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Edited Transcript of KNIN.S earnings conference call or presentation 23-Jul-19 12:00pm GMT

Half Year 2019 Kuehne und Nagel International AG Earnings Call

Schindellegi Jul 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Kuehne und Nagel International AG earnings conference call or presentation Tuesday, July 23, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Detlef A. Trefzger

Kuehne + Nagel International AG - Chairman of Management Board & CEO

* Markus Blanka-Graff

Kuehne + Nagel International AG - CFO & Member of the Management Board

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Conference Call Participants

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* Alex Irving

* Aymeric Poulain

Kepler Cheuvreux, Research Division - Head of Support Services Research

* Christian Obst

Baader-Helvea Equity Research - Analyst

* Damian Brewer

RBC Capital Markets, LLC, Research Division - Analyst

* David Kerstens

Jefferies LLC, Research Division - Equity Analyst

* Frans Hoyer

Handelsbanken Capital Markets AB, Research Division - Analyst

* Jizong Chan

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP & Equity Research Analyst

* Robert John Joynson

Exane BNP Paribas, Research Division - Senior Transport Analyst

* Sebastian Vogel

UBS Investment Bank, Research Division - Director & Sell Side Equity Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the half year 2019 results conference call. I'm Maura, the Chorus Call operator. (Operator Instructions) And the conference is being recorded. (Operator Instructions) The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Detlef Trefzger, CEO of Kuehne + Nagel.

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [2]

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Thanks, Maura. Good morning, good day, good afternoon and good evening to all of you and welcome to the Kuehne + Nagel analyst conference on the half year 2019 results. Our CFO, Markus Blanka-Graff, and I welcome you from sunny Switzerland. We published our results and the associated analyst presentation earlier this morning. And as always, we will start on Slide 3 of the slide deck.

In the first half year of 2019, we achieved a high-level result in a tough environment. The group earnings was stable at CHF 384 million for the first half year despite significant headwind from currency. Strong EBIT in Seafreight were recorded at a level of CHF 235 million, which were CHF 25 million above the previous first semester of 2018.

A stable EBIT in Airfreight were recorded at CHF 174 million, which were only CHF 8 million below the record year 2018. Net turnover growth in Overland of plus 3.3% and a strong operational improvement of EBIT. I will lead you through some details later during the presentation. And net turnover growth in Contract Logistics of 4.4% whilst restructuring the entire contract portfolio as mentioned earlier in some of our previous calls this year.

On Slide 4, you see the overall group performance and some key figures, and despite a tough market environment, we increased net turnover, gross profit and EBIT with a stable earnings per share in the first 6 months 2019 versus last year's first 6 months. And I know it's more interesting for you to go through the details of the business unit, therefore, we directly continue on Slide 5 of the slide deck with some highlights on Seafreight and Airfreight.

Seafreight. We pursued a selective growth strategy with reduced growth of 3% in the second quarter 2019 but still twice as fast as market growth. We have a strong focus on customer service, and especially for our small- and medium-sized customers, this service is adamant to retain and grow their business. And the cargo mix and cost control showed tractions. All these measures were already initiated end of 2018, and we mentioned those measures. When we posted our annual results 2018, they showed traction in Seafreight clearly.

Airfreight. The market continued to be under pressure with a negative growth rate on some of the trades being double digit. We clearly posted lower automotive volumes and also lower volumes in the sector -- industry sector which we call industry or industrial. And we continue to grow with our pharma and health care customers as well as with time-critical solutions and perishables. Also here the selective growth led to new business wins, which have not yet been posted or recorded in our volume development.

On Page 6 or Slide 6, you will see the volume development by -- for Seafreight and Airfreight. Let me start with Seafreight. A very robust volume growth of 103,000 TEU, or 4.5%, reflecting our selective growth strategy. We saw strong growth on the transatlantic westbound, Asia, Europe, westbound and eastbound, and we saw a very weak transpacific development east and westbound.

Our products, reefer and [less-than-container loads], continue to really perform well. We saw double-digit growth in both of them, and there were speciality that we accorded that forestry products got a lot of traction almost compensating the lost volume on nonexisting volume in scrapping [material], recycling material from last year.

Airfreight, I mentioned that already. Market decreased significantly. The volume in our networks decreased accordingly by 50,000 TEU or 5.8%. And this is mainly driven by European exports to North -- to Asia Pacific, sorry, and Asia export to North America and vice versa. So the transpac, again, saw declining volumes.

A sharp decline in automotive and industrial volumes as well as a strong performance and growth ongoingly not being cyclical at all in pharma, health care and perishables. We posted a couple of new business wins, and we didn't lose any major business, but our existing customers down-traded, especially on the transpac, as mentioned before, and the new wins have not yet been recorded in our networks.

Let me continue on some details of the Seafreight business on Slide 7. Seafreight recorded improved yield, and through an active cost management, we were able to improve the EBIT per TEU significantly and recorded CHF 99 per TEU in quarter 2 this year. This was driven by the selective growth, a better cargo mix, more small- and medium-sized customers in our business. You know that this is already a 75 -- they have already a 75% share and more refined LCL business in the network growing fast as mentioned before.

Sequentially, we posted a cost reduction of CHF 14 per TEU and slightly higher than previous year cost per TEU and a significant improvement, as mentioned before, of EBIT per car. As always, let me share some year-to-date variance analysis data with you. For Seafreight, the gross profit, the volume effect in gross profit has been CHF 32 million for the first 6 months. The margin effect in gross profit for Seafreight has been CHF 17 million. The cost effect CHF 24 million, resulting into a total effects of an improved EBIT of CHF 25 million.

Let's go through the same exercise on Slide 8 for Airfreight. And the last panel already alludes to our Quick acquisition but not only it's Quick that drives our yield improvement. First of all, the trend of underlying yield strength also extended in quarter 2. So in quarter 1, 2019, and quarter 2, 2019, we saw yield strengths and yield improvements. The margin improved in total by 22% year-over-year with 2/3 of that improvement or CHF 10 or 15% being driven by the organic growth or organic legacy business that we run, the balance being attributable to the Quick acquisition, which amounted to 7% of our Swiss francs.

The EBIT per 100 kilo improved by 15% or CHF 3 sequentially and were stable compared to previous year quarter 2 EBIT per 100 kilo. And the clear contribution of Quick can be seen in the figures on this slide, and I will not go into more details here, but you see that Quick is a driver of margin and EBIT with a very focused solution that is seeing a lot of traction and demand in the market.

Also here, the year-to-date variance analysis GP volume effect in GP, minus CHF 34 million, so less volume, CHF 34 million less revenue or GP harvested. The margin effect counterbalancing clearly CHF 114 million positive margin effect in GP, gross profit. The cost effect minus CHF 88 million resulting into only CHF 8 million less EBIT than previous year.

Let me continue with the other 2 business units on Slide 9, Overland, and I jump directly into Slide 10. I think it's important to reiterate an outstanding performance. The strong operational performance of Overland business continued in quarter 2, 2019. And this is for sure true through the strong European network performance, especially in France and Germany as well as launch of digital solutions. The last launch has been a platform -- a new platform in Asia.

So what contributed to the strong performance of Overland? As said, European groupage and LTL business, the pharma solutions being part of our integrated approach towards the market and new digital solutions. Despite the headwind, which you can see clearly here in the figures displayed, the headwind from currency, we saw a strong net turnover growth of 3.3%, a gross profit growth of 4.9% and an EBIT improvement of another CHF 2 million for the first 6 months of 2019.

And if I may remind you and allude your attention or attract your attention on the Footnote 2, last year, we had a onetime off effect of disposing a business -- an Overland business in Brazil of CHF 7 million. And this has been fully compensated and even overcompensated in the first 6 months through our organic performance -- through the organic performance of our Overland business unit. As said, an outstanding performance, and we can only congratulate the entire team for the successes achieved so far.

Let's jump to the next business unit, Contract Logistics. Here, I would like to mention that the focus on restructuring our contract portfolio and active cost management in Contract Logistics is ongoing. And you see the first effects already in quarter 2. I will come to that later. And the rollout of our new warehouse management system as well as the warehousing technology or the picking technology is ongoing.

On Slide 12, you see some details. And I would like to reiterate what I've already stated in our last analyst conference calls. We continue to restructure our Contract Logistics business and contract portfolio. This includes the review of the entire contract portfolio in Contract Logistics with a clear focus on scaling high-margin solutions, trading benefits for the business units or our leverage areas as we call it, an ongoing investment in technology, especially picking enhancement in new warehouse management systems, and a more selective organic growth in 2019 and beyond on those projects and contracts that we can scale further.

And you see already, if you look into the variance analysis of the business unit, you see already a slower net turnover and GP growth and an improving but still weak performance on EBIT level. And if you look into quarter 2 versus quarter 8 -- quarter -- sorry, quarter 1, 2019, the comparison with previous quarter 1 and 2 show that we get traction and get growth as the previous year's performance. The EBIT contracted in total by CHF 9 million, of which only CHF 1 million were recorded in quarter 2, 2019.

In total, I would state that this is a clear improvement versus previous year performance, and we see that the measures implemented show first signs of traction, but it's still a longer way to go, and I know that the entire Contract Logistics team is adamant to make this restructuring a success.

And now, I'm pleased to hand over to our CFO, Markus Blanka-Graff, to give you some details on the financial performance 2019 first half year.

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Markus Blanka-Graff, Kuehne + Nagel International AG - CFO & Member of the Management Board [3]

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Thank you, Detlef, and also from my side, welcome to all ladies and gentlemen in the audience. I'm on the income statement Page 13. Should be a lucky number at that point in time. Page 13 of the presentation.

Let me start with GP growth over the first 6 months. We have 5.5% GP growth, and let me jump straight into EBIT of 2% growth, which is CHF 10 million. And I think, Detlef has already spoken about its FX impacts or currency impact from translation becomes an, unfortunately, bigger in tax in times of slower growth for the industry altogether.

When you look at the ForEx impact that we report here for about 2.6%, that actually translates into CHF 13.3 million on an EBIT level. And let me just preempt some of the question maybe that may come up on the Q&A session, and let me get a little bit courageous here and think about what is the currency development for the rest of the year. And I think when we look at the current spot rate, we would probably think that there isn't going to be a greater ForEx headwind to expect for the second half year. You see here then we have -- for the main currencies, we have currency impacts of euro of minus 3.4% and pound minus 3%. And only the U.S. dollar is currently with 3.1%. And maybe there is our assumption at least that the U.S. dollar tailwind may actually appear to dissipate for the rest of the year, while the euro and the pound weakness could potentially remain the same or even intensify. On the pound development for sure, I think we would agree all with me that it's highly unpredictable what's going to be in line with what are the next steps for the Brexit crisis. But having said that, it is a material point that goes into our P&L.

Nevertheless, and when we look into the conversion rates that we all try to manage positively, you see in the second quarter 2019, our conversion rate that we target at 16% has improved sequentially from 12.2% to 13.2%.

Let me quickly jump into net earnings because earnings for the period's something obviously that is impacted by various factors when you go down through the income statements, you will see that there is a bit of heavyweight underneath or below EBIT. And some of these impacts, I would just -- 3 of them, I would try to shed some light on it. The first one we talked about is currency impact. On an earnings for the period level, the CHF 13 million probably turning to CHF 10 million. Then we have, what we have alluded to in the Contract Logistics area, we have a frontloading of the IFRS 16 lease contract, which would have a net impact after tax up around CHF 2 million negatively.

And we have -- you have noticed that, most likely, we have a slight increase in the effective tax rate for the group, which accounts for around CHF 3 million. So taking these variances that are more extrinsic than anything else into account, we talk about an impact of around CHF 15 million on an earnings for the period level.

Having said that, CHF 384 million plus CHF 15 million, CHF 16 million adjustment would probably end in around a CHF 400 million operational earnings for the period situation, which means a real operational improvement of 2% to 3%.

However, we want to become better, and when -- I can ask you to flip to Page #14. And the way we want to become better is eTouch. And I think the term is around for quite some time in the industry. And some of the interpretation of this seems loaded with some questions around it. And let us just clarify what we understand under eTouch so that we're all on the same page. eTouch is -- and you can read that. It's not a platform. It's not a customer portal. The portal that is proprietary to KN is KN FreightNet. And eTouch is not a product, so there is no customer who can phone us and say, I want to buy an eTouch there.

It's not a product. It's not a service. eTouch is, if nothing else, call it like a banner or a name for a bundle under which we understand all kind of automation initiatives that are driving operational efficiency. And understandably, operational efficiency through IT is a pillar of our technology strategy. So based on the above statement, an eTouch is defined by the fact that it has a conversion rate about 60% to 80% because it's being executed virtually without any human interaction or very little of that.

So how is that going to unfold? Page #15. And again, addressing on the back of the definitions that we have just given. What is the deployment plan, if you like? Understandably, the eTouch returns will come with call it a hockey stick effect with a lot of backloading into the years '21-2022 because you need to do a lot of automated steps to link them together to drive the conversion rate that we were talking about.

It's most likely biased towards Airfreight business units rather than the Seafreight business units. And clearly, the target that we have given from a volume and from a conversion rate, which we always said are we going to achieve in 2022. We're not going to stop in 2022. That would mean we are going to stop automation in 2022, and obviously, we're not going to do that.

It was a randomly chosen, if you like, date because we went to the Capital Markets Day in 2017, and we thought like 5 years is a good horizon for planning. But automation is an ongoing process, and efficiency gains will really take off after the years 2020.

Under the strict definition of no human interference for any shipment, we would have to report today that there is hardly any shipment, if not any at all, that is entirely automated process as of today. There might be some of them but not all that significant.

So you might ask us why do you actually feel comfortable on embarking on a 5-year journey where I think everybody can understand our endeavors to do that and our ambitions to do it and what we try to target there. The answer is simple. I think Page #16 tells the whole story. I think we have and we want to have and remain in the position to have a very call it, rock-solid balance sheet. Since 2018, the end of 2018, December 2018, we have loaded a debt position on our balance sheet, and when you look today as of June 30, 2019, you can easily see our net debt position is around CHF [219] million.

And I think going forward, you will see that we remain absolutely committed to a small long-term net cash position that we want to have giving our ongoing efforts to demonstrate that balance, that quality of the balance sheet to our stakeholders as much as to our customers. Our currently net debt position demonstrates on the other side very clearly there our willingness to sustain some degree of debt in support of the right kind of acquisition for a certain period of time.

Page #17 is a more technical reminder for all of us, what is the impact of IFRS 16 onto the balance sheet, which we see on the left side, expansion of the balance sheet of around CHF 1.7 billion, CHF 1.8 billion, and on the right side what is the impact or the estimated impact for the full year, which should take most likely the half year 2019 times 2, and you will see what is being done. Here are the CHF 3 million impact that I was talking about pretax from the front-loading of IFRS 16 contracts, which when you discount it for the tax rate -- for the tax shield, you would probably come to around a 2% plus.

Page #18, cash and cash equivalents. I think over the last 6 months, we have been quite discussing intensively with some of you about what is our cash generation capabilities and what is the free cash flow generation of the business. And I have to say, I think the second quarter free cash flow performance is an extension of the success that we have seen in the first quarter to improve our working capital performance mainly on the back of a much better intensified discipline across all business units. Clearly, we're not going to stop now. We're going to continue building upon this success also into the second half and going forward into 2020.

You have heard from Detlef that the restructuring of the Contract Logistics business entails some of our freeing up of working capital and capital itself. So far, the first half year result 2019 does not include any significant gains of that project, of the reduced Contract Logistics scale.

You see here on the Page 18, we have good working capital as the main driver, CHF 157 million more than we did in the same period last year with cash and cash equivalents net at the point in time, CHF 385 million more than last year.

Page #19. Just to refer back to our conversation a quarter ago, I think one of the questions has been how it's going to beat the trajectory because we have shown the CHF 114 million as free cash flow development in the first quarter. And I said at that point in time, well, the starting point is higher, but the trajectory should actually be the same as it has been in the last couple of years. And I think the second quarter confirms that development.

More details on Page #20, where it's coming from, maybe as a more closer reference point, the first quarter 2019 has shown a net working capital of CHF 1.141 billion and is now CHF 1.033 billion. So from a quarter to a quarter, we have improved by CHF 108 million, which also explains that we are now sitting comfortably, again, within our corridor of net working capital intensity, which means 3.5% and 4.5%, right in the middle at 4% where we were still in the first quarter 2018 at 4.5%.

That manifests itself over the -- also on return on capital employed, Page 21. Again, we have these 2 lines, the 1 including the acquisition impact and the dark line excluding acquisitions, which is nothing else than the consolidation of the balance sheet of the 2 acquisitions of Quick and Sincero, so the difference between these 2. And you see, operationally, we think we have reached an inflection point in the fourth quarter 2018 with around 58%.

Moving finally to Page 22, where the left side of the slide confirms our financial targets going forward. Conversion rate, 16%. I talked about it and also underlined the importance of the eTouch initiative to get to that point. Return on the capital employed excluding acquisitions, up above the 60% again so walking slowly the path towards the 70%, and effective tax rate at around now 23.5%. We will see how that's going to play out further in the year. Working capital intensity currently at the 4% with confirmation of the corridor 3.5% to 4.5%.

With that summary and confirmation of our financial targets that we want to achieve, I would hand over back to Detlef for the volumes in KN 2019 and the market.

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [4]

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Thanks, Markus. Let me start with the market outlook. We have confirmed the market outlook for Overland and Contract Logistics and have also confirmed the market outlook with the 2% growth for the whole year 2019 for Seafreight. We have nevertheless changed the market outlook for Airfreight. Given the quarter 2 market in Airfreight, there is no reason to believe that we will see a 5%, 6%, 7%, 8% growth in the second semester, which would have been required in order to show a flat market development in Airfreight for the whole year 2019. So we assume that the market will stay at a level of minus 4% to 5% volume growth in 2019. If you compare last year's growth rates and if you look back to 2017, that would still imply a year-over-year market growth of approximately 2% year-over-year.

Our ambition is to outperform market growth in all business units. But -- and there is a big but. But we have focused more and more on a selective growth. In Seafreight, we will -- and we have seen that, in quarter 2, we are more selective with the customers we grow with, especially our focus on small- and medium-sized enterprises do not provide high volume but interesting business. And here, we will focus -- or continue to focus on.

And in Airfreight, we are not aggressively replacing lower volumes at all prices, so we focus here also on sustainable business. I told you already when I explained some details on the Airfreight performance that we have not lost any major customer in Airfreight, but we have down-trading customers in the sectors of automotive and industrial. And we have one new business which we believe will become part of our volume -- will become -- the volumes will become part of our networks throughout this year. So we will for sure grow better than market, but at the moment, we are a bit cautious to give a financial or a figure with regards to our volume growth rate. But the ambition stays but not at all price or cost or at all margins, so to say, yes?

Overland, no change. Eventually, we should see some lower volumes in the market reflecting an Airfreight market not to be seen yet, but our ambition is to grow twice as fast as market, so more than 4%. And Contract Logistics, we mentioned that before, the restructuring of the contract portfolio will eventually lead toward effect -- a wanted effect of lower growth, a consolidation, and we expect long term or mid-term to grow on market level in Contract Logistics exactly with those contracts, with those customers, in those industries which we can scale throughout the organization and which have cross-selling effects also to our network business.

All this leads to a market outlook that we stay cautiously optimistic for a second semester 2019 that our targets and ambitions in total for the group shall be achieved, but it will be a tough ride in a tough environment. And this is what we all, our whole colleagues around the globe, will be working for. Thank you very much, and I hand back to Maura to open the Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Aymeric Poulain from Kepler.

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Aymeric Poulain, Kepler Cheuvreux, Research Division - Head of Support Services Research [2]

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I've got 2 set of questions. The first one is on your eTouch definition that has been now narrowed to certain extent and the chart that you put in the slides about the back-end weighting of the progress. Just to be clear, does that mean that we should not expect a major move in the conversion ratio of the Airfreight division until 2022? Or should we expect to see some progression as the automation of the back office and the rest of the operation continues to grow? And secondly, you mentioned some initiative in Asia with the rollout of a digital platform for Road. Could you give us a bit more detail in terms of the size and the ambition in the region with that platform? That would be helpful.

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Markus Blanka-Graff, Kuehne + Nagel International AG - CFO & Member of the Management Board [3]

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Aymeric, it's Markus. I think clearly eTouch is a bundle of automation initiatives. And yes, there is going to be a gradual improvement on the conversion rate for sure. But there is going to be a -- the bigger effect comes when -- and we've talked about it on several occasions. The bigger effect is going to come when multiple steps within an execution are being automated and being linked together.

There is various other drivers for conversion rate. And when you look into our first and second quarter results in Airfreight, we have already improved conversion rate, again, from 24.5% to 27.5%. And I try to avoid confusion here because you were talking about the back-office function. Back-office functions obviously are on a, let's say, different pace. They go into shared service center, into knowledge center, into automation on their own, but this is not directly connected with the eTouch initiatives. So back office is always going to move forward in their endeavor to be more efficient.

The eTouch is, what I said, there is a gradual deployment of automated steps within an execution chain. And that will obviously benefit in many different ways, each and every shipment. But the significant impacts that you will see on our -- in that context, not so small income statement, that is going to be back in 2021, 2022.

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [4]

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Good afternoon, Aymeric, Detlef speaking. Regarding the digital platform in Asia, the question related to Overland. First of all, let me say, we have a couple of digital platforms out in the market for many months and years. The most important one is KN FreightNet. Markus mentioned that. A quote book track platform that we launched 5, 6 years ago, which offers solutions across all business units.

We have myKN out for customers to book directly on our operating system and to get access in a self-parameterized dashboard for their specific needs, access to our operating system and KPIs and information and everything. And we have real-time predictive analytics platform. Our Sea Explorer is one which we mentioned, KN ESP or KN eTouch.

Overland has always been part of that digitalization strategy. They are part of a KN FreightNet approach in Europe very successfully. And they have started in Thailand a platform for LTL business, asset-light, no assets on our side to start with and that will be rolled out in South Asia Pacific food stock. there will be no other market that we will address this solution in Asia with for the time being. So that is the answer for digital platform in Asia. We have global platforms running across all business units, and there is a very specific approach made by Overland in Thailand, which I mentioned before. It's called eTruck now.

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Operator [5]

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The next question is from Damian Brewer from RBC.

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Damian Brewer, RBC Capital Markets, LLC, Research Division - Analyst [6]

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Three questions, if I can, please. You already alluded to the air volumes down over 8% in Q2, but clearly the automotive industry in particular was a challenged environment then, and that generally seems about a 1/10 of Airfreight volume. If we're to look at that business ex auto, could you say a little bit more about what that looked like and whether there's anything to pull out there beyond the perishables and pharma that did a little bit better than that?

Secondly, just looking at the supply chain durations now in terms of sort of, if you like, product to end consumer, whatever that end consumer is in the supply chain. They now look like they are sort of approaching levels of the Euro crisis and almost close to 2008/'09. So if we do begin to see supply chains pull out a bit, how ready is the air business if there was suddenly a surge in restocking demand? And how do you ensure that gets staffed without putting extra fixed costs into the business that might not be sustainable in long term?

And then very finally on Contract Logistics. Obviously, you mentioned that sort of the -- some of the restructuring efforts have yet to come. So can we take from that, that most of the working capital developments in H1 was due to the low volumes in the air and sea business. And then actually, there is better on the working capital to come from Contract Logistics? And if so could you give us an idea of what you can do there?

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [7]

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Right. Okay. Let me start with the air volumes. So first of all, automotive is significantly down. We were the market leader in Germany and in Europe in automotive Airfreight, working for all the OEMs and suppliers. And we see a big, big reduction in main deck capacity, in the demand of main deck capacity as well as in our network, yes? The perishable volumes, and you know that approximately 1/3 of our entire volume is perishable, is agnostic at the moment to any cycle or consumption factor -- pattern.

We see steady growth in perishable volumes throughout our network on all trades, and the same is true for other industries like the consumer goods industry. Consumer gross consumption is ongoing. So it's really automotive, and I would include industrial as the 2 verticals that are down-trading, and automotive is significantly down-trading double digit at the moment, yes?

We expect no stabilization at the moment or no bounce back or a return to growth, again and maybe a stabilization of the volumes in quarter 4. It's too early to say how the next couple of months will progress. And you saw profit warnings of the OEMs in supplier industries. I think there was one supplier announcing figures today in Germany. It was -- there's a huge profit warning. So we see that these volumes, the volumes that they continue to ship, they try to avoid the more costly airfreight obviously but they continue to do business with us in other modes of transport.

The second question was the supply chain...?

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Damian Brewer, RBC Capital Markets, LLC, Research Division - Analyst [8]

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Duration and the restocking question.

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [9]

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So the restocking question is a very good question. So there might be a certain effect of stock levels having being built up and are now being used or deployed for the markets. And if we will see a restocking effect, we should see that in quarter 4 prior to year-end. There are no new trade noises in the market, and remember, there was a hard push to improve or increase stock levels end of last year. And all this virtually evaporated second half of December 2018 when the final decisions on any new trade tariffs has been postponed, not for infinity, but I think at that time, it was postponed to March or so.

And these effects we might see. At the moment, we would not have any special effect on -- no sign of restocking at the moment. But we also have no sign of a peak season. And remember, 2 years ago, we had a similar situation, and at the moment, both in sea and airfreight, we have a normal seasonality but not the hard push, the hard move for higher demand going through a peak season. So that would be my feedback on the supply chain and working capital. Maybe Markus can give you some flavor on that.

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Markus Blanka-Graff, Kuehne + Nagel International AG - CFO & Member of the Management Board [10]

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I think Damian, yes, you're right. I think and I also mentioned it that the improvement of working capital in the first half have been predominantly coming out of the network business this year, freight and Overland. The effect from the Contract Logistics restructuring remains still open. And I think it's safe to say that we at least anticipate as much as a triple-digit million reduction in working capital. But obviously, that's not going to happen in 2019. I would expect a full impact of this in the year 2020.

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Operator [11]

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The next question is from David Kerstens from Jefferies.

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David Kerstens, Jefferies LLC, Research Division - Equity Analyst [12]

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Two questions, please. First on the follow-up question on the developments in airfreight, particularly the yield improvement. I appreciate the mix effect from the Quick acquisition, but with the perishables growing and automotive and industrial down in the quarter, would that not have led to a negative mix effect on the yield? And what has been offsetting that affect? If you could provide more color on that would be very helpful.

Then on the seafreight volume momentum, I think, the market picked up somewhat in the second quarter based on your commentary, but your volumes slowed in the second quarter, almost driving that. Is that the more selective approach with customers? And what are you seeing on the transpacific following the increase in tariffs on U.S. and Chinese imports to 25% as of May? Is that the main reason why you keep the guidance for the year at 2% despite a somewhat better-than-expected development in the second quarter?

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [13]

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Right, right. David, let me start with Seafreight volumes. First of all, we don't see any additional effect on the transpac than what we have seen already through the tariffs, yes? And for sure, higher tariffs have a volume effect, but eventually, the strong consumption in U.S. is offsetting that, and the consumer is willing to pay the loaded cost of the tariffs through a product. And we see this happening at the moment.

The Seafreight volumes, we are not inducing a price war. So we are very carefully growing our business. There is a strong focus on SME account, but small- and medium-sized enterprise, the word already implies for our customer, lower volumes, higher maintenance, so we will not see spikes in volumes through 1 or 2 new contracts that we win. We win a lot of business in Seafreight, but it's all in the SME arena, yes?

The transpac at the moment, I would say, is bottoming out, and I would expect that it's picking up again. And that would be a good thing there for the peak season, the Christmas season, so to say, that we would expect. Too early to say, but at the moment, it's getting a bit more tailwind on the transpac.

Nevertheless, our selective growth approach in Seafreight remains, and the same is true for Airfreight. In theory, your negative mix effect is true, what you have stated before at perishable and automotive. Perishable stable, automotive down-trading, but we have a lot of market opportunities in the current utilization of the carriers to find the right carrier for the demand of our customers.

Also we grow in pharma, I mentioned that before, and also in aerospace. So there are market segments that still post strong growth, and the aerospace sector as such is not only served by Quick with time-critical shipments, but may I remind you of the KN InteriorChain. We have won more than 250 planes to be refurbished -- the interior to be refurbished with 10,000 serial numbers going into each and every single plane, so we post a lot of volumes coming from that side, yes?

And we are very -- we have a preferred carrier policy, so we are very selective with our carriers, which helps to partner in a tough environment for both sides.

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Operator [14]

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The next question is from Robert Joynson from Exane BNP Paribas.

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Robert John Joynson, Exane BNP Paribas, Research Division - Senior Transport Analyst [15]

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Detlef and Markus, I've got a few questions, if I may, mainly focused on the cash flow. If I start off with working capital, since 2008, the cash flow from working capital movements has been better during H2 than it has been in H1 during every year other than n 2009. So it's 10 years out of 11. Is there any reason why that seasonality won't repeat in 2019? So that's the first question.

The second question on CapEx. It was obviously higher during H1 of this year than it was during H1 of last year. Is the expectation though that the CapEx for 2019 as a whole will be lower than that seen during 2018?

And then the final question. There was some talk in the market this morning that the improved cash flow was helped by higher reverse factoring. Could you perhaps just comment on whether that was correct? And maybe also just help to quantify the impact if possible.

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [16]

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Absolutely, Rob. Very good questions, actually. And I like the Excel sheets that go further back than 2008. Maybe we find some to quote on 1994. But yes, I mean there is no reason to believe that seasonality has changed dramatically because, as I said also in the last quarter, there is -- the trajectory for the year should be remaining the same.

Interesting enough, I think you actually hinted to the answer yourself of this, was that we have a little bit higher CapEx in the first half in 2018 -- '19 compared to 2018. So yes, there is a stronger cash flow coming in, in half 2 -- or in second quarter than it was in the first quarter, albeit that we also had a little bit of higher CapEx offsetting that.

So I would not see any change in pattern in that context. And my conviction is that, for the second half, so quarter 3 and 4, we would pretty much be in line on the same trajectory as we had been, at least for the recent future.

The question is the CapEx going to be lower than 2018 total number? I don't think so. We have all the adjustments that we have planned for the restructuring of Contract Logistics as I mentioned. The majority will be effective in year 2020 rather than 2019. So we're still running on a similar CapEx budget than it was in 2018.

Factually, I might be wrong when we then look into the fourth quarter in isolation because there is a clear expectation from my side that, that -- as well as from the management side is that, in the fourth quarter 2019, we will see a reduced CapEx. However, not be enough did we go back into the level of 2018.

And last question on the reverse factoring. We call it our supply chain finance concept, so it is a reverse factoring as such, a program that picks up in year's speed. We are now processing around USD 500 million, USD 550 million volume through that supply chain finance system. The change between quarter 2 to quarter 1 would not be significant enough that it would drive a lot of the improvement of the cash flow.

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Robert John Joynson, Exane BNP Paribas, Research Division - Senior Transport Analyst [17]

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And maybe just one final question, just using my same spreadsheet that goes back to 2008. If I look at the free cash flow, excluding acquisitions and disposals, I actually get the same conclusion that it's been better during H2 and H1 during every year other than 1, which was actually 2009. So we all know what happened then. I mean is there any reason why we won't see the same seasonality for 2019, and I guess, you may have answered the question.

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [18]

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Yes. As I said, Q3, Q4 I think will follow the same trajectory as such the same seasonality as it has been for many years. And let's not forget, the major driver is still an improved profitability. And at the end of today, we will improve profitability in the second half.

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Operator [19]

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The next question is from Bruce Chan from Stifel.

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Jizong Chan, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP & Equity Research Analyst [20]

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I want to ask quickly about IMO 2020. I know that we've talked about it on previous calls, and the party line is that it's going to be a pass-through, but if we look at the balance of this year or the early part of next year, what kind of rate increases are you anticipating? And what do you think the magnitude of effect on gross margins will be for next quarter or for fourth quarter? Is there anything special about how you're positioning ahead of the increase?

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [21]

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So at the moment, and we have made a couple of statements on IMO 2020. From a sustainability and responsibility point of view, that very desired to have a low-sulfur solution in place and forced into the market. That will load or that will lead to tariff increases. There are different scenarios, but we will see a tariff increase that reflects the higher cost. And for us, it will be a pass-through. We have discussions with certain customers already. We can offer alternative solutions hedging that risk, if it was a risk, but at the end of the day, the higher cost will be the cost of shipping containers versus this lower sulfur. I would assess that the overall cost increase per TEU will be around CHF 150, but it depends on the trade, and depending on the trade, might be higher or lower.

But that could be a good indication. For us, a pass-through, no effect on gross profit, to answer this part of your question.

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Jizong Chan, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP & Equity Research Analyst [22]

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Okay. Even temporary?

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [23]

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Sure. Because it's not a surprise. We know about it.

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Jizong Chan, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP & Equity Research Analyst [24]

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And do you think that the rest of the industry has been planning similarly? Or do you have...

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [25]

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You have to ask the industry, Bruce. Sorry, Bruce, you have to ask the industry. At the moment, there have been different conferences, and we are all in the same boat, virtually. And I would be surprised if somebody acts differently. But hard to say.

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Jizong Chan, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate VP & Equity Research Analyst [26]

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Okay. That's fair enough. I'll leave it there then. And just the second question. I think you mentioned that, despite some of the lower volumes on Airfreight, you are seeing some business wins that maybe haven't hit the books yet. Are those coming from customers that may be leaving some of your competitors ahead of the tie-up? Or is there another source?

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [27]

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I think you find customers always going for our views to look for a strong and reliable solution. And yes, our new customer wins reflect our strengths in Airfreight and the solutioning behind our Airfreight network. You know that we sell a lot of the KN whatever chain solutions. And I've mentioned InteriorChain, but we have BatteryChain. We have PharmaChain and so on. And the customers are very alluded to those solutions. So we will see new customers wins becoming part of our Airfreight network in the second semester. And these customers will show a certain effect. But that will be far away from an annualized volume effect because we have to be ramped up, volume starts then in August or September and will slightly increase. Don't expect wonders in your models from that side. But it gives me as CEO of the group the confidence we have not lost any big business. We are able to win business with our high-end and complex solutions and create a benefit for our customers. And that should speak for a very solid second semester in Airfreight.

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Operator [28]

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The next question is from Christian Obst from Baader Bank.

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Christian Obst, Baader-Helvea Equity Research - Analyst [29]

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First of all, you issued a very favorable CHF 400 million bond. Have you any special idea of what you -- what is the idea behind that and where you like to use the proceeds for? Then going towards CapEx, what are the plans until 2022? Currently, do we stay at the current level? Or when we come to 2022, is there an increase in the acceleration of cash out maybe for IT or something like that?

Then I have to come back to the IMO issue. Is there any early import maybe to the U.S. before the Christmas season, maybe because of some scarcity of capacity going into the second half? And the last one. Do you see any volume impact from the DSV Panalpina issue?

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [30]

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So I will start with the last 2 questions, Christian. So first of all, no volume effect from any merger in the industry, also not from CEVA being bought by CMA CGM or others. So customers continue their normal RFQ pattern and waves, and we select those customers we want to do business with and if they're successful or not. So nothing has changed here.

The IMO 2020, we do not expect any rush volumes or stock build-ups through IMO 2020 because it's not a onetime effect. It's an ongoing tariff improvement, an increase, and building up stock is also very costly. And given the size of the IMO -- the expected size of the additional cost driven by IMO, I would not -- we would not expect any special peak or stock build-up as said before.

Now for CapEx and bond, I'm happy to hand over to Markus.

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Markus Blanka-Graff, Kuehne + Nagel International AG - CFO & Member of the Management Board [31]

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I think let me start on the CapEx. You're aware of the restructuring of the Contract Logistics business. I think we should see -- as in the next couple of years, we should see slightly reduction on the CapEx, and then we go through the year 2020, 2021, maybe on a reduced level. And eventually, I think when we find the right size of the business with the right returns, then that will come to that level that we like to have.

From that level, I cannot determine yet from a 2022 perspective. What I can say is because you mentioned IT that there is no capitalized IT cost on our balance sheet as it has been forever. So IT is not driving any of that.

And the first question obviously on the bond, that on the 2 bonds actually that we have issued CHF 200 million each, I think the very clear answer is the financing of the Quick acquisition has been done with, let's say, an intermediate staff from December until the issuing of the bond in June. And that bond replaces literally that bank debt that we have taken on in December.

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Operator [32]

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The next question is from Frans Hoyer from Handelsbanken.

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Frans Hoyer, Handelsbanken Capital Markets AB, Research Division - Analyst [33]

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A question regarding the effect of automotive. I understand it's been quite heavy in the Airfreight operation. Has it had any impact on any of the other business segments, please?

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [34]

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Frans, for sure. If the automotive industry can avoid flying axles or gearboxes and put them into containers again, it has an effect, but you know that one freight main deck capacity ends up in 8 to 12 containers maximum. So it's homeopathic volumes in the Seafreight business. But it's significant missing volumes in Airfreight, and that is maybe the equation.

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Frans Hoyer, Handelsbanken Capital Markets AB, Research Division - Analyst [35]

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Got it. And has there been any fallout from this in the Road business at all?

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [36]

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Not to my knowledge.

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Operator [37]

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The next question is from Alex Irving from Bernstein.

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Alex Irving, [38]

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Two questions from me, please, both on eTouch. First of all, you previously set up targets for 2% to 4% of Seafreight volumes and 10%, 20% of Airfreight volumes as eTouch by 2022. And if you can please confirm whether there's been any changes to your thinking around those targets? Secondly, can you please give us some color around how shippers and carriers are responding to automation initiatives in Airfreight? Are you encountering any bias to adoption there and how you're thinking about finding ways around that?

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [39]

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Alex, I think first question, yes, entirely confirm the number. So yes, we want to have by 2022 of automated volume on Seafreight 2% to 4%. And actually, in Airfreight -- excuse me, in Airfreight we were saying 20% of the addressable volume, which was 45%. So that would translate into 9%. That's just to get the numbers in line.

On the second question on how receptive carriers are. Of course, carriers are actually very supportive and very cooperative as it will also support their own cost structure. And from a, let's say, conversation perspective, we are in Sea and Airfreight, in both areas, we are a top customer if not #1 customer of the carriers as well. So we find a lot of open doors, if you like, but since -- and that is I think reality. It has to do with IT. Some of these questions or some of these open doors seem easy to walk through but not necessarily easy to get into reality. So I think we find a lot of, as I say, cooperation and everything because I think there is a win-win situation since it's going to take out a lot of manual work on both sides. But there is also the reality that needs to put electronic communication between machines in place.

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Operator [40]

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The next question is from Sebastian Vogel from UBS.

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Sebastian Vogel, UBS Investment Bank, Research Division - Director & Sell Side Equity Research Analyst [41]

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I have 3 questions. And the first one would be if can you remind me on -- of the FX impact on net forwarding revenues in both sea and air? And the other question would be in the press release you mentioned that you are addressing currently the significant changes in Airfreight market conditions. Was wondering if that coming -- this addressing these issues, would that cause some cost raisings in terms of making people redundant and so on? And the last one would be on the SG&A cost as a percentage of gross profit on the group level. That came down in the second quarter. Is that a sort of a run rate we can think of going forward? Or how should we think of that? That would be my 3 questions.

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [42]

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Okay. Sebastian, let me answer maybe the last 2. I think the SG&A cost, the run rate I would confirm. It's our aim to improve productivity and overhead cost permanently. And it's not new. It's not related to this year or the previous years. Airfreight market changes, we -- also in Airfreight, we have -- we employ temporary labor. And we will breathe with the market. At the moment, there is no major redundancy wave running throughout the organization, if that was your question.

We don't see any necessity. Foreboarders -- experienced foreboarders are a scarce resource, if I may say so are very rare in the market, especially in some of the growth markets like Asia or even in North America. So we have to make sure that our experts stay in the organization and pursue their career within the organization. So that was the answers for the 2 questions. And FX in sea and air?

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Markus Blanka-Graff, Kuehne + Nagel International AG - CFO & Member of the Management Board [43]

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So I think the impact on turnover for Seafreight is around 3% and Air 2%, each of them minus 3% and minus 2%.

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Operator [44]

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There are no more questions at this time.

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Detlef A. Trefzger, Kuehne + Nagel International AG - Chairman of Management Board & CEO [45]

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Thank you, Maura. Then let me close the call. First of all, thank you to all of you for joining us on our analyst conference for the half year 2019 results of Kuehne + Nagel International AG. We enjoyed the call as always very much. As said and I have posted this internally to all of our colleagues worldwide, we face a tough market environment and even markets that are consolidating, but at the same time, we have surfed the high waves very well, and we are confident that the second semester we will be able to achieve our target, and in total, as Markus has said already, show higher results at the year-end 2019.

And to see whether we got traction in quarter 3, we invite you to join our next analyst conference call on the 22nd of October. We look forward to this, and in the meantime, we wish you summer break and enjoy the time with your spouses and families. Bye-bye.

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Operator [46]

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Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call, and thank you for participating in the conference. You may now disconnect your lines. Goodbye.