Good morning and welcome to Kongsberg Automotive's Q2 2025 Earnings Call. My name is Therese Sjöborg Skurdal, Communication and Marketing Director, and I will be the moderator for today's session. Thank you all for joining us. Before we begin, please take note that today's call will be recorded, and the recording will be made available on our website. The agenda will start with a presentation from our CEO, Trond Fiskum, and CFO, Erik Magelssen, that joined us in June, followed by a Q&A session. If you have questions during the presentation, please submit them by using the Q&A feature in the webcast tool. We encourage you to raise the question in English. Now, I'm pleased to introduce our CEO, Trond Fiskum. Trond, please go ahead.
Thank you, Therese. Good morning all. I will take you through the executive summary and market update before we go into the financial update. We want to start this earnings call with where we ended in the previous earnings call in May. We informed back then that the financial performance was not satisfactory and that meaningful changes were required. Kongsberg Automotive is a clear turnaround case. Turnarounds are not made from one quarter to another, but we have taken many significant and important steps since May. In this slide, you can see some of the highlights. We have launched an additional cost reduction program that will have €15 million in annual impact when fully implemented. This comes on top of previous programs earlier announced. We have renewed the executive leadership team and reinforced a performance-oriented culture in Kongsberg Automotive. We have decided to close our office in Zürich.
We have decided to consolidate our Swedish plant footprint from two plants to one plant by moving our Ljungsarp plant into the existing Mullsjö plant. We have decided to make a strategic acquisition of Chassis Autonomy, positioning Kongsberg Automotive for long-term growth in a fast-growing product and market segment. Before we go into the financials, I want to introduce you to one of these highlights that we are very excited about: the acquisition of the remaining shares in Chassis Autonomy that will give Kongsberg Automotive full ownership. The market for electric and autonomous vehicles is fast growing. There are many technology changes and opportunities. Steer -by -wire is one of those technologies that is expected to grow significantly over the next decade. Kongsberg Automotive has previously taken a 20% position in Chassis Autonomy and will now exercise call options to take full control.
The Steer -by -wire market is projected to grow substantially over the next decade, with estimates reaching €3.5 billion by 2035. Through this acquisition, Kongsberg Automotive aims to secure a meaningful share of this fast-expanding segment. The acquisition aligns very well with our strategic ambitions and our capabilities, and Kongsberg Automotive will be able to utilize our global footprint to create new opportunities and unlock the value in this technology. We position Kongsberg Automotive for long-term growth within fast-growing product and market segments. This is also a reinforcement of our commitment to innovation, sustainable mobility, and to create long-term value for our shareholders. As mentioned initially, a turnaround is not done from one quarter to the next. What we have experienced in Q2 is that revenues are down from Q2 last year by some 8%, although it has improved over the last three quarters.
With minor exceptions, there is a direct correlation between the overall market development and our revenues. EBIT for Q2 is significantly reduced. This is mainly a result of a thorough review that myself, Erik, and the team have done on our liabilities related to future warranty expenses. As a result, we have increased warranty accruals with some €8 million. There are also some impacts related to tariffs and impairments of non-current assets related to a customer contract. Erik will talk a bit about these later. The free cash flow is close to break-even for the quarter and has significantly improved from previous quarters, as well as from Q2 last year, and continues a positive trend the last four quarters. We continue the implementation of previously announced cost reduction programs and launched in May another initiative that comes in addition to the previous programs.
As a result of these initiatives, when fully implemented by Q3 2026, we will have a reduction of approximately €500,000 in direct cost position and some €42 million in improved annual indirect cost base. This represents an improvement that will give an EBIT improvement in the range of 4- 5 percentage points based on stable revenues. This is significant. We do see the impact of these programs starting to materialize, as you will see later in the EBIT bridge that Erik will present. Our business wins for Q2 are €91 million. This is lower than previous quarters. The reason for this is that tariffs and market uncertainty have led to a slowdown in business awards by our customers. This may continue also over the next quarters.
We do, however, remain with a strong pipeline of business opportunities, and while some business awards and the introduction of new vehicle platforms are being postponed, it also means that some of the current business that Kongsberg Automotive holds today will continue for a longer period of time. The picture is a bit mixed. In May, we announced an important business win in China. This is a product where Kongsberg Automotive has a unique capability. It is in a fast-growing market and in a growing product segment. We have a cost-efficient setup and are competitive in the Chinese market. We do see more of these kinds of opportunities going forward. The tariffs continue to be a strong focus. While we have had a negative tariff cost of €2 million in Q2, net negative tariff costs, we expect to recover close to 1% of these costs in the end.
After Q2 closing, we have had several negotiations with our customers and concluded several of them with 100% cost compensation. Over time, we do expect the net impact of tariff costs to be minimal. As reported in May, the primary concern for us is the negative impact on the overall market demand that we have seen materialize. Going back to the turnaround initiatives, in June, we announced a new organization structure and several leadership changes. We eliminated or significantly scaled down several corporate functions. Some of the functions were merged, others were moved into the BAs. An important outcome was the strengthening of the two business areas. They now control all key resources needed to properly manage their business and their P&L. These changes were also a reinforcement of a performance-oriented K culture, where clear responsibility, accountability, and ownership are key elements.
We continue to work on strengthening the teams on all levels and parts of our organization. Since 2008, K has had two production locations in Sweden, with approximately one hour drive from each other. After a review in Q2, we decided to consolidate the two plants into one. The Ljungsarp plant will move out of the existing facilities and move into the existing facilities in Mullsjö. This consolidation will provide cost synergies and a significantly stronger operational unit in Sweden. We will also move steering column product development from Willis in Texas, U.S., to Mullsjö. Together with the acquisition of Chassis Autonomy, this is a strategic bid on both Sweden, advanced steering systems, innovation, and growth. We have recently made a decision to close the Zürich office with the move of Kongsberg Automotive's headquarters back to Kongsberg and a review of our cost structure.
This was a natural consequence and a natural decision to be made. The functions in the Zürich office will be scaled down and primarily be moved to Kongsberg. The full transition will be completed by the end of March 2026. Kongsberg Automotive has for many years had a joint venture with DETC, which is a joint venture between Dongfeng and Nissan. We decided in June to take full ownership of the joint venture, and this was concluded in July. The company is an important part of Kongsberg Automotive's business in China and has several key Chinese OEMs as customers. With this acquisition, we will have more flexibility and have more control to optimize costs and to drive growth in a very important region for Kongsberg Automotive.
Back in May, during the Q1 earnings call, I presented these priorities for 2025: further cost-based adjustments, improved cash flow, strengthening the leadership teams and Kongsberg Automotive culture, innovation, and profitable growth. Since then, we have taken several decisive and important steps to deliver on these priorities, and we will continue on this turnaround journey, and we will keep you updated about any major developments as they happen. Over to the market. First, we do see some short-term uncertainty, and it's hard to predict what will happen in the next few quarters. Overall, we do not see a favorable market in the short term, and it is also reduced compared to our expectations in May. We are managing this situation very actively, both operationally and financially. What is important, and what we can see on this slide, is the longer-term growth.
Currently, the outlook for 2026 is positive, especially in the commercial vehicle segment, where we have a significant portion of our business. Beyond 2026, the market development is positive in all regions and vehicle segments. This is a market growth that should fuel Kongsberg Automotive's growth in the years ahead. With this, we will move over to a deeper dive into the financials, and I will hand over the word to our CFO, Erik Magelssen.
Thank you, Trond, and hello all. My name is Erik Magelssen. I'm the CFO from Kongsberg Automotive since June. We can start with the Flow Control Systems. We see that there's a positive development with an increase in revenue of 3.1% compared to the same quarter last year. The net increase in revenue also includes the effects of a negative currency translation effect. It's a 5.3% increase in revenue at constant currency levels. We see there's a positive development also in the EBIT level, going from close to 0% margin in Q4 2024 to 4.7% in Q1 and to 8.3% in Q2. This is a combination of increased contribution from higher sales and a reduction in both the operating cost base within the business area itself and the corporate cost at the group level.
If we then turn to Drive Control Systems on the next slide, we see here that there's a reduction in revenue level compared to Q2 last year, but slightly higher than revenue in Q1 2025. On the cost side, Drive Control Systems are affected by both the higher accruals for estimated future warranty expenses, the net tariff cost, and the asset impairment related to a terminated customer contract. Similar to Flow Control Systems, there are also reductions in manufacturing overhead costs within Drive Control Systems, affecting the quarter positively. In total, this brings the EBIT for Q2 to a - €12.3 million.
On the EBIT bridge, when comparing to Q2 last year, the two most significant variances are the higher accrual for estimated future warranty expenses, reducing the EBIT, but also, as Trond mentioned, there's a significant reduction in the operational cost base of €6.5 million compared to the same quarter last year. In addition, in the bridge, we see the reduced contribution from lower revenue levels, the net tariff cost impact, and the impairment effect. This is generally the same picture when we look at the first half year 2025 compared to the same period last year. On the net income bridge, on the coming slide, when you look at this bridge, the lower EBIT level is, of course, the key explaining factor when we compare to the same periods in 2024.
There is also a tax effect in the way that we have a net tax income in both Q2 2025 and the first half year 2025 compared to a net tax cost in 2022. The difference relates to the lower and negative result in 2025 and the effect of the deferred tax calculations. On the free cash flow on the next slide, as Trond mentioned, the positive trend on the 12-month level continues, where there has been a significant positive development since Q2 2024. Also, comparing to the negative cash flow in the first quarter this year, the slightly negative cash flow level in the second quarter is a significant improvement. Most importantly, winning cash flow is the cash flow of operations, where there has been a significant improvement from the same period last year.
This is driven also by a reduction in net working capital, which is evident also from the reduction in capital employed, which we will look at shortly. On the next slide, we have the net interest-bearing debt and leverage ratio. In this graph, we have now also included the leverage ratio according to the bond term definition, which is the ratio which is relevant for the financial covenant reporting. This is the blue line. Generally, the downward trend in the LTM EBITDA reported so far is also affected by the significant difference between the results in the first half year 2024, which is relatively strong, compared to a much weaker EBITDA in the second half year of 2024. As you see, the development in net interest-bearing debt is relatively stable and has also been reduced since Q1 this year.
Within this net interest-bearing debt, Kongsberg Automotive has an unrestricted cash level of €72.8 million at the end of June, and in addition, an undrawn revolving credit facility of €15 million. In total, we have €87.8 million in liquidity reserve as per Q2. On the financial ratios on the next slide, we have commented on the leverage ratio already. We see a certain reduction in the equity ratio, but it is at the level that we see as more than sufficient and satisfactory for the operations of the group. As Trond has also mentioned, both now and in the Q1 presentation, one of our key focus areas moving forward is the improvement in cash flow. We have received a reduction in capital employed of around €15 million since Q1 2024.
The capital employed includes the net working capital, which is one of the key drivers for the cash flow from operations. This concludes the financial part of the presentation. Trond, we're going into the summary and outlook part.
Yeah, thank you, Erik. We are coming towards the conclusion of this presentation. The summary of this presentation is the following: the EBIT is impacted by the revenue decline and increased warranty accruals, as you saw from Erik's part of the presentation. This was mainly in the Drive Control Systems business area. We do have a positive trend on the cash flow. We do have an additional cost reduction program initiated. With all the programs fully implemented during next year, we will have EBIT improvements in the range of 4- 5 percentage points, considering stable revenues, which is significant. We continue very focused on implementing the cost reductions, working on other operational efficiencies, working on improving our product portfolio profitability, and preserving cash while we're working on developing our business and winning new business. We have renewed the executive leadership team and are reinforcing a performance-oriented Kongsberg Automotive culture.
We have taken decisions to close our Zürich office and to consolidate our manufacturing footprint in Sweden from two plants to one. We have made important acquisitions regarding Chassis Autonomy and also taking the full ownership in our joint venture in China, which positions Kongsberg Automotive for long-term growth. I want to emphasize that restoring value creation for shareholders remains our top priority and that we strongly believe in the future of Kongsberg Automotive, and we are very determined to make changes that are required to realize Kongsberg Automotive's full potential. On the outlook, while we do see a decline in the sales volumes, the EBIT margin for the second half of 2025 is expected to be better than both the first half of 2025 and the second half of 2024. This is a result that is supported by the continued execution of cost-saving efforts.
Regarding the market outlook for the second half of 2025, this is not favorable, as previously mentioned, and revenues are expected to fall below both the first half this year and the second half last year. The 2026 market outlook is, however, positive. That concludes our presentation, and we can move over to the Q&A session.
Thank you, Trond, and thank you both for the presentation. We will now move over to the Q&A session, starting with the first question submitted. Could you please provide more details on the warranty case, especially what is driving your expectation of increased warranty expenses going forward, and what issues are these related to? Additionally, what measures are you putting in place to ensure that this does not reoccur?
Yes, this is, of course, a very relevant question. When it comes to specifics, we cannot comment on that, as these are ongoing cases and discussions with our customers. The reported warranty cost for Q2 is primarily impacted by the increase of the warranty accruals for future warranty claims and expenses for known cases. This is a global portfolio we have of warranty cases, not only K2. I want to emphasize that it's not uncommon to have warranty costs as a part of an automotive supplier's business. In our case, clearly, costs are much higher than they should be. What this is based on is a quite comprehensive evaluation of the whole global portfolio we have of cases. Erik has been involved, and myself have been involved, and we work in. Based on this assessment, we have concluded that it was necessary to increase the accruals.
This is then what we expect of cost going forward for known cases. Now, with warranty, there are always risks, as these are also ongoing discussions. This is our best estimate of the future cost on cases. The second part of the question, specifically what is driving your expectation? Yeah, that was answered. What are these issues related to? There are several reasons why there are warranty costs. There is a combination of many factors. It is what we have in contractual terms with our customers and what we have accepted in contracts. It is our ability to deliver according to specifications and requirements contractually. It's also very much how we handle the cases once they are known to our customer and ourselves. There are multiple factors and, let's say, also multiple things we can work with.
I will not and cannot go into specifics, but this has been a very, very strong focus for me since day one. We're working on the direct costs. We're working on the indirect costs and the systematic costs. I can assure you that this is something that we will improve. We are working on both preventing future warranty situations at the same time managing the current claims. As a part of the efforts, I also brought in, in May, a warranty expert that is now taking lead on warranty in Kongsberg Automotive. The specific measures are ongoing and need to address all these different aspects, as I mentioned, when it comes to contracts, when it comes to our ability to deliver according to customer requirements, and also how we handle the cases. When it comes to, again, the specifics, I cannot comment on that.
It for sure will improve going forward.
Thank you. Next question is about leverage ratio. Your leverage ratio has increased over time. Do you foresee any issues related to the bond covenant level, Erik?
Yes, thank you, Therese. On the question, no. With the picture that we see now, we do not estimate any issues in relation to the bond covenant level of 4.0. There are several drivers for this, including the significant cost reduction programs that have been initiated and the focus on cash flow improvements. In addition, in the dynamics of the last 12 months' calculation of the EBITDA, it's just good to be aware that the first half year 2024 was reported with a relatively strong EBITDA of €30.8 million, and the second half year, with a much weaker EBITDA of €17.7 million. It is now the second half year 2024 that we will start to replace in the LTM calculation. I think on this theme, it's also relevant to make some comments on the net interest-bearing debt in the company.
Of the net debt level of €126.8 million, the lease liabilities, according to the IFRS 16 calculations, are included with approximately €67 million. The remaining net interest-bearing debt of approximately €60 million is then a combination of the bond loan, the conceivable securitization facility, and the cash level. This is also specified in the Q2 report. As you know, the lease liabilities, of course, have a long-term maturity structure. I think also just on the cash level, the group has an unrestricted cash level of €72.8 million as per June. We have an undrawn RCF facility of €15 million. This gives a total liquidity reserve of €87.8 million as per Q2.
Next question. What is the reason for that the warranty cost is put on Q2 solely, and why not put this on the period Q2, Q3, and Q4 to offset for the future warranties?
The reason why we are putting this in Q2 is that this is an accrual of known cases, and we need to set aside this for the future expenses that we'll have for those known cases.
Okay. Thank you, Trond. That was the last question in the webcast tool today. Thank you, Trond and Erik, for your answers, and thank you all for joining us today. That concludes today's Q&A session and today's presentation. On the screen, you will see our next event, which is the upcoming Q3 earnings call in November. With that, I would like to thank everyone for participating in today's call, and we appreciate the engagement and you joining. Thank you and goodbye.