Volkswagen brand, with the buildup of fixed cost still be clearly higher than the product cost savings. And you mentioned that at Volkswagen brand, about 30% of the cars are produced in MQB. Could you say what the run rate would be end of 2016 and end of 2017?

Frank Witter

For brand Volkswagen the 30% is related to the end of ‘16. So, from around about a quarter to 30% within that respective period, so 5% increase of the total line-up of the brand.

With respect to the product cost improvements, we don’t provide the detail by brand. But at least to give you the target we have for the entire group, for ‘16, we’re striving for contribution of more than €1.5 billion. But we certainly have to take into consideration the significance of the launches to come.

And we certainly would hope for more successful launches like the Tiguan, which is a true success story in terms of launching an MQB related product very successfully. So, this is pretty much the framework we’re shooting for. But we’re not providing more specific details on the brand level.

Oliver Larkin

Okay, thank you Frank. Thank you Daniel. And we’ll take the next caller please.

Operator

And now our next question from Jose Asumendi, JPMorgan.

Jose Asumendi

Hi, thanks. Frank, couple of items, please. The first one is more strategically do you plan to disclose the profitability of the Volkswagen supplier base operating this quarter? Second, we’ve seen announcements on the 150 gigawatt capacity and the electrical modular architecture. So with both items in mind, can we expect Volkswagen is targeting or looking to maintain a flat CapEx over the coming years?

The third item would be basically can you talk about the current level of order intake in Europe, whether it’s stabilizing sequentially or not? I mean this is a clear important factor to supports free cash generation over the coming quarters.

And then finally, there was a lot of noise on Financial Services, but ultimately we’re not seeing a deterioration of your Financial Services metrics. So can you talk with your background please about what you learned from the previous financial crisis and what makes you comfortable as to how you’re running globally Financial Services? Thank you.

Frank Witter

Yes, hi Jose. So, let me start with the Financial Services related question. As you know, you can never ever take anything for granted. But if you have stringent policies, build quality portfolios and invest into the right people, and to culture in an organization that’s probably the most important part and quite essential.

Maybe as an indication to the answer you might be looking for in more detail, very shortly the European Central Bank will disclose the results of the very latest stress-test which have been performed after the 2014 one on all directly major supervised banks. And when you see the results that might give you the same level of comfort I’m having into the quality of our Financial Services operation and performance.

I indicated earlier the outlook for calendar year which is quite strong and comparable to the 2015 results for the division.

I think the other question was related to component business. The component business is positively contributing to the Volkswagen brand result. You also know from the 2025 strategy discussion and presentation that we are going to review the way we organize and structure the component business.

And certainly there is also to be reviewed which part of the component business relates to the growing future business since we will have a much higher exposure to electric vehicles. So therefore it is certainly organization structure how we manage it but it’s also the definition of which component will be particularly critical to be managed in-house.

Oliver Larkin

Okay. And just, there was just two more parts to Jose’s question. One was about ongoing CapEx this year into the next, and then we’ll switch over to Fred for a comment on incoming orders.

Frank Witter

Yes Jose, not only between you and me, but the entire committee, the CapEx has been one major area of discussion and certainly also concerned since we tend to be on the high side. From various angles you will get and see feedback that we are trying to move the mountain. We see quite a bit of success in terms of changing the thinking and behavior.

But we also need to recognize that we have a lot of product and 60% of the CapEx numbers you’re looking at is related to product that we have a lot of projects underway. And I think it would be rather foolish to stop certain products which are very well down the drain and who are basically close to market launch. We have obviously investments which we started to do in some new plans.

So, it is a balancing act but we are actively at all cylinders for all brands addressing the issue, CapEx and certainly R&D expenditures. And it is certainly something which will not happen overnight. There are no dramatic changes overnight. But we are certainly going after it with full force.

And again going back to the future pact, this is also a major milestone since Volkswagen is the largest of all our brands and certainly has the lion’s share of also capital expenditures. But this is a long-winded answer. But it is also describing to you the environment. But you will definitely when you talk to people and you have a lot of context into the organization, it is top on mind of, on of all senior executives but also our internal partners.

Fred Kappler

Coming to the order intake, we have a very precise picture when Western Europe is concerned. We are in the first half year, January to June above the previous year. But as the order intake is concerned, this is also the case for Volkswagen passenger cars. And in total, one can say that order bank at the end of the first half year is also above the previous year order bank.

Jose Asumendi

Okay, thank you.

Oliver Larkin

Thank you, Fred. And thank you, Jose. And we’ll take our next caller please.

Operator

Thank you. And now our next question from Sascha Gommel, Commerzbank.

Sascha Gommel

Yes, good afternoon. Sascha Gommel from Commerzbank. Thank you for taking my questions. I got the only two quick ones left. First of all, one supplier was talking about the change in mix in Europe, and it’s all very low order-intake for diesel products, and the supplier is heavily exposed to the German OEMs. So, I was wondering if you could comment, if you also see in your order intake a change of behavior of the end customer. And then secondly, the fact that you split MAN commercial vehicles and MAN power engineering, does that mean you make the business ready to sell?

Oliver Larkin

Okay Sascha, thank you. I think Frank will deal with that second question and then we’ll pass back to Fred.

Frank Witter

Now, this is the main and only reason is to provide more transparency to the MAN business but also to do justice to the different lines of responsibility for the business. I think MAN diesel turbo and Rank have completely different businesses and cycles than the truck business. I think it’s basically request from your community and has nothing to do with any disposal discussions or speculations in the marketplace.

Oliver Larkin

Okay, then, Fred to you.

Fred Kappler

Yes. The diesel mix development, this was the question of Chris, in the United States, we would do diesel sales stop. But what Europe is concerned, our main diesel market we cannot see significant changes in the first half year either or to total market development is concerned but so what our intake is concerned although we have still at a stable diesel share in our order intake.

Oliver Larkin

Okay, thank you.

Sascha Gommel

Thank you very much.

Oliver Larkin

Thank you, Sascha as well. And we’ll take our next question please.

Operator

Our next question now from Frank Biller, LBBW.

Frank Biller

Yes, hello, thanks for taking my question. One question, coming back to this issue of the supplier base here, maybe it’s not only related to the SCR technology or diesel demand here. So, the company yesterday said, okay, we are lowering our guidance for revenues in the range of 7% to 8% and this was mainly due to lower order intake coming from Volkswagen, so that Volkswagen reduced their expectation for the second half of this year.

And this does not fit to your guidance when assuming we will see better sales here in the second quarter, so deliveries in cars as a total. Maybe you can elaborate on that. What’s behind here, was just the supplier too optimistic on your orders what you gave, or have you changed your mind here? So that’s the first question.

The second one is based on the settlement agreement in the U.S. So here there was mentioned an amount of $2 billion for zero emission vehicles infrastructure and my assumption here is that this has not been covered by provisions. Maybe you can confirm that or not. And then coming to the outflow of cash here within the next 10 years, so does this go against the operating earnings line maybe in others?

Oliver Larkin

Thank you, Frank. A couple of questions there, and I think our Frank will take those as well.

Frank Witter

Okay. With respect to the U.S. settlement agreement, it is correct that for those investments, let’s call it green project that there is no way to provision for that because there are no concrete projects identified at this point of time. We disclosed that fact that those future investments are committed in our Annual Report, it’s in, at the end of calendar year 2015. It’s the other financial obligations, so there is nothing new to it. And it was and it is part of the agreement you are referring to.

It’s certainly hard to respond to suppliers not known. If you talk to a supplier who has a major share in the diesel business of Volkswagen in particular in the United States, there are certainly significant impacts because we currently have a stop sale as Fred in all-detail elaborated.

But in general terms, we are sticking to the guidance we gave for the year. For individual suppliers have known the situation might vary but in general terms the picture is as we described it.

Frank Biller

Thank you.

Oliver Larkin

Okay, thank you Frank. And we’ll take the next caller please.

Operator

And now our next question from Michael Punzet, or Tim Rokossa, Deutsche Bank, excuse me.

Tim Rokossa

Yes, hi, I assume it’s me. Tim Rokossa, Deutsche Bank. Thank you for taking my questions. I would only have two left, please. And the first one is just on the dealer situation in Europe. I believe you received some approvals again. Can you just update us on where you stand with respect to the recalls and perhaps also what you make out of the latest statements by the European Commission that now probably wants to coordinate some of the lobbying efforts by the consumer agencies over here?

And secondly, just coming back a bit into the direction of Charles’ question about the sustainability and asking it more direct about the VW brand margin, which really was the very positive surprise here. You give a number of reasons for the improvement, like Western Europe, fleet bias, product and efficiency costs and we have clearly seen very strong results by some of your competitors, mainly driven by the strong European market and partly without really having much new products, and you already touched on your largely unchanged product with its fixed cost spread.

Is it therefore fair to assume that the strong European market was the main reason for the improvement in the margin in Q2 versus Q1, also because of seasonality, or do you feel that there was already materials has helped the improvement here? Thank you.

Fred Kappler

Let’s start with the status of the recalled here in Europe. In the meantime we have KBA release of some 4.6 million cars. So we’re close to half of the volume which is now covered by release. Of course most of the releases are just recently so we are now in the rollout of the service campaign up to now we have some 300,000 cars already repaired.

And the solution for the customers’ result and no changes to fuel economic mileage, engine driving performance, handling characteristics and the German Federal Motor Transport Authority to Cabby has confirmed that we as Volkswagen and the brands have fully achieved this goal which goes 2-liter TDi engine. So, we have up to now also no major problems reported from the 300,000 repairs already. So we are here really well on track.

Frank Witter

Let me take up the question on the Volkswagen brand margin. And as I said earlier, we continue to aim for the 2% margin for the full calendar year. This is definitely not a walk in the park. The second quarter traditionally is the strongest quarter. And therefore we have a lot of hard work left for the remainder of the year.

The efficiency program clearly contributed positively. And we certainly all know that the European market also in terms of profitability is important for every OEM doing in that market. But we should not over-estimate the accomplishment in Q2 and just multiply what was accomplished in Q2 times three. This would not be right and would not work.

So therefore, we mentioned the 2% but it is not a given, and this seasonality certainly is also a factor as well as launches. But one product which we certainly take a lot of comfort from is the new Tiguan which has been very well received, it is already launched.

Oliver Larkin

Okay Frank, and thank you Tim. And I’m hoping that Michael Punzet is still on the line to come up next. Michael, hopefully you’re still there.

Michael Punzet

Good afternoon. I have two questions. The first one is on the other line. I think you touched it briefly in your comments. But when I look the improvement in your effort, it could be fully explained with the swing in the other line. Maybe you can explain a bit in more detail what’s going on there in Q2 and if this development will be sustainable?

And then an additional one to the diesel issue, I first want to clarify the provisions you booked in Q2 that amounts to €2.1 billion, is that right? And finally, on that topic, I have press reports I was talking about compensation for dealers in the U.S. and also for settlement in Canada, maybe you can give us some comments and if you have already included some amounts for that in your provisions?

Fred Kappler

Yes, let me start with the other line which contains mainly internal postings, especially the elimination of internal group, internal profits, investments, supply and reserves. And particularly internal profits are the result of the various transactions we have between Group companies.

This line item can very strongly over the quarters and I think and therefore, it is a snapshot result for a quarter. But it is not a line item which can be safely predicted. The significant variance between the first half of the year compared to previous year was truly mainly related to currency effects on the eliminations in calendar year 2015.

Frank Witter

The other question related to dealers in the U.S. and Canada, you know how highly we weigh the relationships we have with our dealers in all markets. Certainly dealers in North America are particularly impacted by this situation. We have class action proceedings in those jurisdictions. And very shortly the Ontario Court, I think it’s tomorrow we’ll provide an update. We are not going to discuss in public or not able to discuss in public the state of discussions. But we certainly take their concerns very seriously as we should.

Oliver Larkin

Just two end-points there Frank, there was a comment there about the dealer-body in the U.S. as well and then to come back on the diesel proportion of the Q2 special items.

Frank Witter

Yes, I mean, we see, we’re also maintaining a dialog with the U.S. dealers. You organize it through the National Dealer Council. We always said from the beginning, we want to make things right. But you could certainly appreciate that since those discussions are in process, work-in-process, that we can’t and should not comment at this point of time in order to respect the relevance and importance to our partners in the U.S. but also in Canada.

With respect to special items from diesel, we have in total €1.6 billion. We obviously had the €2 billion effect in Q2 offset by the positive around about €500 from Q1. And so, the currency effects are certainly putting some volatility to it. But the main driver for changes were legal risks predominantly related to North America, which is at the end of the day the sum of positives to negatives, because also some risks included in that line item reduced. But in total we had an increase.

Oliver Larkin

Okay, thank you Frank. And in interest of time, we’re going to switch now to take a couple of calls from journalists. So operator, the next question please.

Operator

Okay. Now our next question from Christoph Rauwald, Bloomberg.

Christoph Rauwald

Yes, good afternoon. Thanks for taking my question. Your CEO Mr. Muller said last month that Volkswagen is in advanced talks with a local carmaker in Asia to develop a budget car. Has there been made any progress since then that you could share maybe with us? Is this car make a Tata Motors as has been reported and does that mean that the efforts, that has already existed to develop a budget car will be ended or are these two separate projects? Thank you.

Frank Witter

There is nothing to be added Matthias Muller said at that time. The budget car segment is considered to be important in various parts of the world. China is certainly for us one of the most relevant one. So, at this point in time, there is no news to be shared on any of those negotiation centered customers.

Oliver Larkin

Okay, thank you Frank. And we’ll take the next journalist question please.

Operator

And our next question from William Boston, Wall Street Journal.

William Boston

Hi, I’m not sure if you can hear me, so just let me know if you can please.

Oliver Larkin

Yes, we can hear you. Go ahead please.

William Boston

Okay, great, thanks. I just wanted to ask, it’s about the future pack talks. I realized you don’t want to go into detail about the talks itself. But you have a wage deal with [indiscernible] which is long-term. Mr. Muller and the controlling shareholders ruled out in Germany. So I’m just wondering if you could discuss a few, just a little bit, give us a sense of what else they’re talking about with labor that could have a substantial impact on your business because you seem to place a great way on these talks in the future? That’s my question. Thanks.

Frank Witter

Yes, hi William. Certainly as you stated, we are bit cautious and certainly making public statements too detailed at a time and where those discussions are undergoing. But basically let me confirm to you that the work groups have actively being defined and they started to go into the details of the defined areas which, basically goes through all areas of the business.

It’s about process excellence it is about obviously a CapEx it is about all sort of fixed cost improvements. But we have identified so many opportunities together that I’m quite positive. But nevertheless at the end of the day it is certainly a lot of work and we also with some more smoke coming out of those books, as we’ve seen in the past because those discussions are not easy.

But we try and we are committed to maintain the partnership approach which has been part of the solid foundation when Volkswagen is operating on. But we also have the ambition that there are no sacred quotes which are not being talked about.

So, this is the one pillar. And the other pillar is that we continue to ask for support from all parties concerned that we continue to drive the efficiency program, which ultimately at the end of calendar year ‘17 is supposed to contribute €5 billion. That is the gross number. Please take that as a gross number because we have obviously offsetting negative developments in other areas. But we strive for a positive contribution in the range of €5 billion for brand Volkswagen by the end of ‘17.

I’m not saying that this is obviously all going through the bottom line. But nevertheless it is an important contribution on our way to more competitive profitability levels also for brand Volkswagen. But we continue also obviously to deal with very difficult market environment for example in Brazil.

But if you like maybe also couple of more items, IT expenditure is also one of those. We talked a lot about this heavy-duty product line management which is a complete restructuring on the way we developed products, reduce complexity. I talked about the successful launch of the Tiguan. We have other examples which have not been that successful. So those types of costs and we’re making sure that we optimize those is all included in those negotiations. So, it’s a comprehensive approach we are taking through the future picture.

Oliver Larkin

Okay, thank you Frank. We will just squeeze one last question in on the list from journalist. And then we’ll close the call. So, just one last question please operator.

Operator

Okay. Our last question from Christiaan Hetzner, Automotive News Europe.

Christiaan Hetzner

Yes, thank you very much for taking my question. Two, very quickly, first of all on Brexit. Could you give me a feeling about any price increases you’re planning and whether they may just mitigate or fully compensate the effect of sterling?

And then secondly, on the announcements from the European Commission concerning economization of Transport, what sort of effects do you predicted, was that worse or more stringent in terms of what you were expecting and what do you see for early next year when we get the final targets for Transport? Thank you.

Oliver Larkin

Okay, Fred, I guess we’ll pass to you for the pricing on Brexit and Frank on the EU Commission question.

Fred Kappler

Of course pricing primarily is always in comparison to the competition. And Brexit has not yet happened we have a development of the pound, yes. We have to look how this will develop. We have of course to look how the market, the competitors were actually will be.

On the other hand, our customers that used to have stable pricing strategy from our side, so we will not react on short-term currency effects for sure. If this would be a long-term effect, then of course we have to look into it.

Frank Witter

Yes, just briefly Christiaan on your question on the latest announcement of the European Commission. In all honestly, we are in the process of analyzing it and putting it into the context of our plans to see the potential impact we’re going to face down the road. But certainly we’re all aware that it becomes quite challenging to meet all those objectives and targets. But nevertheless it’s a job to be done. And we are certainly focusing on it.

Oliver Larkin

Okay. Thank you, Frank, and thank you, Fred. Thank you, participants in the call today and thank you and goodbye from Wolfsburg.

Operator

That will conclude today’s conference ladies and gentlemen. We thank you very much for your participation. You may now disconnect.

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