SGS SA (SGSN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the 2022 Full Year Results Conference Call and Live Webcast. I am Sandra, the Chorus Call operator. [Operator Instructions] The conference is being recorded. [Operator Instructions]. At this time, it's my pleasure to hand over to Toby Reeks, Investor Relations, Corporate Communications & Sustainability. Please go ahead, sir.

Hi, there. Welcome to SGS Full Year Results Conference call. As per usual, Frankie and Dominik will present, and then I'll return to host the Q&A. [Operator Instructions]. With that, I will hand over to Frankie.

Thank you, Toby. Good afternoon, everyone. As usual, I will give you a highlight of our performances for the year. Dominik will then provide you a more detailed financial review, and then I will cover the business outlook for '23 followed by Q&A. But before we start on the result, I'd like to take this opportunity to thank all my colleagues across the SGS Network for their contribution to the group. Many of them in their personal and professional lives were impacted by some significant challenges in '22, including the war in Ukraine, COVID in many countries and [ partly ] in China recently and the impact of high inflation. Beyond their dedications to keeping our operations running, the sense of community and the support provided to each other during these challenging circumstances is something that I have really appreciated and have learned from. So thank you to all of them. So as for the results, just before the Investor Day of last November, we issued an ad hoc communication revising our guidance for the full year '22. Since then, some further operational disruptions have occurred in China. The lifting of all the COVID restrictions resulted in high sickness rate, which is impacting us and our customers' operations. However, I'm pleased to report that despite the unforeseen event, our operations performed strongly, and we have closed the year in line with our revised guidance. So for the full year '22, total revenue increased by 6.8% at constant currency, while organic growth was 5.8%. Adjusted operating income stands at CHF 1.023 billion, at the same level in constant currency as 2021. Free cash flow stands at CHF 507 million. This is a decline of 20.2% compared to prior year, partly due to the increased working capital required to support the growth of our activities. And the Board of Directors is proposing a dividend of CHF 80 per share at the AGM, same as last year. Despite the difficult market conditions, we are continuing our journey as a purpose-driven company. We're convinced that the balanced approach to planet, people and performances will result in the best long-term value creation for all our stakeholders. This slide shows some of the progress we made during '22. Maybe one of the most important changes in this slide is the approval of our SBTi 1.5-degree ambitions by the Science Based Target initiative. Our commitment to 1.5 degree is the first step in our new trajectory. This requires to step up our effort on current reduction program on SCOPE 1 and 2, and to launch additional programs to tackle SCOPE 3 emissions as related to our supply chain in a more systematic way. We're also looking at expanding the seasonality-related short-term incentive KPIs across a larger population of managers. This to create more accountability and to give a stronger focus on achieving our goals. We'll further update you as those programs are implemented. Now with our strategic focus, we made four more acquisitions during the second half on top of the three companies we acquired during the first half. Proderm, based in Germany, is a leading player in the cosmetic and personal care testing sectors with strong scientific expertise, significantly reinforce our global additions in Europe and globally, I'm sorry. Silver State Analytical Laboratories is based in the U.S. complement our network of EHS laboratories in North America. They are specialized in the environmental testing of water and salt. Penumbra Security in the U.S. helps SGS to continue the expansion of its cybersecurity testing network, adding accreditations and competencies in information security conformance and regulatory compliance testing. Industry Lab in Romania specialized in food microbiological testing. This acquisition brings forth our service offering in Romania and our food network in Eastern Europe. As a reminder, the three companies acquired during the first half were Gas Analytics Services (sic) [ Gas Analysis Services ] based in the U.K., bringing the pharmaceutical, semiconductor, food and beverage expertise and gas instrumentation and calibration. Ecotecnos, based in Chile, is specialized in monitoring the impact of industrial activities on biodiversity in aquatic and marine ecosystems. AIEX, based in France, is a technical inspection and NDT specialist in the nuclear sector. We have also acquired the remaining majority of -- minority, sorry, stack of two companies during the first half, 32% of Advanced Metrology Solutions based in Spain, specialized in metrology and dimensional measurement in the aviation industry, and 49% of SGS Digicomply, a JV created by SGS that specializes in regulatory monitoring in the food sector using digital technology. So on that, I'm going to hand over to Dominik for more detailed review of our financial numbers. Dominik?

Thank you, Frankie. Good afternoon, ladies and gentlemen. I will start with the overview of the financial highlights for fiscal year '22. Frankie already mentioned the operating highlights in his introduction, revenues of CHF 6.6 billion and adjusted operating income of CHF 1.023 billion and a free cash flow of CHF 507 million. Revenues for the group in constant currency increased strongly by 6.8%. Adjusted operating income was with CHF 1.023 billion in constant currency, broadly stable, fully in line with our trading update provided a couple of days prior to our Investor Days. Consequently, AOI margin dropped by 100 basis points in constant currency to 15.4%. We incurred restructuring costs of CHF 46 million versus CHF 50 million the prior year, and one-off costs of CHF 29 million due to our decision to cease two key upstream projects in Libya following the absence of cash collection. Net profit after minority interest declined by 4.1% to CHF 588 million, which is, to a large extent, a function of currency. Adjusted EPS increased by 3.4% to CHF 92.46. Cash flow from operating activities declined by 11.9% to CHF 1.030 billion, mainly due to higher net working capital requirements to support the strong revenue growth. For '23, we expect less net working capital need than in '22, and therefore, a stronger cash conversion. Organic revenues increased by 5.8% in '22, equally split between volume and price growth. The contribution from acquisition is with 1% limited and reflects several smaller, but strategically very important additions to our network. The currency impact was 3.1% negative as the Swiss franc continued to strengthen against several important currencies, leading to revenue growth rate and actual rates of 3.8%. Moving on to the revenue growth by business. Organic growth in Connectivity & Products was 3.9%, very solid, especially considering the COVID-related impact in China. Growth accelerated strongly after the lockdowns in the second quarter '22 in China, but slowed towards the end of the year as higher sickness rates occurred given the opening up -- reopening of the economy. Strongest growth was achieved in softlines given 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. Hardlines organically declined given the challenge in duration in China and supply chain disruptions. Revenues in Health & Nutrition increased by 7.6%, supported by the continued focus on M&A. Organic growth was 4.1%. Food grew organically above the divisional average, supported by growth across the network. Health Science has replaced much of COVID vaccine-related work, however, organic growth declined slightly. Revenues in Industries & Environment increased by 5.4% in constant rate, while organic growth was 4.8%. Field Services and Inspection grew above divisional average driven by good performance in environmental field and marine services. Technical Assessment and Advisory delivered double-digit organic growth continuing to benefit from the increase in supervision and consulting work in Latin America as well as strong performance in Middle East and Southeast Asia and Pacific. Public mandates, revenue declined due to loss of contracts in Africa, partly compensated by price increases in Latin American vehicle and compliance services. The 8.7% organic growth in Natural Resources was driven by double-digit growth in laboratory testing and metallurgy and consulting. Growth in trade and inspection was strong, primarily driven by good momentum in minerals and in oil and gas commodities. Knowledge posted strong organic growth of 8.7%. Growth was achieved across all SBUs and regions. The strongest growth was delivered by consulting, primarily driven by the strong performance of Maine Pointe, benefiting from strong demand for supply chain optimization and performance improvement services. From a regional point of view, growth was primarily driven by the Americas and Asia Pacific. The Eastern Europe and Middle East countries achieved double-digit growth across the majority of its key end markets with the exception of Russia. Growth in the African countries was mid-single digit, while growth in the key European countries was, to a large extent, modest to moderate. In the Americas, revenues increased strongly by 11.1% in constant rate, while organic growth was 10.2%. The strong growth was notably driven by double-digit growth in several Lat Am key countries, while growth in North America was also strong. The organic growth in Asia was 6% strong, especially considering that China was impacted by COVID. In most markets, mid- to high-single-digit growth was achieved, while India, Singapore, Vietnam and Japan posted double-digit growth. FTEs at the end of '22 increased by 2% versus prior year, primarily driven by organic additions, partly offset by the impact of restructuring. Average FTEs in '22 increased by 3.7%, clearly lower than the total revenue growth of 6.8%. Adjusted operating income was CHF 1.023 billion, broadly stable in constant currency. Currency had a negative impact of 3.1%, leading to a decline in AOI of 3% in the period under review. On this slide, I would like to provide an update on our Level Up initiatives. In '22, Project Prometheus was implemented. The purpose of the program was to outsource IT infrastructure, application maintenance and application development to reduce the time to market for new solutions and to reduce costs. This program is the basis to roll out new solutions globally in an accelerated manner. For '23, we expect the full realization of the benefits of this program. We established a Builders Organization to design and develop new technology-based products, initially focusing on higher productivity internally, leading to 5 MVPs in '22, and we're aiming for 12 MVPs in '23. We introduced Salesforce as the new global CRM tool. We implemented CertIQ as the global knowledge platform. Almost 20% of our lab revenues are covered by the digital lab concept, while we expect the coverage to increase to 30% in '23. At the same time, additional functionalities will be considered via release upgrades. We added 15 additional countries to our financial shared service center setup covering now 60% of group revenues with regional financial service center support. For '23, we will add additional shared service center in Mexico to cover the Americas, and we expect to add globally 20 additional countries to cover 70% plus of our group revenues. We also implemented billing centralization. We added 17 countries, covering 13% of group revenues in '22. We will add more than 20 additional countries in the current year to cover more than 30% of group revenues. For our world-class service program, 65% of the labs are audited, and we expect that 20% of the labs will reach bronze award level during '23. With these initiatives, we're building a strong platform for growth, positioning SGS as a more resilient and a higher-productive business. With the benefits realizing from those investments, margins and returns will further increase. Our adjusted operating income margin dropped by 100 basis points to 15.4% in constant rate in '22 as strong revenue growth didn't result in an increase in AOI. As I mentioned before, the AOI was broadly stable in constant rate. Our margin performance in '22 was negatively affected by more impactful lockdowns in China, primarily in the second quarter, worldwide supply chain disruptions and subsequent effects of geopolitical events, leading to a notably higher inflation in second half and softening of demand in some of the [indiscernible], higher sickness rates in December in China and temporarily higher bad debt expenses in the second half. Our Connectivity & Products business is mostly geared to China. Given the COVID-related impact in China in '22, the margin decline is 30 basis points rather limited as an improved profitability in cybersecurity and a strong performance of some key [indiscernible] partly offset the negative COVID effect in China. The AOI margin in Health & Nutrition decreased to 13.3% from 17.1% (sic) [ 17.3% ] in the prior year. affected by the end of COVID vaccine-related testing, the impact of the lockdown in China in Q2 as well as the continued investment into our global network and inflationary pressure, which was partly offset by price increases. AOI margin in Industrial & Environment decreased by 90 basis points to 10.4%, due to COVID restrictions in China, the ramp-up of new contracts and collection delays from certain government contracts. This was partly offset by the positive performance of recent acquisitions. AOI margin in Natural Resources decreased by 20 basis points to 14.2%. Strong operational level in minerals was offset by changes in portfolio mix in oil and gas and agriculture commodities. The margin decline of 70 basis points to 20.3% in Knowledge is primarily a function of change in the service mix as an easing of travel restrictions and return to onsite audits resulted in increased travel costs, with the full impact of price increases will be in '23. Operating net working capital stands at 0% of revenue. While not any more negative as in the last 2 years, it is still the short best net working capital position in history of SGS. The high net working capital need is primarily a function of strong growth as well as some collection delays, especially in China at the end of '22 and, in general, somewhat lower levels of provisions. For the whole year, these all levels remain strong and sustainable, supported by centralized cash collection in years to come as well as net working capital benefits from our centralized billing initiatives. Cash flow from operating activities decreased by 11.9% compared to the prior year, primarily due to higher working capital needs given the growth of the corporation, partly offset by lower tax payments. We spent net CHF 369 million in investing activities, which considers also CHF 65 million for several smaller bolt-on acquisitions. Dividend payments as well as NCI transactions amounted to CHF 651 million. We bought back own shares for an amount of CHF 268 million. We paid back CHF 250 million bond and issued CHF 500 million bonds. All this leads to a cash position of CHF 1.6 billion at the end of '22. For '23, our cash conversion will be stronger as -- stronger as less net working capital need is expected to be required compared to '22. Gross CapEx for '22 decreased by 2% to CHF 329 million, and as a percentage of revenues by 5%, slightly lower compared to the prior year. Net CapEx stood at 4.8% in '22. To sum it up, our revenue in '22 increased by 6.8%, of which 5.8% is organic. Our adjusted operating income is broadly stable as guided during the Investor Day in November. Our return on invested capital remains strong, but decreased by 100 basis points to 18.6%. We will propose a stable dividend of CHF 80 to the AGM. With this, I hand back to you, Frankie.

Thank you, Dominik. So let me go through the outlook of the five divisions. As usual, all the divisional growth outlook combined related to our expectation for full year '23 organic growth and relative to the total group organic growth. So let me start with C&P. Connectivity & Products should grow above the group average. We're expecting some short-term market disturbance to continue in Q1 in China following the lifting of COVID restrictions. The situation should gradually improve in the second quarter, and we anticipate some catching up for some of those activities in the second half. Connectivity is a key growth driver for C&P. We expect the market to continue to grow strongly in '23 as product development cycles and new testing requirement continues to evolve. For example, our order book for our cybersecurity lab network is already secured for the full first half. The investment we have made in both our capabilities and capacity in C&P globally will continue to generate positive momentum, especially as part of the supply chain continues its transition from China, particularly in hard good and softline. At the same time, as the Chinese market reopens, we are seeing new market opportunities for operations, supporting our domestic market growth. Our Health & Nutrition, growth should outperform the group average. Our largest headwinds in '22 for Health Science were decreasing volume of COVID vaccine testing and talent retention in that very tight market. Both of these factors should ease as we move into the new year. The [ environment ] market remains strong, and our continued investment across the network should help to add further growth momentum. Our Food Testing services will see pressure in Europe as customers are becoming more cautious due to the current economic volatility. However, as Asia and particularly China reopens following COVID, we expect our food services related to the hospitality sectors to pick up. Together with new investment made in testing facilities in North America and South America, we're expecting growth in these sectors, but slightly below the divisional average. The recently acquired proderm in Germany strengthened our leadership in the cosmetic and hygiene sector. With product becoming more complex and a great regulatory focus on ingredients, we are seeing increasing market demand for our solutions. I&E. So Industries & Environment, growth should be below the group average. Our strong momentum in health and safety-related services will continue into '23, with expansion of our scope into the renewable energy sector. New contract wins in Lat Am -- Latin America and Europe will start this year. Technical assessment related to the infrastructure and construction sectors is also expecting to have a strong year, with new projects in Asia and Latin America. Market condition remains difficult for now in our environmental testing activities, particularly in Europe. Low economic growth and project delays are having an impact. However, growth in '23 should be better than last year. The structural drivers of the environmental market remain healthy and will strengthen as environmental concern and regulatory control increases. Our public mandate and field services will continue to be impacted by end of contract in certain countries as well as some project delay. Natural Resources. So Natural Resources growth should be above the group average. While overall mining exploration expenditure is expected to decrease in '23, it should not have a significant impact on our activities. Demand for minerals related to the renewable sectors, such as copper, should remain strong. SGS is the leading service provider in [indiscernible] activities, and we are continuing to expand our network with new projects. For the agricultural sectors, while a better crop season is expected, overall market has been significantly disrupted by the war in Ukraine. As new supply chain emerges, we will see new opportunities within our network. The demand for oil and gas is increasing and drive better volume for Inspection & Testing services. However, current pricing can be very competitive, particularly in the inspection services. The oil and gas supply chain are also being impacted by the war in Ukraine, and we expect the market to remain volatile throughout this year. As a consequence, we are continuously redistributing our network resources to manage these changes. And finally, Knowledge. Knowledge should grow above the group average. The underlying market conditions for Knowledge remain healthy, supported by increasing demand in certification scheme, such as medical devices, information security and food safety. We're also seeing a noticeable increase of market interest in services related to ESG, including gap analysis, consulting and auditing. The [indiscernible] impact is still limited, but as the market develops, we should see ESG-related services becoming our clear growth drivers for the division in coming years. Clinical consulting services had a strong year in '22, and we are seeing the same momentum moving into '23, with expansion of our services in Asia. Interestingly, the evolution of our technical consulting is partially driven by our customers seeking help to reduce their operational environmental impact. Our field and testing expertise is enabling us to provide a broader ESG solution than pure auditing. So going into the outlook. In terms of outlook for '23, many of the uncertainties of last year continues, including the current macroeconomic environment, uncertainty over the impact from COVID in China in Q1 and the ongoing war in Ukraine. However, I'm confident that with our focus on key tech market growth sectors, continuous improvement in operational efficiencies and our abilities to get better pricing in sectors of expertise, we'll deliver growth and margins improvement with an acceleration in the second half. So given that, the expectation for next year is mid-single-digit organic growth, improving adjusted operating income and margin, strong cash conversion, maintain best-in-class organic ROIC, to continue to accelerating investment into our strategic focus area with M&A as a differentiator, and to at least maintain the dividend. The last slide. We are entering the final year of our Plan 2023, and this slide is a reminder of the different objectives we set at the beginning of the period. With the outlook I have just given for this year and the progress we made in our sustainability ambitions, we're well on track to achieving all our midterm target by end of this year. However, while we expect an improvement, with improved adjusted operating income and margin for '23, the 10%-plus adjusted income CAGR target for the period of 2023 becomes more challenging given the progress in '22 and our disciplined approach towards M&A. As a conclusion, the long-term drivers of the tech market remain intact, will continue to develop positively, and, in many cases, are strengthening. We're investing in the business, building our platform for growth, and SGS is well positioned to capture on this evolution. On that, I think, Toby, we can go through the Q&A. Thank you.

[Operator Instructions] The first question comes from Kate Carper (sic) [ Kate Carpenter ] from Bank of America.

Two for me. So if I look at the organic growth for the second half relative to what you reported for July to October, it looks like organic growth decelerated quite sharply to 3% in the last 2 months of the year. Just want to check how much of this deceleration was a function of one-offs from absenteeism in China and COVID revenues leaving the system versus a broader slowdown in activity? And then second question, just if you could clarify how much you expect pricing to contribute to growth this year, and also what the underlying cost inflation assumptions are?

Thank you for the question, Kate. So basically, if we look to these 2 months, the organic growth in these 2 months was actually 3.8%. So November, December, so you take the organic, which we said to the Investor Days October year-to-date and then these 2 months 3.8%. And if I would take out the effect from China, we would be by roughly 5% growth for these 2 months.

Pricing.

And then regarding the pricing environment, I mean, half of the organic growth is -- basically was the price increase. This is basically fully in line with what we expected. And that obviously means there was a good acceleration also into the end of the year. So we expect a further acceleration into this year. We have seen good momentum for price increases in the second half, which would be effective this year. So there's definitely a higher -- clearly higher impact on price increases in '23. And then on the cost inflation, surely, some -- in some labor markets, there's higher wage inflation in '23 than in '22, but there are also some areas where we proactively tackled some, yes, personnel cost already in '22. So it will also accelerate. But, yes, we will see how it's moving on. But overall, the vast majority of the cost will be passed on.

Thank you very much. Can I remind everyone? So all major inquiries should be directed to corporate communications or directly to me. So this call is aimed at analysts and investors so we will stick to analysts and investors on the call. The next person to ask questions, and please keep them to two, is Daniel. Please go ahead, Daniel.

I would have another question on pricing. If I look at your guidance for '23, you also expect some volume growth, would be happy to just [ be ] stable in volumes and pricing will do the rest? That's the first one. And you mentioned higher labor costs, probably more acceleration than '22. Could you maybe also discuss other costs like energy, for example, what impact we expect in '23?

I mean, obviously, let's say there is still -- let's put it this way. Obviously, we look for mid-single-digit organic growth, which is a certain range. And I think it's now too premature, but it's the exact growth number. I know where you're coming from. But our view would be the maturity of this growth is coming from pricing given the environment in which we are in, and we see how things are going on in that regard. If you think about cost inflation, there are, obviously, some areas where the kind of cost run rate, which we experienced in the second half of last year, is not yet in the full year. So there's a little bit of catch-up. So for example, if you think about energy costs, energy costs was, of course, a clear increase in certain jurisdictions like Europe, where we, in the first half last year, still benefited from contracts in place prior to the increase in energy cost. They are renewed and they are now on a different level. So there's definitely some, I would say, additional costs moving from our incremental cost as the full run rate of H2 was lower in H1 coming into next year. Other part is also, if you think about travel-related costs, in the beginning of last year, we were still not traveling that much. We went then up, but a country like China, traveling or retraveling only started with the opening up. So there will be also some cost increases, which would be higher than what you normally expect from an inflationary point of view to get it to the right level.

Thank you very much, Dominik. The next question, or questions, I guess, come from Annelies from Morgan Stanley. Please go ahead, Annelies.

So just firstly, just a quick one on the replacing of the vaccine volumes in Health & Nutrition. I think in the comments, Dominik, you said that most of that has been replaced. Do you have a time frame over replacing the rest of it? And if you could give some flavor as to what kind of work you're replacing that with, and how the margin compares to the COVID vaccine work you were doing last year? And then secondly, just on Industries & Environment where you stand fairly bearish for this year. Clearly, there's been a lot of talk from capital goods and chemicals around destocking and slower volumes there. Is that the main dynamics that you're seeing in your end markets? And do you see that continuing through to at least the second half? Or are there other dynamics at play? Any color on that would be helpful.

So I start with the -- so if you first think about the COVID-related work, so basically, the health science part had a very slight decline in terms of organic growth, but it was really, very slightly. So the most of the COVID-related work is replaced. There was still some remaining work there, which is phasing out, but it's not anymore very relevant in that regard. Obviously, it has taken also some time until certain projects are coming in. So there are sometimes a bit of a time delay during '22, where the vaccine work, to a large extent, reduced a lot after Q1 and until new business is ramping up. So that's one of the key reasons why the margin is more materially down than in other segments in Health & Nutrition. And surely the vaccine work had rather high profitability. But that being said, it's now in the baseline. The new businesses and projects started, so you should expect a strong margin increase of the Health & Nutrition business in the current year.

On the second question, Annelies, I think the I&E portfolio is quite large. So in fact, there's a lot of moving parts in there. Clearly, the -- having safety-related activities or the construction supervision related activities were looking at a positive development, especially that we have secured quite a few contracts related to renewable energy, wind farm and so on. On the environmental sector, the year is still going to be positive, but a little bit more challenging than the other two services I just mentioned because of the fact that there are some delay in implementation of regulations as well as some projects beginning in Europe. So this is how we're looking at it. But it should be slightly better than last year, for sure. Then you have sectors like the upstream sectors where it could be a little bit more negative in [ power ] outlook. The automotive sector -- inspection sectors would be flattish. And also all the strategic work with NDT and so on as well as some of the transportation sectors will be pretty soft in our view, partly in Europe and to some extent, in North America.

Thank you very much, Frankie. The next person we have on the call is Simon from Stifel.

Two questions, please. First of all, on the 2023 outlook. Could you give us some details on the phasing of margins between H1 and H2? And secondly, on the working capital, if you could give us some details on the dynamics there? And should we expect another outflow for 2023?

So if we think about the phasing of the margins there, there should be clearly stronger margin increase in H2. Now what are the kind of events? Obviously, H1 was already more impacted last year by China. Excluding China, margins were, in H1, still okay. Now we need to see probably the first or second month in China there will be still a little bit of higher sickness rates, even though we hear good signs, which could have a little bit slower start. But then it should ramp up and have then the second quarter easier comp as there was the lockdown in China. And then in the second half, the margin should basically more accelerate. To a certain extent, the question is a little bit how the bad debt recovery is happening? We assume, obviously, the majority of the kind of incremental bad debt expense which occurred in '22 will be collected, in general, more in the first half, but it could be also throughout the year. But in general, I would say the margin increase is more geared to the second half. And then on the working capital. The working capital, there will be with mid-single-digit growth. There will be some outflow, but the outflow will be surely lower than what we experienced in '22 because while, for the whole year, these were stable. It's clear that towards the end of the year, this -- yes, especially in China with having high sickness rates, there was also much less collection, which should move into this quarter and into this year in that regard. And also in general, provisions were somewhat lower end of -- for last year. So yes, there will be outflow, but it will be less. So cash conversion should clearly increase for '23.

Thank you. Next up, please Sylvia from JPMorgan. Please go ahead.

First question, could you discuss a little bit more kind of the margin trajectory. So you said margins up, but I guess you've identified the bad debt. Do you still expect to collect those? What about the cost savings of CHF 50 million? How much of that has been done already? Is that fully going to benefit 2023? And then could I just check, within the Knowledge business, what margins is that consulting business coming in? It seems to be growing very quickly.

Maybe the second one first. So basically, the Knowledge business has good margins, but it's below -- sorry, the consulting business within Knowledge has good margins, but it's below the average within Knowledge, yes. So it's slightly lower. So you could argue it's a bit dilutive, but I would not say that's the reason of the margin decline last year. It's really more that, in the year before, we did a lot of work remotely and had with this, so basically in the year '21, a situation where our delivery model was simply cheaper, right, because we did more remotely. So we definitely expect a margin increase in Knowledge, even if the consulting piece, which probably will outgrow the rest, has slightly lower margins because the difference is not that big, but they are somewhat lower in the consulting business than in the more legacy Management System Certification businesses. Regarding the margin development, I mean we're not guiding for exact margin. I mean, we are -- I think we are very confident that we have good margin increase, but I can give you some -- of course, some moving parts. So basically, the CHF 50 million restructuring is in implementation, is in motion. So this should -- will be -- is expected to be achieved in '23. Then the majority of the bad debt, yes, CHF 20 million was the higher bad debt last year. The maturity should be collected. So this is definitely on the positive side. Obviously, we should also get the first benefits from the digital lab program in terms of productivity. But there are also some offsetting items which we need to consider. So for example, bonuses in '23 are assumed to be on target. Bonuses in '22, they were clearly lower given the fact that we had to revise our guidance and certain KPIs related to it. We have, as I mentioned before on the question regarding cost for gas electricity, it's not the new norm of these costs. It's higher than what we have in '22, so that the H2 run rate needs to be considered. What I also mentioned before on the travel costs, there will be more traveling, also with China opening up, there will be more traveling in one of our biggest markets in that part. And we will also further accelerate our investments into IT, into digitalization, into Level Up.

Thank you very much. The next on the call is Allen from Jefferies.

Just two quick follow-ups for me, if it's okay. I just really go back to kind of the November comments on the first question. Obviously, at the time, the run rate was pretty good. The guidance was for the upper end of mid-single digits. So I just wanted to just dig into was it purely the China recovery that kind of caught you off guard? I just wanted to check, was there anything else in those November, December months that maybe was slightly weaker than you were expecting back in November? That's my first question. And secondly, I just wonder if you could provide a little bit more color on China specifically. Like what exactly are you seeing in terms of group level, the sickness levels, the impact on activity and margins? How has that been trending through January? And then just thinking about kind of Q1 versus Q2 impact for '23. Obviously, already offer a low base in the restrictions in there. Would you expect China to still be down year-on-year in the first half or net-net positive?

If we first start with the guidance. So basically, when we had Investor Days, our guidance was we said we're looking for organic growth more on the upper end of mid-single digit. So if I say mid-single digits, between 4% and 6%. So I think with 5.8%, we are basically there. What we assumed, obviously, we could not know mid of November when we had Investor Days, the sickness challenge in December -- mid of December in China. So obviously, this was a -- I could say, this was not considered. What we assumed, like we also said at the Investor Days, we see some softening in some of the European markets, which occurred. So this was the assumption. So the only difference is really the China part. But again, if we adjust for China, these 2 months will be about 5%, yes? So from this point of view, and 5.8% was achieved, yes, it considers a bit of slowing in Europe, what we kind of expected. On the second part regarding China, if you think about China, it is actually -- of course, there were often challenges if you think about the big lockdown or the COVID start back in H1 -- when was it again, H1 '20, we recovered very well in the second half. I mean I think our team did a fantastic job to recover in the second half. Yes, we were helped also by all this work for the masks. If you think about the lockdown in the second quarter, we had after the lockdown in the big cities in the second quarter, we had very quickly strong growth basically up to late autumn. And so from this point of view, I think our business, our ability to recover fast is very strong. So I'm not concerned about the growth rate in H1.

Maybe just to add on that, so end of the year -- more or less towards the end of the year, we were about 70-plus percent sickness absence. So the operation was pretty down. By the second week, just before Chinese New Year, we were more or less back up to not fully 100%, but pretty much close to 100%. So -- but this also consider that our customers have their own problems. So it's not one -- it's one thing that we are back up, the second thing is whether the supply chain and our customers are back up to 100%. So we're going to monitor the situation after Chinese New Year to see how things goes, but quarter 1 would be challenging, quarter 2 will pick up again once the situation stabilizes.

Thank you very much, Frankie. The next question or questions we have is from [ Michael ] at Vontobel.

Two questions. The first one is regarding capital allocation priorities. And if you have identified any further areas of potential divestments with the possibility to deploy the cash elsewhere. And the second question tying into that is your equity dropped quite a bit, so net debt to EBITDA continuously increasing. You mentioned that cash flow will be better in 2023, but are you planning any other measures to improve the balance sheet?

So if you think about capital allocation, obviously, we focus, first of all, of course, on organic growth. We put, 2 years ago, our CapEx more towards the higher end of the range, 4.5% to 5%, which we'll continue to do and allocate especially capital into above-average allocation into areas like Connectivity and to areas like Health Science, but we'll continue to do. We are, obviously, open for acquisitions in the core segments, which we defined, where acquisitions would also help. As I mentioned at the Investor Days, we're not seeing currently a lot of acquisitions. Also, we are very disciplined on pricing. So it will be more smaller bolt-on acquisitions in that regard. We also continue to work on our portfolio. So there are a couple of businesses where we have current discussions about -- with external parties about divesting. So maybe there is one or the other could be announced in the -- during the course of the year, but this will be more smaller ones in segments like we outlined at the Investor Days where we have -- which are not of high strategic priority where we have a low market share and also not the right or the best returns. Net debt-to-EBITDA increased. Now obviously, we had some years ago also very, I would say, unleveraged balance sheet. It increased. We also had a share buyback throughout last year. So share buyback is definitely not a priority. It's really about bolt-on acquisitions, organic growth and, of course, a stable dividend. Otherwise, we feel comfortable with our leverage, so there is no other actions needed.

Thank you. Next up, please, is Arthur from Citigroup. Please go ahead, Arthur.

First question for me, just on the working capital outflow again. Are you just able to sort of specify how much of that you think is China driven? I know you've mentioned it some of it, but whether you could just put a number on that? And likewise, sort of what the outflow is likely to be in 2023? And the second question I had was just within Connectivity & Products. Obviously, you've talked quite a lot about connectivity, but in the autumn, some of your peers were talking about destocking cycles having an impact on softlines and hardlines. And I was just wondering whether that was something you were seeing any impact on now or not so much?

I'll go on the second part of the question. Certainly, there's a lot of caution from the retailers about the inventory level and so on. So -- but on the softline side, we are still seeing quite good growth for 2022. And moving to the new year, I think that the growth trajectory might be slightly lower than last year, but I'm not too concerned about that. How good? Same trajectory. I would say, last year was really more difficult. We're looking at the better year this year. But again, while the destocking is an important factor, we also look at the number of SKU and so on. So there's not always a one-to-one relation between the large inventory of our customers and retail sectors versus what we do in the production countries. The last point as well, I think we also extended our network to capture different sources of supply chain away from China. As I mentioned, we've invested quite a lot over the past few years into Turkey, Vietnam and so on, and we're seeing this to be part of the drivers in terms of the way we're growing our unit here, so.

Regarding the development in terms of net working capital movement, it will be in the ballpark, I would say, outflow this year around plus/minus CHF 75 million for '23. In '22, China effect, it's a bit hard to say what if and so on, right? Because -- but it most likely was around CHF 25 million, CHF 30 million. There is a bit of a timing issue, but also -- I know there were also bad debt which we still want to recover or which we will recover, which impacted also working capital in '22.

Thank you very much. [Operator Instructions] The next person on the call is Karl from RBC.