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Edited Transcript of SFSN.S earnings conference call or presentation 19-Jul-19 8:00am GMT

Half Year 2019 SFS Group AG Earnings Call

HEERBRUGG Jul 23, 2019 (Thomson StreetEvents) -- Edited Transcript of SFS Group AG earnings conference call or presentation Friday, July 19, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Jens Breu

SFS Group AG - Chairman of the Executive Board & CEO

* Rolf Frei

SFS Group AG - CFO, Member of Executive Board & CEO of SFS Services AG

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Conference Call Participants

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* Armin Rechberger

Zürcher Kantonalbank, Research Division - Analyst

* Jörn Iffert

UBS Investment Bank, Research Division - Director and Analyst

* Marta Kinga Bruska

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Michal Lichvar

Bank Vontobel AG, Research Division - Analyst

* Tobias Fahrenholz

MainFirst Bank AG, Research Division - Director

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to the presentation half year results 2019 conference call and live webcast.

I'm Alessandro, 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 Mr. Jens Breu, Chief Executive Officer. Please go ahead.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [2]

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Good morning and welcome to the presentation on our first half 2019 results.

Today's speakers are Rolf Frei, CFO; and myself, Jens Breu, CEO of the SFS Group. The agenda over the next 60 minutes will be key takeaways, development by segments, development of key financials, updated guidance 2019, Q&A before closing.

I will start with the key takeaways first half 2019, which can be best summarized as modest growth in a challenging environment. Nevertheless, our strong position with customers has been confirmed with ongoing successful acquisition of major new projects throughout all segments.

Sales increased in the first half 2019 by 1.4% to CHF 867.8 million. The market position in the U.S. was strengthened by the acquisition of Triangle Fastener Corporation, overall strongly contributing positive to the consolidation effects of 4.6%. Organic sales development ended at minus 2.4%, burdened by weaker economy and trade tensions. Earnings are marked by the mix effects and demand-driven fluctuations in capacity utilization. An adjusted EBIT margin of 12.6% resulted, compares to previous year 13.6%. Onetime effects of minus CHF 3.7 billion have been considered for in the adjusted EBIT margin.

Measures to cope with the challenging environment and to strengthen profitability have been implemented. Further, a successful and seamless commissioning of the new manufacturing platform in Nantong, China can be reported for. For the second half 2019, we expect overall a slightly better development due to seasonal effects and new product introductions.

Continuing with the development by segment, starting with the headlines of Engineered Components segment where challenging markets burdened performance.

Sales decreased to CHF 454 million, minus 3.6% in local currency, compared to a strong prior year period. The decline is driven by challenging Automotive and Electronics market conditions, starting in Q4 of 2018. On the positive side, continued dynamic sales growth was achieved in the Medical division. Correspondingly, profitability was burdened by mix effects and fluctuations in capacity utilization. Corrective actions have been taken to recover the adjusted EBIT margin of 16.1%. Besides, our strong position with customers is unchanged, as evidenced by the attractive new project wins as later on especially seen in the Automotive and Medical divisions.

CapEx spend is reduced, as expected, by 16% compared to prior year, reflecting the completed commissioning of the Nantong site north of Shanghai, China. Sales is expected to increase in the second half 2019 due to new product introductions and seasonal effects.

The key messages of the division Automotive: weak demand, but attractive new projects acquired further underlines the just mentioned development of the segment; relevant global car sales running at minus 8% to minus 6%; and adjustments in the supply chain taking longer than expected, impacting first half 2019 performance. Ramp-ups of innovative customer projects are generally on track, however, with limited impacts due to weak demand. Sales run rate of the Automotive division is at minus 4.3% to previous year and plus 4% compared to second half 2018. Stable innovation trends and our strong position as engineering partner fueling the project pipeline. The first half 2019 EBIT profitability increased versus second half 2018 by 4.9%. Business is expected to remain flat during second half 2019.

The key messages of the division Electronics follow along the same characteristics as we just have heard with the division Automotive. Due to last year experience and in the first half of 2019 further escalating trade tensions, we see an impact in behavior of end users on supply chain in Electronics alike. Demand stabilized below levels of the prior year period. The relevant smartphone shipments are expected to land the full year at minus 14% year-over-year, and HDD drive builds at minus 15% year-over-year. The impact to the Electronics division is expected to be offset with new product line introductions on a full year basis besides expecting a seasonal pickup of demand due to new product introductions by our customers in the second half of the year. Thanks to capacity adjustments and productivity gains, profitability has been successfully defended. The commissioning of the new manufacturing platform in Nantong has been completed as planned, hosting all SFS core technologies, serving as strategic hub also for Automotive, providing ample capacity for future growth.

The division Industrial returned with its Aircraft business back to growth. Still the overall sales development of the division is slightly negative in trend because the individual business areas of which the divisions is composed of are developing unevenly. The Aircraft business returned back to the growth track, as expected, due to the ongoing ramp-up of the Airbus A350; strong capabilities in micro injection molding, providing as well additional growth opportunities in dental applications, drug delivery products. Therefore, a site expansion project at Stamm in Switzerland of the microinjection competence center of SFS has been launched and is expected to be completed until mid-2021. The division expects a further stable development in the second half of 2019.

The key messages of the division Medical can be best summarized with continued dynamic sales momentum. The strong sales trend 2018 has been confirmed and accelerated in the first half 2019. Successful customer project launches in the application areas of sports medicine, urology and vascular surgery have been achieved; improvements in productivity supporting the positive margin development program. The standardized production machine part of multiple sites confirmed to be a competitive advantage. Based on a robust project pipeline, we expect the positive trend is to continue.

Coming to the headlines of the Fastening Systems segment, where the market position in the U.S. has been substantially strengthened. Strong sales growth of 16.6% to CHF 248.3 million has been achieved, driven by the consolidation of HECO and TFC representing 20.4% sales growth contribution. However, the organic development with minus 8 -- 1.8% and an FX impact of minus 2% are showcasing the [diligent] trends among the divisions. In the Construction division, stable demand can be reported, driven by the construction industry and on top by the positive consolidation effects as mentioned. In the Riveting division, a significant drop in demand from automotive and industrial customers has been accounted. Accordingly, the EBIT margin remained at 9.4%, with that matching prior year level but also not improving as envisioned. Going forward, we plan our activities on a continued strong project pipeline and expect a stable development of the business in the second half of the year.

Looking into the details on the progress with the division Construction, we can summarize that we have experienced an ongoing positive development. Organic growth momentum continued at a slower pace than in 2018. Progress is probably supported by several business units, including the important flat roof applications. The division is clearly benefiting from the new and close collaboration with TFC and HECO, hence having significantly strengthened the position in the U.S., achieved an expansion of the product portfolio with innovative solutions like in timber construction. Trends to greater safety, energy efficiency and building automation continue to be key areas of innovation and further growth. The positive trend is expected to continue in the second half 2019.

With our new entity Triangle Fastener Corporation, the acquisition stage has been completed, and the integration passed; and projects started with good spirit. The strategic rationale behind the acquisition: gain of direct access to a broad customer base through a well-established sales network in the U.S., realizing of cross-selling potentials, strengthening of the competitive position in the U.S. construction market. The TFC facts and figures in a nutshell are sales of slightly larger than USD 70 million in 2018, 200 employees at the end of 2018, 23 proprietary sales offices in 15 states, about 6,000 active end customers.

Coming to the key message of division Riveting. Further development was burdened by weak demand caused by a significant exposure to the automotive and general industrial markets, mainly in Central Europe, as well as by the uncertainty due to Brexit strongly impacting the business development. The corresponding shifts in capacity utilization rates, clearly having impacted the earnings. Capacity adjustment measures have been taken to mitigate impact on earnings. On the positive side, the strong competitive position has been maintained without a doubt. Thomas Bamberger left the SFS Group. Urs Langenauer, former head of division North America, took over. Due to unchanged challenging markets, no material change is expected to the business trend in the second half of 2019.

Coming to the headlines of the Distribution & Logistics segment, where continuous growth of the customer base has been achieved; along with a slightly positive organic growth of 0.3% to a strong prior year period, resulting in segment sales of CHF 165.3 million. The development is attributed in particular to the tools business, e-Shop and retail stores. The May 2018 divestment of security system business and currency headwinds in the current year, negatively impacting sales and totaling with minus 2.9%. The positive 2018 earnings trend has been maintained with the adjusted EBIT margin of 7.9% or plus 70 basis points year-over-year. Reported earnings benefited from book gain on the sale of a property in Switzerland. The positive trend is expected to continue in the second half 2019.

On the operational side, Distribution & Logistics has initiated a project to further optimize its logistics operations, this to ensure efficiency and competitiveness by transfer of management responsibility and sale of the logistic infrastructure in Emmenbrücke, Switzerland to an external service provider by the end of 2019, subsequent relocation of further logistic operations from Bäretswil to Emmenbrücke in late 2021. Afterwards, all Allchemet or [harbor trade based] logistics activities will be consolidated and operationally focused at one site. The new concept will result in reduced number of customer shipments, benefiting both SFS' customers and SFS alike. The envisaged setup is planned to be fully operational by the beginning of 2022.

With that, I conclude my explanations and will now hand over to Rolf for covering the development of the key financials and the updated guidance for 2019.

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Rolf Frei, SFS Group AG - CFO, Member of Executive Board & CEO of SFS Services AG [3]

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Good morning and welcome. Rolf Frei speaking now.

Here is the development of our key financial data.

The first slide shows the influencing factors of the total growth of 1.4% year-on-year. Dominating factor as to widening of the scope is the first-time consolidation of HECO January to June and TFC from April to June. The total net consolidation effects amounted to 4.6% growth year-over-year.

The organic growth suffered from the mentioned customer-driven lower demand in Automotive and Electronics. The first 6 months were 2.4% weaker than the previous first half year. The average organic growth of minus 2.4% is also due to a strong base effect. As you can see, the organic growth in the first 2 quarters of 2018 was running at the pace of around 7%. The quite weak quarter 4 2018 continued into quarter 1 2019 with a drop of 3.1% year-over-year. The Q2 of 2019 was somewhat better and came out at an organic growth of minus 1.8%. This was disappointing, as we anticipated at the beginning of the year a faster acceleration of the economy already from Q2 onwards.

The end markets got shifts towards Construction and Medical. Construction is up 370 basis points to 30% of total group sales, which was driven by slightly organic growth and the first-time inclusion of HECO and Triangle Fasteners. Medical had a strong double-digit organic growth and is now up by 130 basis points to 7.5% of total group sales. In return, the share of both Automotive and Electronics came down by a bit more than 200 basis points.

For the first time, the region America contributed with more than 20% to the overall group sales. This increase of 360 basis points was supported by organic growth, the acquisition of TFC and a slight positive currency effect. By contrast, the Asian market region lost 230 basis points and stood at the sales share of 16.6%, mainly contributed by a market slowdown in the HDD and smartphone business.

The adjusted operational margin stood at 12.6% after the first 6 months of this year, against the 13.6% last year. The backdrops were: a, the insufficient capacity utilization due to lower customer demand; and b, a substantial change in the sales mix due to varying growth in the end markets. This resulted in a shift to below-average EBIT margin businesses. We estimate this mixed effects to have a negative impact of around 50 basis points on EBIT. The onetime effects have already been mentioned. This reduced reported EBIT to CHF 105 million.

Still on the operating profitability. We can trace that, in the past, the second half year always was stronger than the first half, not so much in 2017 where the second half year was burdened by high advance outlays, for example, the power adapter; material cost increases from suppliers and currency related in Switzerland; but also from the one-off costs in optimizing the supply chain in Fastening Systems. However, in the other years, the second half year is noticeably better, and we expect a similar trend this year.

The exposure of the Swiss franc operating expenses trends to a further decline of total operating expenses. After 6 months, we have 38% moved into the strategic target range of below 40%.

The net working capital at midyear was at the seasonal peak. The slightly higher levels of inventory measured at relatively stable sales accounts for this. The days inventory outstanding have increased by 5 days, whereas accounts receivable are well under control.

The CapEx is back to normal, I would say. The Nantong site was completed last year and does not contribute any longer to the spending. The segment Engineered Components with a share of 79% of total CapEx is still a driver of this number. It reflects the innovation and new project wins going on in Automotive and Electronics. Spending is expected to accelerate in the second half of this year but still to remain below 7% on net sales.

In the reporting period, we generated CHF 105 million cash from operations. With that, we fully financed a CapEx and net working capital increase. This left an operating free cash flow of CHF 49 million, which represents an EBITDA conversion rate of 31.9%. For the full year, we expect an accelerated increase in free cash flow triggered by higher profitability as well as by net working capital that has already reached a seasonal peak.

SFS' balance sheet remains healthy and solid. The equity amounted to CHF 1.1 billion, and the equity ratio stood close to 70%. Net cash at year-end turned into net debt of CHF 52 million, certainly influenced by the acquisition of Triangle Fasteners in the U.S. which was completed with cash-out in April of this year. As seen in the past, we await a strong improvement in the second half year on net cash due to higher inflows and lower outflows.

The internal KPI ROCE is loaded with increased capital employed due to the record CapEx we have seen last year as well as to higher net working capital. Together with a stagnating adjusted EBIT, ROCE came out at 19.5%. More stringent and tough measure is the return on invested capital. EBIT after tax is measured at the invested capital including the goodwill offset. The site work development on the level just below 10% is not yet meeting our target range. Drivers for improvement have to be higher profitability and better utilization of installed capacity.

Let me summarize the financial key indicators for the first 6 months with just one single statement: We are well positioned in the market and have achieved satisfactory results in a challenging economic and political environment.

This brings us to the guidance for the current year. Looking forward, SFS believes that the challenges and in particular the trade conflicts will carry forward into the second semester. Therefore, in contrary to the initial assumptions, we expect only a slightly positive business trend supported mainly by the startup of new projects, seasonal effects in Construction and Electronics and the base effects coming from the unexpected low sales we have seen in Q4 2018.

SFS estimates revenue growth of 3% to 6% for the full fiscal year 2019, including the acquisition effects. Under these conditions as well as no further tightening as a result of ongoing trade conflicts, SFS expects an adjusted EBIT margin of around 13% for the full year 2019. As also stated earlier, we expect that onetime effects will burden the reported EBIT in 2019 by a high single-digit to a low double-digit Swiss franc million amount.

With that, I hand over to Jens, who will further explain what key priorities we face, the challenges, before he will then open the Q&A session.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [4]

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Welcome back.

On the operational side, we set our priorities to focus on cost control and new project acquisition, meaning wholly owned, through the current continued selective hiring freeze and adjustment of capacity where needed; carrying forward on ramping up of growth projects while meeting profitability targets; increase offering with digitization solutions, allow -- along growth revenues, as percentage of sales; identification of next-generation applications in our core markets with above-average growth potential based on underlying megatrends; pursuit of suitable M&A add-ons.

We are now at the end of the presentation of our first half 2019 results and available for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from the line of Jörn Iffert with UBS.

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Jörn Iffert, UBS Investment Bank, Research Division - Director and Analyst [2]

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Three, please. And the first one would be on the momentum going into Q3 and we see a better outlook for the second half. Do you already see visible that Q3 is improving versus the Q2 organic growth trend? And if yes, which are the key areas here? Number two, the question number two would be, please, on the SG&A cost base. I understand you mentioned you have some cost-efficiency plans, et cetera. Can you give us more clarity here and what you expect your total SG&A cost base is doing in 2019 and '20 versus 2018? And the last question, please, on all your new projects: I think you spent more than CHF 100 million extra CapEx in the last 2 to 3 years, including 2019. And I assume this will generate extra revenues of more than CHF 100 million. Where do we stand here? How much of this potential is already utilized in the 2019 top line?

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [3]

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Jörn, happy to answer the question. Firstly, when we look forward into Q3 and Q4, the momentum we expect -- and we can clearly state that we have 2 seasonal effects. So we have the seasonal effects on the Electronics side with the new program implementations on our customer side, which will certainly help to lift the revenue of the electronic divisions up compared to the first half of 2019. Secondly, also the division Construction usually has a pronounced seasonality, where we also expect a sales increase in the second half of '19 compared to the first half of '19. And on top, I would say we have the Medical division which has a full project pipeline already [peel -- holding peels] in their hands until the year-end. And there we also expect a slight increase of the sales pace in the second half of the year compared to the first half of the year. So those 3 divisions will basically help to increase or to build the slight increase in momentum we expect for the second half of the year.

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Rolf Frei, SFS Group AG - CFO, Member of Executive Board & CEO of SFS Services AG [4]

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I'll take the second question, on cost efficiencies. There have been measures taken already in the first half. For example, in the division Riveting, based on the low demand, we have reduced the head count also in the U.K. in Riveting, altogether in the range of 30 to 50 people. And the corresponding restructuring costs are already accounted for in the first half year 2019. So that will be certainly a cost down in the second half year, as those employees are no longer on the list. In Switzerland we have taken measures in the first half year, reduced especially overtime which was sitting there in the range of 20,000 hours, reduced in the first half year. And we see in our records that our employees still have recorded overtime in the range of 30,000 hours, so there is more capacity to use that in the second half year. Maybe as a third element, Unisteel has adjusted their employees numbers, according to the lower demand in HDD and smartphones, already in the first half year. They normally react quite fast and based on demand. That's what I can say, so far.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [5]

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Then answering the third question, on the projects which are expected to ramp up, especially in the second half of the year of 2019. When we go back to our initial guidance, we clearly said that half of the growth will come from new product introductions, and the other half of the growth will be driven basically by solid and sound market conditions. Now the markets, I think, we have seen. We have seen a slowdown in the Automotive and Electronics side due to trade tensions and -- or the other Automotive-specific effects. On the projects side we can confirm that the projects are still valid and in ramp-up; however, somewhat or slightly reduced compared to the initial assumptions. So we have clearly seen the Electronics side somewhat reduced demand. As mentioned earlier in the presentation on the Electronics side or on the smartphone side, we see a 14% reduction year-over-year in smartphone shipments. And so we would apply the same number probably to the project we have ramping up so that over there the top line sales will be reduced to that or to a similar degree. On the Automotive side it's similar. We certainly see and experience now the softness in the market for many months. We have not seen a pickup in demand. Actually, for May and June where we expected a pickup, we have seen that the markets remained soft. And we expect also for the second half of the year that the market on the Automotive side remains soft and that new product introductions will cover for some of the softness but will not be able to trigger a revival of sales in Automotive.

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Jörn Iffert, UBS Investment Bank, Research Division - Director and Analyst [6]

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So there's just one follow-up. Can you confirm that Q3 organic sales growth should already be better than Q2 in terms of trend? Or is it too early to say?

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [7]

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It's too early to say.

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Operator [8]

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The next question comes from Tobias Fahrenholz with MainFirst.

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Tobias Fahrenholz, MainFirst Bank AG, Research Division - Director [9]

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Firstly starting with the margin outlook. Could you comment here a bit on the mix effects you're seeing year-over-year in the second half and then also in the next year 2020? So should we stay more or less at the same 50 basis points burden? And do you see more or less a flattish development then in the next year? And in correlation to this, your former 15% EBIT margin target, is it still valid? And when do you expect it to be reached at the earliest? And just for clarification: In auto segment you're not really speaking about an upswing in H2. When you speak about a flat development, do you actually mean a year-over-year trend; or an absolute flattish sales trend, which wouldn't be that because H2 is seasonally more -- not that strong normally? So could we expect here, despite the ongoing market weakness, that you continue to gain market share here? And in the past year, you gained 5%, so is it still a figure you hope to see going forwards?

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Rolf Frei, SFS Group AG - CFO, Member of Executive Board & CEO of SFS Services AG [10]

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Okay. Let me go on the first question, on the margin outlook with a mix effect. We have seen that 50 basis points due to the shift and the varying growth rates we've seen in the various divisions. Most probably we will see the same 50 basis points, I would assume, in the second half year, nevertheless some high-profitable divisions. For example, Electronics, we said, will pick up seasonally and also due to ramp-ups. For 2020, it's a little bit early to say, as we do not know yet, say, budget and what sales growth will be, but I would speak just for 2019.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [11]

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Coming to the next question, on the EBIT expectations as we have guided for the year, 13% to 15%. And now we position ourselves on the lower side of the guidance and knowing also that in 2020 we will have not any more onetime costs. And probably fair to expect that we will probably remain in the guidance range 13% to 15% for a while, as long as we see uncertainty in the market, but this is probably, as Rolf mentioned, too early to say and to confirm. I will just take it as an indication that 13% to 15% will be probably the new normal, as long as we see uncertainties out in our main 2 markets Electronics and Automotive as well as on the political side. When it comes down to the second half of the year, we certainly have a seasonality always in our business. So meaning also, in order to keep and maintain the current pace we have against the first half of 2018, we need to see also a slight pickup in the second half of the year 2019, to just maintain the pace compared to 2018. So we would expect, as mentioned, an increase in the division Construction seasonally. We would see an increase in Electronics seasonally. And we would see in Medical a slight increase due to ongoing project implementation in the second half of the year. I hope we were able to answer your questions.

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Tobias Fahrenholz, MainFirst Bank AG, Research Division - Director [12]

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Yes, but again on Automotive then: So the question of H2. Do you see it sales-wise flattish or year-over-year growth-wise flattish?

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [13]

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We see -- in the second half of the year, we see a flattish development compared to the first half of the year, but again the uncertainty is still very high because we have a second phase of the WLTP coming up in the third quarter. So that could in general take the trend down. And then we have -- in 2020, we have the new CO2 standouts come into play, where maybe the OEMs are subject to charters due to their CO2 profile, which maybe could shift some demand into fourth quarter from first quarter next year. So truly very difficult to give you a clear and concrete outlook for the rest of 2019.

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Operator [14]

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The next question comes from Michal Lichvar from Vontobel.

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Michal Lichvar, Bank Vontobel AG, Research Division - Analyst [15]

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I will -- I would first start with the growth outlook that you put out there. When we look at the organic growth from the upper end of 2%, this means 6% growth for the second half, more or less. What would need to happen for you to actually achieve this 6% growth? Because it seems quite strong. And this probably is not only -- couldn't be only explained with the new projects, so could you maybe talk about that a bit? And then in terms of these measures that you are taking in Fastening Systems and also in Distribution & Logistics, are you going to incur any one-offs, for example, from letting off the people or any social plans or anything like that? And then maybe last question, on taxes: Tax rate was very low in first half '19. Is this a new normal?

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Rolf Frei, SFS Group AG - CFO, Member of Executive Board & CEO of SFS Services AG [16]

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Okay. The first one, on the growth outlook, you are right. We said for the full year we expect the organic growth of 0% to 2%, coming from a minus 2.4%. So probably, if we grow 4% in the second half, we should -- we will then be, say, at the higher end of the 2%-plus. But there is a certain uncertainty, as explained, so we make therefore the -- therefore a range which says 0% to 2%. And the reasons were explained. It's -- first of all, it's a base effect due to low Q4 2018 and some seasonal effects as just mentioned before and some ramp-ups of new projects. If I just take also the last one, on the tax rate: You're right. It was very low for the first half year. There was a special infect -- impact due to the staff -- the Swiss changes in the tax rates due to the EU requirements basically and that lowered the tax rate from 17.4% in Switzerland to around 14.5% in Switzerland. And based on all deferred tax liabilities, which have been calculated at 17.4% at the end of 2018, they have to be recalculated at the lower tax rate of 14.5% now. And that gives a onetime effect of roughly CHF 5 million and reduces the tax burden in the first half year. That's the main reason. Without that special effect, the tax rate would have been to -- close to what we have seen in the past, around 19%. So the ongoing tax rate, we would expect to be around 19%.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [17]

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Following up with the second question, on the one-offs with the changes in our Distribution & Logistics segment. Here we -- as we announced, we have onetime effects in the year of 2019, one due to the Nantong transfer, and that's a negative effect. And then we have a positive effect due to sale of property in (inaudible) and Emmenbrücke. So that means all the effects due to these projects already accounted for in 2019. Beyond 2020 -- or '21 we do not have -- we do not expect to have major one-off costs due to these projects.

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Operator [18]

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The next question comes from Marta Bruska from Berenberg.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [19]

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I have 2 or 3 of them. So first of all, I would like to ask about your organic growth guidance of 0% to 2%. So with including HECO and Triangle which together I estimate should contribute at least 4.4% on -- based on the last year's sales, that should be more into the range of a 4% to 6.5%. So -- in the organic growth guidance. So that overall growth guidance is lower, from 3% to 6%, so I just would -- and just sort of wanted to ask if the sales trend in Triangle is perhaps negative. Or what's the reason of this 1%, about, difference on the lower end of the growth guidance? And the second is also related to the guidance. I'm a little bit struggling. How do you get to the 0% organic growth with H1 trend at minus 2.4%? And if you are not really sure if Q3 is seeing any pickup with Q3, then if it continues negative, I see somehow a quite higher risk that Q4, being the weaker quarter normally, will be quite difficult to compensate then. So what really gives you then the confidence you're going to reach -- I mean wider range -- you lift the range. It seems to me like you leave the range quite exposed to some disappointment. And then finally, back in March, you mentioned 2 big projects with some 30%, 40% perhaps of the revenue potential in the second half of 2019. Is it still the same range of the revenue or the incremental sales, or has that changed?

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Rolf Frei, SFS Group AG - CFO, Member of Executive Board & CEO of SFS Services AG [20]

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Okay. Let me answer on question number one, on the organic guidance. We have seen a scope change with HECO and TFC, and that amounted to 4.6% in the first half year. There we have to consider that TFC is included since April, so for 3 months. And there will be another 6 months to come where TFC will add to the growth. However, on HECO, if you remember, we increased our stake in HECO July 1 last year. So we had in the second half year last year already HECO included. So HECO accounts only for the scope increase or the -- for the acquisition increase for the first half year 2019. There will be no additional impacts from HECO on the change in scope, so it's just TFC which will add some more growth in the second half. So we feel quite confident with the range of 4% to 5% growth. And as mentioned before, our indications say that organic guidance, organic growth will be in the range of 0% to 2%.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [21]

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Going, coming back to the expectation on the projects and the positive lift in the second half of the year which those projects contribute for. Then again we had a guidance of 3% to 5% for the full year. Half of the guidance, we expect that it will be covered by contribution of these new product introductions, new product ramp-ups. And those -- and we still see as well it's maybe discounted a little bit for the current softness in the market; maybe discounted for -- by, let's say, 10% to 15% softer than initially expected. So the project introductions are still on plan, are still scheduled but maybe need to be accounted for due to the softness in the market maybe by around 10% to 15%. Those projects help to support the expected organic growth we see in the second half of the year. So this is one element of the organic growth we expect in the second half of the year. The other element, as mentioned, is the seasonality of the business which usually tends to higher sales in the Construction division, in the Electronics division, as mentioned before. So we hope we were able to answer those questions.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [22]

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With the Construction, especially in Europe but also to a certain degree in the U.S., it's rather a strong start into the year, with indicators falling into the second half indicating weakness. So do you have any special projects? Where do you expect to outcompete the market?

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [23]

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On the Construction side there are no special projects. They are -- these are mainly, I will say, smaller orders carried by some of larger customers usually we have in any specific region. We have between a few hundred to a few thousand customers. So usually the market is governed by the short-term demand of those construction companies, and due to that, there is not high visibility, but what we can state is that overall the market information indicates that the construction market is still in good health. We see that our customers have projects in their hands for which they need construction material. And we don't see yet a decline or a cloudening of the expectation for the second half of the year.

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Operator [24]

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(Operator Instructions) The next question comes from Armin Rechberger from ZKB.

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Armin Rechberger, Zürcher Kantonalbank, Research Division - Analyst [25]

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Yes, just to clarify. I mean your new guidance for sales is now a growth of 3% to 6%, isn't it? Because when I got it right, Rolf right, he just said it's new 3% to 5%. Now it's 3% to 6%. Just to clarify. And then I was a little bit disappointed about the EBIT margin in Engineered Components. Can you put a little bit more flavor on this topic? And then 2 questions regarding products: first, the new power adapter. Where is the standpoint there? Where it -- is it introduced? And you mentioned an expected downturn in smartphones of 14%. Will it not be possible to compensate for this, the new power adapter? Then the other product I am interested in is the driving brakes, the electric driving brake. There you were just in one model, in an Italian model. Is there an inroad into other models now?

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Rolf Frei, SFS Group AG - CFO, Member of Executive Board & CEO of SFS Services AG [26]

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Okay. Good. So maybe the first one, on the guidance. You're right. The guidance we have given for the full year is 3% to 6%, including acquisitions, FX effects and the organic growth.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [27]

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On the ET -- EC margin side. When we take a look at the segment margin, then certainly we've seen here an erosion of the margin mainly due to underutilization of our manufacturing plants as we have seen a downturn in the fourth quarter of 2018 on the Automotive and Electronics side. We have seen this being carried forward into the first quarter and second quarter alike. And basically those 2 areas or those 2 divisions contribute or account for the majority of the downturn in the margin. On top of it, we have to also consider the mix effects. So we have the Medical division as well in the segment Engineered Components which have -- has lower margins compared also to the group average. And that's another reason or that's another driver of the reduction in the margin in Engineered Components. It's the mix effects we see in there. So it's mainly those 2 drivers. We had some -- I would say, some minor effects due to product ramp-ups but not something substantial which we have to announce or which we would have to break out, or product introduction ramp-ups. I think those were minor, normal upfront costs which we usually see every year happening. The large upfront costs, we had last year, which have burned them out in 2018, where we implemented the power adapter project and also the ball screw drive project for division Automotive. So we see margin mainly burdened by some mix effects as well as underutilization of the manufacturing plants.

When it comes to the projects, we have -- first, in the division Electronics we have the power adapter project, which is ramping up. It's performing plus, minus on plan; as mentioned before, reduced probably by around 14% due to the softness in the relevant smartphone market but still helping us overall to increase sales with important customer. So meaning that the customer for which we produce and manufacture components -- the customer is growing in a growing stage overall and with the SFS Group. The softness of the division Electronics can be mainly also attributed for to because of the softness in the HDD market, which is also a substantial contributor to the top line sales in division Electronics and in the segment Engineered Components. Then on the question on the driving brake, on the ball screw drive systems, yes, new customer logos have been added to this product line, meaning that our customer has obviously received additional orders from new logos, new customers for which a capacity increase is needed. And as also mentioned, earlier in the year, we have received a new allocation and order increases for the following years, meaning between 2020 and '23, which will help us also to continue with the positive sales momentum with this application. Well, I hope that was, however, able to answer your questions.

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Armin Rechberger, Zürcher Kantonalbank, Research Division - Analyst [28]

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Yes. And minor question more, if I may, Medical. You mentioned low margins in Medical, which is unusual for that market. Is that a problem you can solve? Is it on your side, or is it the markets you're within? Or I mean usually in -- at Medical you would expect high margins.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [29]

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Yes. This is certainly on our side. We have -- with the Tegra Medical acquisition, we have clearly -- or we were clearly aware that the margins are probably not in the top basket of a medical activity you would expect. On the other hand, the manufacturing base or the platform was very interesting to us. And also the margin profile allowed us to afford also such an investment into the medical market where usually very high multiples are paid. So the margin development, as mentioned, in the last 2 years suffered due to product mix changes in the product mix of manufactured components at the Medical division. And we have seen that we reached [bottom] last year with the margin development; and also that, last year, we started to see new orders coming in, new product introductions, which then led to a sales increase. This year, we have a double-digit sales increase. We have roughly around a 20% year-on-year sales increase, and this also helps to improve and increase the margins of the Medical business. However, we have also to keep in mind these are in some cases very new products, very new introductions. That means there is also upfront costs involved. If -- need to be hired, need to be trained well ahead before we see first revenue coming in. So this is a second reason why the EBITDA margins are below group average at this point in time, but we clearly expect that overall in the next 2 years we will see a step-by-step improvement of the margins and that the Medical business then should reach group average margins.

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Operator [30]

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The next is a follow-up question from Jörn Iffert.

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Jörn Iffert, UBS Investment Bank, Research Division - Director and Analyst [31]

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The first one will be on the gross profit margin, just to better understand the mix impact. Your gross profit margin is improving in the first half 2019 year-over-year. Can you tell us why -- are raw materials supportive? Were the FX hedgings supportive? To have some clarity here. And the second question is on your [just] quite high capital intensity on sales generation. You are slightly above cost of capital [on return of capital, cash flow, return of capital]. Is CapEx coming down then in the medium term? Or is it purely a function of improving profitability that you are targeting your above 12% medium term?

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Rolf Frei, SFS Group AG - CFO, Member of Executive Board & CEO of SFS Services AG [32]

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Let me take the first one, on gross profit. It has increased. You are right. There were some special effects we had last year. I'll give you one example on the Aircraft business, what -- which was slowing down last year. That had then an impact on our stock valuation. We are quite strong there with the adding a stock provision if it's not turning. Now we have this year an opposite effect. Aircraft is growing and those stock provision could have been released. That's one thing. On the other side, we increased sales prices last year. Remember there were increases in the raw materials side. They're starting to help as well. And there's certainly also a mix effect. Think of Medical business, which is growing strong with high value added in the 80%. And I guess also the new power adapter, which is picking up in sales quite good now, has extremely good gross profit. And when we say gross profit, we always say sales, less direct raw materials and plating and outside processing. So it's a little bit a mix of everything which has helped to increase and improve the margin.

The profitability on the capital. I would believe that the CapEx most probably will stay in the range of 6% to 7%. That's the range. We will see ones a little bit higher and ones a little bit lower, but the range 6% to 7%, I think, should count also for the future. And it's mainly driven by the 2 divisions in Electronics and Automotive. And as we referred, there will be another, a new property in Hallau Stamm, which will -- also will of -- add, of course, some to the CapEx. But all in all I think it is to better utilize what we have installed -- in installed capacity and machinery. And that will come with higher sales, of course. And the major driver, I guess, has to be profitability. We have to increase in the range above the 13%, and that will certainly help then to improve the return on capital.

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Operator [33]

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The next is a follow-up question from Michal Lichvar with Vontobel.

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Michal Lichvar, Bank Vontobel AG, Research Division - Analyst [34]

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I would just have 2 very short ones. Can you comment on Construction margins? We heard that Medical is low, Electronics rather above average. Where does Construction land? And then maybe on Engineered Components, there we've really seen kind of then negative effect of the operating leverage with lower sales. Did you also started, initiated any measures or cost savings measures on Engineered Components side?

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [35]

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Yes, thank you for your questions. First, on the Construction margins. Yes, the Construction margin is also below group average. It can also be seen with the Fastening Systems EBIT, profitability around the 9.6%. So the Construction margins is probably more at line -- in line with the margin we see with the segment Fastening Systems. When it comes to the EBIT margin and operating leverage performance of Engineered Components, yes, certainly we have seen an underutilization of the manufacturing plants and sites, and this underutilization has -- we had a big impact on the development of the profitability. The measures have implemented mainly on the labor side, meaning that we have reduced staffing -- or just the staffing we needed, as mentioned earlier by Rolf; and that we have also initiated partially some short-time work weeks, for which we will see the effect in the third quarter. Some of the effects, we have seen in the second quarter, but more to come and more to be seen mainly in the third quarter of 2019. As I said, I think we have also to keep in mind that we have -- that the large projects we'll carry forward in the Engineered Components segment is the consolidation to the new Nantong facility that will be also causing some inefficiencies which also have to be attributed for in the Engineered Components profitability. We would expect that, in the first quarter of 2020, all of those effects should be gone.

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Operator [36]

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The next question is a follow-up question from Marta Bruska with Berenberg.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [37]

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I just wanted to ask a little bit about your EBIT margin guidance which is for adjusted EBIT margin of 13%. While -- with all those cost-cutting measures you have already mentioned and given that your revenue growth guidance is so very broad, I was just wondering. What is the rationale? And specifically, wouldn't you have some positive operational leverage with all those cost measures if you -- that you have taken and the positive organic growth of 2% in the second half? If you -- and if you can just quickly summarize the few points what needs to happen in order to achieve this 2% organic growth in the second half.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [38]

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Okay. So that -- looking some more into the second half of 2019, what needs to happen...

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [39]

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Sorry. There's 2% for the full year. I mean the 4% in the second half.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [40]

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Yes, it's 2% for the full year and the 4% for the second half. Exactly what needs to happen is, as we mentioned, the project ramp-ups, which are a key contributor for the second half of the year besides seasonality. So we need to see the proper project execution. We need to see a regular seasonality as we usually see throughout the years. And I think here we had that specific chart also where you could see the development of the operating profitability and the EBIT in the second half of the year. So I referred to this chart, that you usually see in the second half of the year there's a pickup in demand. And due to this pickup in demand, there's a better utilization of capacity that supplies leverage effect in the second half of the year. So we would need to see a same or similar performance like we usually experience in any given year, plus, minus. I think what -- to turn this question around and say what shall not happen: What shall not happen is that we see a further slowdown, for instance, in the global car sales; that we see a tightening in the trade tensions; that maybe we see tariffs coming in on cars imported or -- to the U.S. or exported to the U.S.; and further -- I would say, a further just cloudening of the global economy; and maybe a starting of cloudening or softening in the construction market; maybe an unorganized Brexit. I think these could all be very valid reasons to not reach the guidance. So we would expect normal business to carry forward as we had experienced it, and we would not see a further tightening of our environment in order to achieve to our guidance. I hope I was able to answer your question.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [41]

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Yes. And then in this case you would see a higher EBIT as well or so. Because where there is a mismatch between the range for organic growth and just one number for EBIT, that's better to input, very simply.

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [42]

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Yes. The EBIT -- 13% EBIT margin, intentionally we set it there because of the uncertainties in how the mix also will be developing. We see in the second half of the year certainly the potential for top line improvement and also bottom line improvement, but this is also highly reflective on the specific development of each division, meaning at this point in time we are not in a position to keep a more exact and precise guidance because of the uncertainties which are out there.

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Marta Kinga Bruska, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [43]

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So is this 13% for 0% organic growth, or is it 13% adjusted EBIT for 2% organic growth?

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [44]

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That 13% adjusted is for the guidance as a whole as seen and as given, plus, minus.

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Operator [45]

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Ladies and gentlemen, that was the last question. I would now like to turn the conference back over to SFS for the live feedback. Please go ahead.

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Unidentified Analyst, [46]

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Okay. We have received one additional question submitted by (inaudible), representing (inaudible). "You've repeatedly mentioned the negative impact of ongoing trade conflicts. How exactly do they influence your day-to-day business? Which divisions are most affected?"

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Jens Breu, SFS Group AG - Chairman of the Executive Board & CEO [47]

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When we talk about the trade conflicts, the trade tensions, we can clearly state that divisions Automotive and Electronics are affected the most. We -- when we first maybe dive into the Automotive division, we clearly see a reduction of car sales in China between 12% to 16%. This reduction is mainly coming from the uncertainties of the economic development in China itself; the uncertainty of the outcome of the trade tension, trade conflicts between China and the U.S. So consumers are uncertain about the future and, due to that, just defer spending and investing into new cars. On the European market we see in some areas similar effects, Germany in some areas still being strong with new car sales but outside of Germany see in some markets also a softening of car sales due to same or similar concerns, uncertainty of the Brexit but also uncertainty overall of the state of the economy. Then we have the dieselgate, which also is certainly impacting the consumer not knowing which type of preferred engine or drivetrain to be chosen. Shall it be a battery? Shall it be hybrid, or shall it be diesel engine? These are all questions which also dampen the demand in the automotive market. In North America it's more also a structural change we see happening. We see that pickup trucks are still in demand, but demand for sedans have come to a hold. And the sedan sales has broken in the U.S. and in North America overall. So we see multiple reasons in the automotive environment to why sales is slowing down. We see also the technology-side reason which is mainly due to drivetrain. We see changes in behavior towards more pickups, but we also see clearly a strong and clear mark that the trades tensions leads to uncertainties in what kind of equipment shall money be invested.

Then the second division, division Electronics, which is also affected by the trade tensions, there we see also uncertainties in the market. First off, the decision that Huawei does not get any long access to U.S. technology also led to uncertainty; consumer probably not knowing yet, when they buy a phone, will it be supported in the future, will it not be supported in 2, 3 years from now, so they probably just defer out purchases of new devices. Then we also see the consumer sentiment. Usually when trade tension is happening on the nationalistic side, probably people have a very strong opinion. They maybe support the one brand or more -- national brands more. It's maybe in other brands which stands maybe for the opposite side of the affected countries in the trade tension. So this is also leading to a reduction in demands in the smartphone environment.

Above and beyond that, we see then also some impact in Europe, meaning when the car or the automotive industry is weakening in Central Europe, in Germany, for instance, then we also see an impact to the industrial companies, those which manufacture family lines, those which produce consumables which are needed to produce cars. Those companies then usually also slow down; and we see over there a weakening of the demand, a dampening of the demand happening. So the trade conflicts having certainly a substantial impact of the negative organic sales development we have seen in the first year of 2019.

Good. With that, we see that there are no more questions coming in. And we can conclude the presentation of the first half 2019 results, and we thank you for your attention.

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Operator [48]

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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.