SGS SA (SGSN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the 2022 Half Year Results Conference Call and Live Webcast. I'm Alice, the Chorus Call operator. [Operator Instructions] The conference is being recorded. [Operator Instructions] At this time, it's my pleasure to hand over to Tobias Reeks, Senior Vice President, Investor Relations, Corporate Communications and Sustainability. Please go ahead, sir.

Thank you very much. Good morning, good afternoon to you, and welcome to SGS First Half 2022 Results Conference Call. We all hope that you've had a good start to the year, and we're going to be able to meet many of you at our Investor Day later on this year in November. In a few moments, I will pass over to Frankie and Dominik, who will run through our presentation, and then we will move to Q&A. [Operator Instructions] So without further ado, I will hand over to Frankie to start the presentation.

Thank you, Toby. As usual, I will give you highlights of our performances for the first half. Dominik will provide you in more details on financial review, and we'll cover the business outlook for the second half of this year as well as the full year 2022 guidance and then we follow as Toby mentioned by Q&A. Let me start with the financial performances. I have to say, despite the difficult market conditions faced during the first half, including the war in Ukraine, the current global economic context, the China lockdown and the absenteeism by COVID, I'm pleased to report a strong set of results highlighting the resilience of our global network. These results are driven by the strong underlying performances in our strategic focus area and our commitment to investing in the long term. You can see total revenue increased by 6.8% at constant currency, while organic growth was 5.8%. Our adjusted operating income stands at CHF 458 million, a 1.6% increase at constant currency compared to 2021. The first half margin was heavily impacted by COVID-related restriction in China. Excluding China, adjusted operating income growth was double digit. Our ROIC stands at 18.4% compared to 17.8% same period last year. And our basic earnings per share of CHF 36.78 is a 1.4% increase compared to 2021. Regarding the COVID situation, in terms of how it impacts our colleagues, I'm glad to say that the new variants are much milder, and we have had very few severe cases within our global network. However, the impact of COVID on our operations is still important. The 2.5 months of lockdown in China was the primary one, but also, we continue to have high-level absenteeism across the network due to COVID-related sickness, which is having a clear impact on our operational management. The situation was quite severe in January and February, much better in March till May, and we have seen, again, an increase in June in part of the network. Additional preventive measures has been put in place to mitigate risks and support our colleagues. I'd like to take the opportunity here to thank my 96,000 colleagues in the network for their dedication in ensuring the day-to-day running of our operations and supporting our customers and the communities where we operate. As outlined in our strategy, which we presented to you in May 2021, we are on the journey to become a more sustainable and more data-driven company. We have made good progress and are in line with our strategic planning. As you can see, the revenue on our sustainability solution framework increased from 45% to 47% in 2021. We have also migrated 9% of revenue to our next-generation digital platform, services and solutions, confirming our target of 20% by. Dominik will provide you more details on the progress made in our Level Up initiative in a minute. I will highlight a couple of the achievements during the first half. All our Knowledge division business have now migrated to our new CertIQ application platform. These applications set the foundation for an end-to-end digital journey for our customers in terms of interaction with SGS. The development of our cybersecurity laboratory network is continuing with the expected opening of 3 new facilities by end of this year. The market relations and the client demand are in line with our expectations and will further enforce our leading positions with this development. Our objective of migrating our services to a new digital ecosystem continues with good progress made in our digital lab initiative, digitizing the customer journey and new digital service offering. The more mature new digital service being Digicomply, with which you are all familiar and through our upcoming solution for the e-commerce sectors, which we will tell you more about in due time. Acquisitions continue to be an important part of how we allocate capital to support our strategic priorities area. We made 3 acquisitions during the first half, Gas Analysis Services based in the U.K. will enhance our expertise across the gas instrumentation, measurement and valuation industry value chain, particularly in the sector of pharmaceuticals, semiconductor, food and beverages. Ecotecnos based in Chile is specialized in monitoring the impact of our industrial activities on the aquatic and marine ecosystem. These services are in line with our focus on developing new sustainability-related solutions to protect the biodiversity, the environment and the local communities. AIEX based in France is a technical inspection and NDT specialist in the nuclear sector. It provides critical services to ensure the safety of nuclear plants and support our long-term vision related to energy transition. We have also acquired the remaining minority stake of 2 companies during H1, 30% of AMS, Advanced Metrology Solution based in Spain. The initial investment into AMS was made in 2018, and this will, of course, our position in the 3D metrology and dimensional measurement inspection in the aviation industry. And 49% of SGS Digicomply. If you recall, Digicomply is a JV created by SGS that specializes in [indiscernible] monitoring in the food sector using latest digital technologies. The solution is now in full production and have been on those by many of the leading food manufacturers, while now developing the solution for other sectors such as cosmetic and nonfood. Finally, after the first half closing, we have announced 2 subsequent acquisitions. proderm in Germany significantly reinforced our leading global position in the cosmetic and personal care testing, adding innovative capabilities and strong scientific expertise. Silver State Analytical Laboratories based in the U.S. is specialist in the environmental testing of water and soil. Their expertise will further complement our network laboratories in North America. All these acquisitions support key sustainability development goals and comes under our sustainability solution framework. They are supporting our midterm ambitions of reaching 50% of group revenue by 2023. On that, I'm going to hand over to Dominik for a detailed review of our financials.

Thank you, Frankie. Good afternoon, ladies and gentlemen. I will start with the overview of the financial highlights for the first half '22. Frankie already mentioned the operating highlights in his introduction with revenues of CHF 3.3 billion and adjusted operating income of CHF 458 million and a free cash flow of CHF 11 million. Revenues for the group in constant currency increased strongly by 6.8%. The adjusted operating income increased by 1.6% to CHF 458 million in constant currency, leading to an AOI margin decrease of 70 basis points to 14.1%. This reduction is solely related to China, where our business was impacted by the lockdown between mid-March and end of May. Excluding China, the adjusted operating income is growing double digit in constant rate. Net profit after minority interest increased by 1.5% to CHF 276 million in the under review, while adjusted EPS was up 3.9% to CHF 40.37. Cash flow from operating activities declined by 23.1% to CHF 263 million due to higher net working capital requirement to support the strong revenue growth. Organic revenues increased by 5.8% in H1 '22, out of which approx 2.5% is a function of price increases to pass on the majority of the absolute cost inflation. The contribution from acquisitions is with 1% limited and reflects several smaller but strategically very important additions to our network. The currency impact was with 1.6% negative leading to revenue growth in actual rates of 5.2%. Moving on to the revenue growth by business. Organic growth in Connectivity & Products was moderate to 3.1%, which is a result of the lockdowns in China. In the month, China wasn't affected by lockdowns, the unit experienced high single-digit to double-digit growth. The best growth was achieved in Softlines given the very strong performance outside China, namely Turkey, India and Bangladesh. Also Connectivity experienced above-average growth given recent investments and the strong performance of Brightsight. Hardline organically declined given the challenging situation in China and in Automotive [indiscernible] in the first half '22. Revenues in Health & Nutrition increased by 8.9%, supported by the continued focus on M&A in Health & Nutrition. Organic growth was 5.2%. Food grew organically above the divisional average, supported by the growth across the network. Health Science grew organically below the division average, impacted by significant reduction in COVID vaccine-related testing. Revenues in Industries & Environment increased by 6% in constant rate, while organic growth was 5.6%. As a strong demand for environmental field services offset lower volume in nondestructive testing and supply chain services in field services and inspection. Technical Assessment & Advisory delivered double-digit organic growth, continuing to benefit from the increase in supervision and consulting work in Latin America and from a very strong performance in Eastern Europe and Middle East. Public Mandates revenue declined due to lost contracts in Africa, partly compensated by price increases in Latin American vehicle compliance services. The 7.6% organic growth in Natural Resources was driven by double-digit growth in laboratory testing and metallurgy and consulting. Growth in mineral commodities was strong, in oil and gas commodities solid, while agricultural commodities were negatively impacted by metrological conditions and trade restrictions. Knowledge posted strong organic growth of 8.4%. Growth was achieved across all SBUs and regions. The strongest growth was delivered by consulting, primarily driven by the strong performance of Maine Point, benefiting from strong demand for supply chain optimization and performance improvement services. From a regional point of view, we delivered almost double-digit organic growth in Americas, while organic growth in the other regions was mid-single digit. The Eastern Europe and Middle East countries achieved double-digit growth across the majority of its end markets. Growth in the African countries was high-single-digit, while growth in key European countries was, to a large extent, moderate to solid. In the Americas, revenues increased by 10.7% in constant rate, while organic growth was 9.9%. The strong growth was notably driven by double-digit growth in several Latin key countries and the U.S.A., while growth in Canada was solid. The organic growth in Asia of 4.7% were significantly impacted by the lockdown in China, which experienced a small revenue decline. In the most markets in Asia Pacific, we achieved mid- to high-single-digit growth, while India, Singapore and Bangladesh posted double-digit growth. FTEs at the end of H1 '22 increased by 3.9% versus prior year, primarily driven by organic additions given the demand for our services. Average FTEs in the first half '22 increased by 4.1%, clearly lower than the total growth of 6.8%. The magnitude of the change by region needs to be set in perspective with the revenue increase. Overall, we showed a good increase of productivity. Only in Asia Pacific, the differential between revenue growth and FTE growth is limited given the conscious decision to not actively reduce headcount during the lockdown in China to secure the full recovery potential, which was already evident and started in the month of June. The adjusted operating income increased at constant currency by 1.6%, which reflects an organic growth of 1.2% as well as a small contribution from acquisitions of 0.4%. Currency had a negative impact of 1.4%, leading to approx stable AOI in the period under review. The very modest increase in adjusted operating income in constant rate is primarily driven by the lockdown in China. Excluding China, our adjusted opening income would grow double digit. Consequently, the [ old ] margin decreased by 70 basis points to 14.1%. On this slide, I would like to provide you an update on our Level Up initiatives. The following objectives and milestones we achieved in the first half '22. Project Prometheus was kicked off. The purpose of the program is to outsource IT infrastructure, application maintenance and application development to reduce the time to market for new solutions and to reduce costs. This program will build a strong basis to roll out our new solutions globally in an accelerated manner. We established a builders organization to design and develop new technology-based products initially focusing on higher productivity. We introduced Salesforce as the new global CRM. We implemented CertIQ as the global knowledge platform. For the second half of the year, we'll focus amongst others on the following objectives: 20% of lab revenues will be covered by the digital lab concept. We continue to invest in our -- in the global digital lab core model for environment, food and industrial. We will add additional 15 countries to our finance shared service center setup, covering approximately 60% of group revenues with the regional financial shared service center set up at the end of the year. The successful WCS program will cover 3 additional labs. We are fully on track to achieve our '23 Level Up objectives. We'll continue to increase the scope in terms of group revenues coverage and additional functionalities to the different digital lab platforms as well as to CertIQ. Acceleration of productivity gains will be realized. Moving on to the margin by division. Our Connectivity & Products business is mostly geared to China. Despite a negative margin impact from the lockdown in China, we were able to increase the AOI margin by 30 basis points, which is a result of cash collection, recovery of bad debt in trade facilitation services and improved profitability in cybersecurity and strong performance from key affiliates such as Turkey, India and Bangladesh. AOI margin in Health & Nutrition decreased to 12.4% from 15.5% in the prior year, affected by the end of COVID vaccine-related testing, the impact of the lockdown in China second quarter as well as the continued investment into our global lab network. AOI margin Industrial, Environment decreased by 100 basis points to 8.6% due to COVID restrictions in China, collection delays from certain government contracts as well as the mix effects as we are winning a couple of sizable value generating contracts in Latin America with very low invested capital. AOI margins in Natural Resources increased by 20 basis points to 12.8%. Good margin increases in laboratory testing and mineral commodities, they are partly compensated by lower profitability levels in oil and gas trade as well as agri commodities. The margin decline of 60 basis points to 19.1% in Knowledge is primarily a function of changes in the geographical and service mix. Operational and working capital stands at 1.8% of revenue, reflecting the strong growth. DSO levels remain strong and sustainable. Net working capital was negative in H1 2020 and H1 '21. However, this year's number of 1.8% is still materially better than what we have seen in the years 2019 and before. Furthermore, despite the continued strong growth, we believe we will finish with a negative working capital at the end of '22. Cash flow from operating activities decreased by 23.1% to CHF 263 million due to higher working capital needs given the growth of the operation. We spent net CHF 153 million in investing activities, which considers also CHF 11 million for a couple of smaller bolt-on acquisitions. Dividend payments as well as the NCI transactions amounted to CHF 611 million. We bought back own shares for an amount of CHF 51 million. We paid back CHF 250 million bond and increased short-term borrowings by CHF 592 million. All this leads to a cash position of CHF 1.1 billion at the end of June '22. Gross CapEx for H1 '22 increased by 4% to CHF 156 million and as a percentage of revenues was 4.8% on the same level as in the prior year. To sum it up, our revenues in H1 '22 increased by 6.8%, of which 5.8% organic. While the lockdown in China impacted our growth and especially our profitability in the first half '22, we experienced a strong growth recovery in China in the month of June. Our adjusted operating income increased by 1.6%, held back by the lockdown in China. Excluding China, the [ oil ] growth was double digit. Our return on invested capital increased by 60 basis points to 18.4%. With this, I hand back to you, Frankie.

Thank you, Dominik. So let me now go through the outlook for our 5 divisions for the second half of 2022. Note that all the divisional growth outlook comments here relates to the second half organic growth in relation to the overall group average. Let me start with Connectivity & Products. Connectivity & Product organic growth should be well above group average. Connectivity should see its growth momentum carrying on into the second half with acceleration of our cybersecurity services demand. Softlines will continue its growth pattern with solid pipeline in many countries, including China, Turkey, Bangladesh and Vietnam. Growth in Hardlines will be stable with some improvement expected in the toys and juvenile product testing volume, offset by continued supply chain disruption in the Hardgoods sectors. Growth in trade facilitation would remain stable due to the termination of government contract in Africa and impact on [indiscernible] related to the situation in Ukraine. Health & Nutrition organic growth should also be well above the group average. Health Science will accelerate growth in the second half as new project comes online replacing the COVID vaccine volume. Those contracts are signed, but have different start dates during the second half. Talent acquisitions remain an issue that needs to be carefully managed, especially in certain key regions such as North America. Solid growth to continue in the second half in food, with positive market outlook and new SGS facilities adding capacity, particularly in Latin America. Cosmetic & Hygiene growth should accelerate as well in second half as some of the project delay on operational resources issues seen in the first half has been addressed. Moving to Industries & Environment. Industries & Environment organic growth should be below group average. Growth momentum will continue in both health and safety and technical assessment services in line with the momentum seen in the first half with a strong project pipeline in most geographies. Supply chain services and activities related to our oil and gas sectors will see limited growth in the second half due to supply chain disruptions and the completion of some oil and gas OpEx projects. Government mandate growth will remain flat with contract termination in some countries and limited growth in our vehicle statutory inspection activities. Environmental testing growth should accelerate in the second half, supported by better market conditions, less [ weather-related ] disturbance and a catch-up on delayed projects such as [indiscernible] testing program in Europe. Natural Resources organic growth should be broadly in line with the group average. Mineral-related services, particularly related to testing activities will continue the growth momentum in second half with new on-site project coming into operations. While there are concern related to possible economic slowdown, the current demand for oil, steel, copper, cobalt and coal remains strong. Agricultural services will remain under pressure. While we expect a slightly better crop prediction in Europe and North America, however, this will be offset by trade disturbances in Ukraine and Russia. Oil and gas trade and testing should continue to benefit from steady volume increase, so we expect growth in the second half to be similar to the first half level. Knowledge organic growth should be also brought in line with the group average. The underlying market conditions for certification remains solid with increasing requirements for schemes such as medical device, information security and in the food sector. Growth in the second half will continue to be held back by the challenge comparable to 2021, which was as recertificate year and generated a higher volume than usual. New drivers for ESG regulations will further support market growth in the midterm, and SGS is well positioned to capture this growth with our comprehensive suite of ESG-related services. The very strong growth of our consulting activities will continue in the second half. Demand for technical operational support, which provides improved efficiency and cost control, is increasing against some challenging market condition for our customers. So in terms of outlook for the remainder of the year, the full year 2022, so mid-single-digit organic growth, improved adjusted operating income with margin at a similar level to prior year. Strong cash conversions, maintain best-in-class organic return on invested capital, accelerating investment into our strategic focus area with M&A as the key differentiator. At least maintaining of the dividend and utilize our new share buyback program on an opportunistic base as part of our flexible capital allocation strategy. This is just a reminder of our 2020, 2023 midterm target in which I mentioned earlier, we're still on track to achieve what we presented to you in May 2021. In conclusion, I would like to mention that we will continue to support all our colleagues across the network affected by the Ukraine war and particular those who have remained in Ukraine. We'll continue to monitor the situation and take actions to ensure they're having safety and well-being. Also, I would like to express my personal gratitude to all my colleagues who have volunteered in supporting our different actions and particularly my colleagues in the neighboring countries of Poland, Slovakia, Hungary, Moldova and Romania, who have provided a logistic support to assist our Ukrainian colleagues and their families. On that, I'll hand it back to Toby for the Q&A session. Thank you.

[Operator Instructions] So we will take our first questions [Operator Instructions]. Paul Sullivan.

Yes. Just -- yes, usual couple from me. The outlook statements by division read quite well, but your full year mid-single-digit guidance implies a second half slowdown if you strip out the China lockdowns. So can you give us a sense of what you're building into your thinking and expectations in terms of pricing, the broader economy and the balance between recovery and further lockdowns in China? And then Secondly, can you walk us through the bridge back to flat margins for the full year? And specifically, how much of the feels like CHF 40 million, CHF 50 million China shortfall in the first half can come back in the second half?

I take this. Every -- I mean first of all, I mean mid-single digit is a range, right? And obviously, there's also opportunity to be at the upper end of this range. And I think we also have to see this guidance in light of the overall uncertainty, which we have in the economy. We are optimistic and -- but generally think the outlook statement, mid-single digit is the right number, but don't want to rule out that it's more at the upper end for sure. Now from a pricing point of view, pricing impact was from the 5.8% organic, 2.5% was pricing. There are still a bit more coming in, but this could be the trending. And then from the economic outlook, I mean things can change. We know it's an overall challenging market condition, and this is also in light we have to see this -- the outlook. Regarding China, whether they are locked on happening or not happening and how long they are or not -- how long they are, that's for us very -- it's not possible to judge for us yes. We wanted to outline here more what was the impact of China in that regard for the first half. Regarding the second point, if you think about China, we -- in the month in which we didn't have the impact of lockdown, we'd actually really good growth, high single digits, even double digit, for example, June, but I think June has to be seen also in the light that the lockdown just finished. So there was, for sure, also some extra work in the month, but at least it shows that the supply chain is functioning. And this is how we also manage our cost base to say, basically, they are to assume kind of what we expected those at the beginning of the year, mid- to high single digit -- mid- to high single-digit growth. So obviously, it is -- it will be not possible to recover the full impact of not generated potential profits in the first half from the lockdown, but some of it we could cover. And based on this, we feel comfortable to have similar margin like in the prior year for the whole year.

Very clear. Shall we move on to the next caller, please? Suchi, do you want to go ahead?

[Operator Instructions] Mrs. Varanasi.

Two from me, please. Is it possible to quantify the revenue impact from the China lockdown in the order of 1.5% or so? And which divisions saw the most impact. This can probably help us model it off if God forbid, we have something else coming up in second half. And second, we've seen a fall in margins in Health & Nutrition and Knowledge. And Health & Nutrition is from the COVID contract step down plus something else, Knowledge is because of the mix. How should we think about the normalized margins for these 2 divisions on an annualized basis, please? So for Health & Nutrition is on the order of 14% to 15%, maybe Knowledge, maybe 19.5%, 20.5%, would love to get your thoughts there.

So first of all, if you look to China, so the revenue impact was only 0.5% down in the first half because basically, the good growth we had Jan-Feb and June was more or less not completely, but almost offsetting the revenue reduction in March, April, in May. But as I mentioned before, we planned the organization for a different growth profile, therefore, of course, we had more costs. If you think about the margin development in Knowledge, in Knowledge, it's really about -- it's about the service mix. We're getting very strong demand in consulting work where margins are a little bit lower than in the more traditional business. It's also fair to say that we compare, especially last year with a very tough comp because we had last year the year where we have additional -- this 3-year cycle where we have additional audits. So we could definitely do every 3 years a higher productivity. And I think what is partly -- needs to be also partly considered is the fact that last year, a lot of audits still happened very much remotely, which is from a cost-to-serve model, of course, more efficient than having this on-site. And now we start to have much more on-site audits again. It's already in the run rate, and this is partly also driven by the regulators. So from this point of view, last year's margin was, I would say, also exceptionally, exceptionally strong. On the Health & Nutrition part, it is definitely fair to say that we are very strong on vaccine-related testing last year. And surely, we have given to those clients a priority. And we are not able to, yes, to serve other demand, which potentially being there. And subsequently, this business was also respectively well priced as a priority has a value and help the pricing. So it will take -- we are very confident to replace the volume. I mean if we look today, excluding vaccine-related testing, we're growing double digit, but -- and it will accelerate. But of course, it takes some time until this project starts, and we need even more volume because now we have, let's say, good prices, but not exceptionally high prices. So the margin gap will be definitely still there or you could say maybe last year's margin were more from a short-term point of view had a bit of access potential. So it will take some time to narrow the gap in that respect.

Shall we move to the next caller. So Anvesh, please go ahead.

I got 2 questions. First, you sort of flagged the benefits in I&E from collections and -- sorry, the negative impact in -- from collections and then at the same time, in Connectivity, there was some sort of benefit from the collections. Can you just help us quantify that? And are those one-offs? Do you expect them to repeat in the second half? And the second is really around the free cash flow and working capital. Clearly, sort of it has picked up because the revenue growth has picked up. But is 1.8%, do you think is sort of a sustainable level beyond FY '22 as well? Or we should expect sort of an increase in that as we go along?

So I mean if you look to the net debt development, I mean, for the whole company, it's neutral, right? So basically, there is not higher or lower bad debt expenses this year versus prior year. But there are shifts within the units. They are definitely still in the single-digit millions, but it's fair to say that the more meaningful positive impact was the collection in trade facilitation services, so C&P. And this was not completely offset by more bad debt expense in I&E, but I&E was the -- yes, the biggest one with more bad debt expense. There were a couple of other things in other regions, but it's still in the mid-single-digit level. And for the working capital, excuse me, working capital, excuse me. Working capital, obviously, there is strong growth. And I think if we look to the trends in working capital, it is DSO are strong. Actually, they are 1 day down. So that's good to see. So it's not because of increasing DSOs, it's just growth and activity. And surely here, there are more areas on the payable side, which are -- sometimes it's just the timing of certain payments versus when the activity happened. Overall, we believe we will continue to have strong working capital in the future. As I mentioned also in my remarks, for the end of the year, I believe, working capital in percentage of revenues at the end of the year will be still negative, not to the same level like the last 2 years, but still negative. And I mean, of course, with more growth, there is more need, but you need also to consider that our Level Up initiatives in terms of centralizing billing and adding more centralized billing will further help to make structural improvement to partly offset they need in terms of good growth.

Thanks very much, Dominik. [Operator Instructions] So next, please, could we have Sylvia, if you have your two -- two questions, if you want.

Yes. So for me, just could I go back. So just to make sure that I understand the China impact. So China itself grew by 0.5%.

Negative decline.

Versus -- negative, sorry negative, sorry. Negative 0.5%, and you would have been, I don't know, [ 8%, 9% ]. So the, I guess, the negative impact in the half is kind of CHF 40 million, CHF 45 million and then whatever drop through you've got on top, I guess that's the right way to think about that. And then just to check on Russia and the Ukraine. So you've previously said that, that's about 2% of overall group sales. It doesn't seem that you've exited, you just reduced kind of business activity or at least business development. But can we just confirm if that 2% is still unchanged overall within the H1 numbers?

And maybe I'll see if -- I'll answer the second part of the questions, then Dominik can confirm the first part. Yes, you're right. In terms of activity in Russia, we have -- as we mentioned in our press release, we're still active in Russia, but we have stopped all of our business development activities. We have stopped all new investments, and we are basically working on existing contracts but the revenues has decreased. So it's below 2% now of the group.

I think that covers that actually, isn't it? So next, please, could we have Neil from Redburn.

Connectivity & Products. The impact -- the margin impact of improved collections. Can you just help me understand which of the 2 years, this year or last or 2 periods is the abnormal? I mean, presumably, you've improved collections and you hope to keep in there, but that's the first question. And then secondly, with regard to the outlook and the focus on M&A, I understand there's been a couple of deals post June 30. But you're not spending a great deal in M&A at the moment. So can you talk a little bit about what the pipeline looks like, please?

So if we look for the whole group, there is in the last 2.5 years, as a group, nothing abnormal, so to say. There was a bit more bad debt expense in the year 2019, but the full year 2020, '21 is comparable and the first half this year is also comparable. But obviously, there could be always some movements between divisions like we have it now in the first half this year. On the M&A side, I mean, we flagged at the beginning of the year that we don't expect very sizable transactions because the kind of more sizable in our industry, they are all well known. We know what will most likely come then to the market, which is of interest, and we didn't foresee in general that sizable things which we are looking for will come in the market that, of course, could sometimes change, but so far, that's basically the case. But we see, of course, continuously interesting opportunities, which are smaller partly, very small, which are small, but which are of high strategic interest. And we will continue to go after them if they make strategic sense and basically meeting our EVA criteria. But for this year will be not a significant amount of M&A spending. Next year, it's too early to say how ability of targets, pricing and so on develops.

Thank you, very clear. Thank you, Neil. Next to go is Rory from UBS.

It's Rory here. Firstly, just on Natural Resources, your commentary suggests that, that turns a slow in H2. Is that just a strong growth in minerals in cost comparators? Or can you be a bit clearer where else the slowdown we should worry about? And then secondly, looking at customized audits, it's clearly been a pretty busy period for changing reporting requirements, all these plans to do so in Europe. Can you just explain today how big customized audits are in Knowledge relative to the traditional certifications? And what percentage of your customer base currently is taking up some kind of ESG-related audit service today?

Maybe I'll start with the second part. So in terms of the new reporting requirements, which will be effective next year. And in fact, it's not all the companies. To be clear, there's about 50,000 plus companies, if I'm correct. The schedule is over 3 years and not over 1 single year. So you're not going to see all those companies. And second is most of these are more the larger companies to go on the first batch and then the SMEs and so on will go. So we have seen quite a lot of increase of demand for these kind of activities. We are offering services to our customers. In fact, it's a mix between some kind of consultancy to help them to navigate the new requirements, especially in the SME operations where they have less, a bit less expertise in dealing with this kind of requirement, the larger company has usually their own internal structure. So we're dealing with that in terms of services. [indiscernible] in the medium term, we'll start to look at the validation, the review and certification of those audits or those requirements. So it's an evolution of the market. So we're seeing more demand for us to help them schedule. Obviously, we can't do consulting and certifications in one point in time, but the market for time being in our views more on the consultancy part of the processes and in the medium term. So again, our target population for the time being is the SMEs. The larger customers has their own structures, but once they will start to request for certification, we'll be stepping in as well to see whether we can offer those services to them. I don't have an exact number in terms of how much we need to study for that, because what we do for our customers in terms of ESG certification for the time being is voluntary because the requirement is not coming to a mandatory stage yet. So is more, as you say, customized voluntary certifications that I don't have the numbers. The first question was...

Natural Resources, the guidance for a slowdown in the second half, does this relate to minerals or tough comparables?

I think if we looked at, in general, we are very, very optimistic and upbeat when it comes to minerals testing, also minerals commodity Obviously, there was also a bit of a pickup already in the second half last year. So tough -- the comps get a bit tougher. And I think it's fair to say that obviously some of this business, like especially agriculture is impacted from certain trade restrictions. And while restrictions happened, rather early, it takes some time until they're really in the system. So we expect maybe from this point of view, doing a bit more difficulties, but it's not -- I would not call it a slowdown. I mean the growth rate is maybe a tiny bit lower.

The next on the call is Arthur from Citi.

I think you mentioned the -- firstly, I think you mentioned that the oil and gas trade activity is a little bit less profitable than perhaps they had been before. I firstly just wonder whether that was linked to the issues with industrial new play, and if not, then sort of what was the issues? And then question two, just on the energy CapEx side, both in terms of renewables and indeed oil and gas, just wondering sort of how you're seeing the second half of the year in terms of that?

Sorry, Arthur. I did not really understand...

The first question was related whether there is -- whether the lower margins oil and gas trade is more a function of price pressure or more a function of Russia.

[indiscernible] has to do with volumes in Russia and Ukraine or something like that or just trying to get a sense for what the reason was, if that makes sense?

Yes. I think the -- as I mentioned earlier, the Russia impact is limited to the SGS group, it's less than, as I mentioned earlier, now it's less than 2% of the group. The pressure on the oil and gas margin is still remaining the price pressure that there are the excess capacities, the trade is getting better. We're seeing growth, but the competition is quite high. So when we talk about pricing strategy and so on, there are sectors in which pricing is more difficult than others. So oil and gas sector is one of those sectors where pricing is leading more challenging, and this is reflecting to the margin. I would say the Russian current sanctioned restrictions are not the bigger part of the margin evolution. The second question was, I'm sorry, I did not hear as well.

Sorry Arthur, could you repeat the second question?

Yes. It was just around how you look at the outlook for revenues relating to energy CapEx. So that's both oil and gas and also renewable energy?

Okay. So the outlook for energy CapEx, oil and gas, I mean, we do very little oil and gas CapEx now.

And also the renewable as well, and also renewable as well. [indiscernible]

So there's certainly an evolution in terms of the CapEx spend into the infrastructure. We're still -- we hear a lot of discussion with our customers about putting more CapEx into refineries or so because of the fact that the oil price is high. But we have heard a lot of discussions planning, but for the time being, it does not hit directly our activities yet. On the other hand, we are -- we're seeing much more demand in terms of renewable, whether it is wind farms in South America, we have secured a few contracts there. If you can put nuclear as renewable energy depending on how you see it, we're also seeing a more increased demand into the technical expertise for the nuclear sector as well.

The next to go is Kate from Bank of America.

Just as we think about the second half of the year, could you remind us how much exposure you have to Germany and the industrial sector, in particular, just given the potential risk to gas supply? And then of that exposure, any details that you can give around how much is kind of more volume-driven versus more recurring or regulatory base would be great.

Okay. So why don't we talk a little bit about the volume-related business and any cyclical parts of our European business in general. I guess that's probably the question especially focusing on Germany?

I don't have the exact number for the oil and gas specific related activities for Germany.

I think it's more that if Germany -- correct me if I'm wrong, Kate, but if Germany is impacted, the economy is impacted by higher gas prices or gas shortage, it would impact the industry, which might not be able to function. How would that impact our business?

Yes. In term of...

Yes. Exactly. I'm sorry, go ahead.

Sorry, Kate, sorry. Yes, in fact, we do, like every other laboratories, we do have contingency plans. So obviously, it's dependent on the extent of the severity of the impact in Germany evolved, the energy sources being cut up. So we do have a contingency plan across the group. And typically, in our business continuity plan, we also look at severe event. Some of the activities will be migrating to our neighboring countries like Belgium, Netherlands and France and so on because we do have across the network similarity in terms of the capacities that we have. So these are on the study. In fact, it's part of our business continuity planning studies. If the severity goes to the extent that we have to -- we cannot function in Germany, and we have to migrate all those volume out, France, Italy, Netherlands and Belgium will be the country we'll be migrating some of those volumes. The exact impact of how much this means to our businesses is difficult to quantify because I don't know yet. I can't tell you how much of the economy would collapse in Germany for the time being. But we have contingency plan.

The -- I guess, the other part of the question referred to how cyclical is our business in Germany, how regulatory driven is it?

Everything is linked. It depends on the sectors again. You look at all the environmental activities that are extremely regulated. On the industrial activities, you looking at the statutory control and so on is all regulated. The food activities is regulated in the sense that you need to meet certain criteria. So quite a lot of the activities is regulated across the different spectrum of our customers. Some of them have a specific requirement, but they go in line against regulation on the background as well.

Thanks very much. The other thing is that we are starting to see some refineries opening up in Germany again and coal power stations which obviously counters that cyclical element. The final caller on the line is Paul from Credit Suisse.

So a question on supply chain disruptions. In the auto section, you mentioned that you expect Hardlines stores and auto to improve in the second half. Are you seeing any easing in terms of supply chain issues in those areas?

Yes and no. It depends on the product. I mean, if you look at the automotive sectors, we see a little bit of the easing of the supply chain, but not too much. So on the automotive sectors, we are very cautious about that. On the toys, on the juvenile products, things seems to be more stable these days. We see an increase in terms of volumes. And we're still seeing some of the difficulties in the different kind of Hardgoods product. The logistics, with the component on is still problematic, but we see different increase of different volume. But the automotive sector is probably the one that is more challenging.

Thank you very much. And that brings the questions on the call to an end, but there are some questions online. So I will attempt to group them because these were submitted -- some were submitted prior to the Q&A session, so some of them are probably outdated. A lot of them cover China and quantifying that impact. I think we've covered that enough already. So if you do have any additional questions, please just send them to me. Dominik, we've got a few on quantifying the impact on pricing, in particular, our ability to continue increasing our prices given the inflationary environment.

I mean if we look to it, I think, in general, we increased prices 2.5% in the first half. Of this we ask on the vast majority of absolute cost inflation, whether as wages or non- cost inflation. It's a very strong focus of us because we see high inflationary levels. And from this point of view, the operation is very focused on it. So I guess, this 2.5%, it will further increase throughout the year. And there is, of course, a strong need also, at least in the short to midterm, to work on it, and we are very, very committed. But I also think, and it's important also to see that overall I would say that the industry is very rational, more rational than maybe other business service sectors in that respect.

Absolutely. Another one for you, Dominik, as well. So we've got some comments asking for some guidance around full year net debt levels and free cash flow conversion. I guess, obviously, the dividend was paid in the first half, and we we've sort of got clear guidance around CapEx, but maybe talk about the other factors.

Yes. So I mean, if you look to it, I mean, we have a pretty clear dividend policy where we say CHF 80, and we will only increase the absolute dividend if we are down to a payout ratio in 75% to 80%, which will be, this year, not the case. Obviously, the payout ratio will drop with looking to our outlook statement in that respect. We have from a working capital point of view, we had, yes, some need in that respect. But as I mentioned before, assuming a slightly negative working capital in percentage of the balance sheet at the end of the year and a bit more CapEx, we still should be able to have a kind of similar free cash flow. So from this point of view, the net debt will go a little bit up because we announced the share buyback, which is basically on top, but it's not overall that material in that regard.

Thank you very much. Maybe one for Frankie. If there were more lockdowns that came in China, what measures can we take to mitigate those effects?

Yes. I think, again, then we need to differentiate the city, which was locked down. So if you look at the lockdown that happens in the first half was Shenzhen and Shanghai. Shenzhen for about 10-plus days and Shanghai for 2.5 months. These are the 2 largest operational site of the SGS group in China and certainly Shanghai is one of the largest in the group. So the full lockdown of those 2 sites, certainly has a major impact. We were -- and especially the length of the Shanghai lockdown did not allow us abilities to move samples to the rest of the network within China. As I said, we have contingency plan, but the lockdown was much longer than anticipated. On top of that, our own customers was in lockdown, so we couldn't even send our own inspectors and auditors to their site. So there a quite customer impact. So if we look at the future, in terms of lockdown, we do see some spot lockdown in China still ongoing, but we have a much more flexibilities around because the network is quite large, and we have duplicated a little bit moving around to reassess a little bit the footprint so that we can move sample volumes and little bit more across the network in a more even way. But obviously, if there's another lockdown of a month or 2 in Shanghai, considering the size that we have in Shanghai, would be something that we have to need back. But if it is one of the smaller sites that we have with Tianjin or Beijing, the impact will be much smaller because we'll be able to take the volume and move it to a lot of laboratories.

Thank you very much. I haven't given names to the questions because they've all been grouped so far. But Carolyn Price from Fargo has got a couple of questions around the magnitude of the recovery of bad debts in Connectivity & Products and the end of some PCA contracts. I'm not sure if we actually disclose those details, but could you talk a little bit about how that will impact the C&P business as we go through the rest of the year?

So basically, on the C&P side, so the kind of contract loss, they are not that meaningful because obviously, the key driver for the acceleration of growth, like Frankie said, an outlook statement is really the recovery of China, which the C&P is really benefiting from it, given the big impact of China for the C&P business. In terms of collection of bad debt in C&P, there was, yes, great efforts. So it was a positive thing in the first half. As I said in the question before. It's in a single-digit million. There was also in the second half last year, they did quite a good collection on this -- in that part. But in the C&P part, there is no other big outstanding they are. So basically all bad debt was completely recovered.

Thank you very much. And then we've got 2 more. So the first one is from Stefan Buller. And he would like to ask, given 96,000 employees and personnel costs, sorry, I should say, about 50% of revenues, how are we managing the impact from that?

Yes. In terms of wage inflation, obviously, we calculate all that into our -- so 2 aspects. So first is in terms of pricing strategy. We do calculate into -- do factor into our pricing strategies the biggest cost base that we have in the group, which is people. So this is factored into the pricing that Dominik has been talking about. And second aspect is also a question of continuing to implement those efficiency measures that were put in place. So part of the cost inflation, whether these are wages or those, is compensated by the price increase and the other part is also a continuous evolution of optimization in terms of productivity gains and so on across the operations that makes the difference. So we are forthcoming. We managed to balance the two.

Thank you very much. And for the final question, which, again, is a sort of a mix of a few people asking. In terms of the investment plans in the second half, where are our key focus areas? You want to go, Dominik?

So the key focus areas, as I said, again, #1 is Health & Nutrition. We will continue to expand our network of strategic area focus on Health & Nutrition has a few new projects into the discussion to our planning so that we will continue to invest. Connectivity & Products, I mentioned the 3 [ sublots ] will be established across the network with the support of Brightsight. We also have a few more CapEx investment into the wireless activities. These are the traditional -- the Knowledge businesses will continue to expand, but this where we talk CapEx is more people related. We also have a few on-site labs that are coming on board with minerals, which is in support of our evolution in terms of the market evolutions. These are, I would say, for top of my head the larger CapEx we're looking at.

Thank you very much, and thank you to everyone for joining us on the call. As I said before, we do hope to be able to meet many of you face-to-face at our Investor Day later this year. And with that, I will end the call. Thank you very much.

Thank you.

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