Securitas' (SCTBF) CEO Alf Göransson on Q4 2016 Results - Earnings Call Transcript

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Securitas AB (OTCPK:SCTBF) Q4 2016 Earnings Conference Call January 7, 2017 8:30 AM ET

Executives

Alf Göransson - President and Chief Executive Officer

Analysts

Srinivasa Sarikonda - HSBC

Robert Plant - J.P. Morgan

Mikael Holm - Danske Bank

Andrew Farnell - Morgan Stanley

Ed Steele - Citigroup

Sylvia Foteva - Deutsche Bank

Paul Checketts - Barclays Capital

Viktor Lindeberg - Carnegie Investment Bank

Karl-Johan Bonnevier - DNB Markets

Henrik Nilsson - Nordea Equity Research

Rajesh Kumar - HSBC

Alf Göransson

Hello, everyone, very welcome. I would like to present our full-year report for Securitas 2016.

We are proud of the year. We think we had a good year in 2016, and we are delivering on our strategy. We are growing faster than the security market in average, which we have kind of committed ourselves to try to do by the strategy that we have, and so we did in 2016. Coming back to the divisions in a minute.

We improved our operating margin, 0.1%. Real change, 9%, dividend increase compared to last year, which was an increase compared to many years before that. And maybe one of the most important factors is that we have a very good growth on our security solution, electronic security sales. 56% growth including acquisitions of course contributing quite a lot to that. But still without acquisitions - completely without acquisitions, we have an organic growth of 22%.

So it’s now 16% of total sales in the group, which is up from 11.5% a year before. So we are moving definitely in the right direction. And when the 16%, you have to remember that we also had a very good growth in extra sales and the man guarding side of our business as well. So that we are pleased we have good - and we will think we can continue to work - to grow along those - along that path in the coming years as well, to continue to increase the relative share of electronic security and security solutions, which is really the key fundamental of our strategy, where we are very pleased with that development.

And here you see the numbers for the full-year. Again, basically, the same numbers are - I guess we will come back to those in a minute.

When North America, solid situation, good situation, good momentum, good energy, good leadership and driving our strategy in a very consistent way. We have good growth, good momentum in the growth, we have had very good new sales this year, record-high new sales. And also we have record high client retention, which I think a good proof of our strategy that we keep our clients and that we have good new sales. So a very positive portfolio development and we are coming into 2017 with a good speed.

We have spent quite a lot of resources, including management, in integrating the acquisition of Diebold Electronic Security nowadays SES, Securitas Electronic Security, in our North American operation. And there has been quite a lot of work in the back-office in the integration, in the preparation to get a leverage from that acquisition.

The business has performed according to our expectations during 2016. And now we think we can start to get more leverage from that in 2017. And all that preparation work has been done, and also hopefully now management will be a little bit more freed up from the integration process and the back-office integration work that has been performed in 2016. So we think that we are well positioned now to take good advantage of that acquisition in the North American operation. [Oops, wrong, right?]

The margins are consistently improving, where year on year, we improved last year compared to 2014. Now, again we improved here with 0.3%, 30 basis points up in the full-year. And that is a combination of different things, good growth, good leverage from that, many small things that adds up when you have a stable good performing organization. And also, of course, the inclusion of SES now in the business that supports the margin, so those three together, they are representing the key cornerstones of that very positive trend in North America.

In Europe, we have had a good growth throughout the year, which you now already who you follow us very closely. But of course now, as we already said in Q3, we would see a lower growth and meeting tougher comparatives. We lost a few contracts and so forth, all well known facts. And we were actually expecting a little bit lower growth in Q4, when it actually became, so the 2% that we had in Q4 was slightly better than we were expecting. So that’s the good news.

Still we now will get the full effect in the coming quarters of the contracts that we lost. February 1, they’re all under contracts stopped. And the refugee related extra sales are coming down, that trend remains. So we will have a couple of difficult quarters ahead of us. And then, we hopefully we will start to recover in the second half of 2017 in Europe.

On the margin side, the margin in the last quarter was slower than last year due to a couple of things. But from a full-year, I think that’s the important part to look at, we actually improved the operating margin by 10 basis points, 0.1 on percentage. And that has been supported by the extra sales and also the volumes in security solution and electronic security, which is growing in all our divisions, including the European one.

But in the quarter we had some issues, we had some one-offs that we took to adapt to the volume that we’re now facing right now and in coming quarters.

We took some restructuring measures in few countries in order to adapt ourselves to the situation we were in and try to improve also going forward our margins. So we had a couple of one-offs there in the quarter. The Turkish electronic security business is burdening us a little bit compared to the year before, and also a little bit lower extra - less extra sales with high margin and those to anticipate, probably a question of that, they are kind of…

Operator

Hello, this is the operator speaking. John from Delta Group, can I confirm your surname for the attendee list, please? Hello, John from Delta Group, if you have your line on mute, could you un-mute? I need to confirm your surname for the attendee list, please.

Alf Göransson

And trend in Colombia, while we have more tougher times still in Peru. But the really good news in the quarter was - in the last quarter was very good growth. We saw growth in Portugal and Spain in the range of 5%, 6%, 7%, which we haven’t seen for a very long time, organic growth. And we are employing people now in Spain and Portugal, which we haven’t done for a very long time.

So that was encouraging and more positive view on the market, but also we were successful winning contracts.

And one of the reasons is that some competitors of ours are having big difficulties. One filed for Chapter 11, in the last quarter for example, one major player. And then we can be more aggressive in picking up business from the weaker ones in the marketplace. So that was encouraging to see and supported why we came to the 16% in the quarter. Yeah, and the rest I think is self-explanatory.

When it comes to the margin it’s pretty much flat on the year-on-year basis. And we have a technicality, which Argentina peso which has a negative effect. But if you exclude that one, then it’s basically a flat trend in Ibero-America.

On the wage situation, it’s important to say that we had with wage cost increase which we could not manage on the market. So we have a negative gap between wages and price increases in Spain that we suffered a bit from that in the second half of 2016.

We do not expect any CBA and any cost increases of any significance placed in Spain in 2017. There has been quite - in comparison to inflation and wage inflation in Spain, we have had quite some increases during 2016. So we are not expecting anything of that in 2017. But we will continue to try to push through that wage cost increase we had mid-2016 and now in 2017. And we’re still working on that and we have a bigger price campaign going on in Spain, trying to compensate for that gap. And hopefully, we can recover some of that gap or another piece of that gap in 2017. So that work is still going on.

Cash flow was a disappointment in the quarter. We should have delivered better, which we normally do in the last quarter. But primarily there are number of different explanations, and it’s fairly well explained more in detail in our quarterly report and also on the right hand side of the slide as you see. But still the main explanation is the growth in the accounts receivable that we did not collect as expected in the last quarter.

So we fell short on our targets and our expectation on the free cash flow. The money is of course not lost. We just need to shake it out our balance sheet. We have taken some measures, which is led by our CFO, Bart Adam, and the North American team in North America where we think we have some potential to really improve our accounts receivable and our DSO. And that project started now in Q4, and hopefully gradually we will start to see some results from that project.

But also we are tightening the controls and we are - we will focus more as a management in all levels in the company on the cash flow to recover the gap that we should have collected in the last quarter.

A small information is that the cash flow in January was better than it normally is in January. So it looks like some of that money that should have come in Q4 came in January instead, but not all of it, but some of it at least. So we will have to recover where we fell short in 2016. So in our report I think that’s our disappointment and that we need to fix in 2017.

On the net debt no real important comments to make. Acquisitions, of course, a big one in U.S. the main one that affects that one. And I already commented on the electronic security piece which is now 16% of total sales, a good trend and it continues like that. And we are certain that we can really continue to make that a substantial piece of our total business and that definitely drives the margin.

And this slide that we have shown for years now with 4%, 6%, 8%, 10% improvement path, that works. It still works very well it’s still the truth. And as we move contracts, we certainly improve our margin.

So all in all, we are proud of 2016. It’s the best year in Securitas history. From a financial point of view, we have a good momentum in the group. We are coming into 2016 with full of energy and a good momentum, and into 2017 very good momentum and full of energy. And we really are convinced that we have a strategy that will help us to grow faster than the market and continue to improve our margins.

Having said that, see if there are any questions, please ask your questions, you’re welcome.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Srini Sarikonda of HSBC. Please go ahead. Your line is open.

Srinivasa Sarikonda

Thank you. Hi, this is Srini from HSBC. Couple of quick questions on U.S. please. First, with possible immigration restriction from the U.S. and depending on whose estimates one believes, between 7% to 15% of the workflows being immigrants, would you share with us whether you have had or anticipate any supply shortage of labor?

And also can you reduce the staff turnover in the U.S., now that ObamaCare seems to be likely to be withdrawn?

Alf Göransson

Well, we don’t see much of a shortage of labor. In certain places we’ve had some difficulties from time to time depending on the time of year to find people, recruiting people who are qualified, the language, who will be passing the tests, who will pass our own test, who will be approved by the government to be authorized to work as a guard. So we cannot take people just coming with very short notice from a different country and put them into our workforce. That doesn’t work simply for many different reasons.

But shortage of labor, we have not had much difficulties we’ve had in our business. But of course, if unemployment goes really low, then of course that will be an issue for us. And that normally results in a little bit more wage inflation. But that is not a major deal for us, because if we have - if it doesn’t go very, very high or you have very big swings in that. But if it’s just kind of normal inflation, little bit more and little bit less, then we manage that by our price increases, because that’s, so to say, that’s how this business works. And that is not a concern, if that is a controlled, so to say, transition process.

When it comes to turnover of staff in U.S. or any other part of our business that’s relatively high. Of course, we’ve seen those numbers before pre-2000 - pre the Lehman Brothers crisis, we were in 2007 and 2008 on the same kind of level. And we are used to manage that. It’s not something we like, but that’s the way we are geared for managing this turnover for our staff. And to reduce the staff turnover, the cost of doing that is much higher than the benefit.

So if the industry is not willing to pay and the customer base and so forth is willing to pay on a different level of salaries then it’s impossible for us to do that ourselves, because that will not make us competitive.

Srinivasa Sarikonda

Okay. I understand. Just one follow-up question on the wage inflation. If you look at the market data in November and December, and particularly in security services segment, wage inflation was a lower double-digit range. Do you see that on the grounds actually?

Alf Göransson

If we see what?

Srinivasa Sarikonda

Double-digit wage inflation if you look at the market data?

Alf Göransson

No, no, no, we don’t see that. We don’t see double-digit wage inflation. I mean, wage inflation is relatively low. Unemployment from the category of, let’s say, more low educated segment of the market where we are recruiting, we don’t see lot of pressure and then consequently not much of a wage inflation.

Srinivasa Sarikonda

Okay, okay, thank you.

Operator

Thank you. Our next question comes from Rob Plant of J.P. Morgan. Please go ahead. Your line is open.

Robert Plant

Afternoon. On the cash flow, it sounds like you’re already getting some of it in, but do you think there has been any structural change, perhaps the shift to electronic or the working capital of acquisitions? And how much of that SEK 250 million that were to in receivable, would you think your gap - was like revenue did increase, so that is a nice issue to have? Thanks.

Alf Göransson

There is nothing structural in the sense that we are running the business in the different way. We have a few things. We paid some more money into the pension fund. We have some more taxes paid and less deferred. We made some major investments in the U.S., because we moved to a new head office in the U.S. and refurbished the big building completely. So those are things which are, well, let’s call it kind of occasional one-offs or not something which is repetitive in any way.

So, I mean, but the major matter where we fell short is collecting the DSOs. And we also had quite a lot of accrued sales in the end of the year, which we normally would not have, because we had some transition matters in one area of our business, where we were not ready to send the invoices as expected. And then we accrued the sales, which is correct, of course. But then if you don’t send the invoice, you don’t get the cash. So we send the invoice when the system is up and running, and then you will have a little bit more accrued sales over year-end.

So those money are related to - that’s nothing structural. It’s temporary and it’s the matter of just putting pressure, incentivize the organization in the right way and the right focus. And then the major part of that where we fell short, we will recover and a piece of that actually we already, looks like we did already in January. We should not be too jumping again too much about that. But still it’s important to say that we haven’t a quite a much better cash flow in January than we normally have in January.

So I feel confident that we do not have to take any drastic measures. But we need to be observant on this. We need to be alert and vigilant on this matter and put the focus there, and then recover in 2017, where we fell short in 2016. And I think that’s how I see it. It’s not a concern. It’s just a disappointment I would say.

Robert Plant

Okay. That’s clear. Thanks, Alf.

Operator

Thank you. Our next question comes from Mikael Holm of Danske Bank. Please go ahead. Your line is open.

Mikael Holm

Yes. I have first question on the margin development in Europe. Last year, you mentioned cost relating to extra sales for margins declining, and this year you’re mentioning less of high margin extra sales negative in the year-on-year comparison. Could you give me some more color on that, how it has been negative last year and negative this year as well?

Alf Göransson

Yeah, well, I think, yes, that’s a relevant question, a good question. In Q4 last year - well, 2015, we have very good, very high extra sales. And then we were - well, we were asked or even criticized for why that did not generate higher margin than it did in Q4 2015. And the reason was that we had a lot of extra costs, we had a lot of training, a lot of overtime to manage that tremendous ramp-up of refugee and terror related sales that we got in a very, very short notice, October, November, December 2015.

So which meant that - and we were not taking - we were not abusing that situation even to take - to ask for prices which were too high so to say, and abusing our position to be able to solve a big societal problem, issue. So we had kind of an average margin on the extra sales in Q4 2015.

Now, then during Q1, Q2, Q3, gradually we have then of course taken lot of that cost initially. We have been able to keep the same people. We did not have to do - so we have been able to grow the margin on this piece of business and other extra sales what we have got. We have a good development on extra sales in general.

So margins have been gradually, as usual in this business, creeping up, and we have been proved. So step-by-step that has been better and better. And now we start - now we are losing some of that volume, which has been improved over the past three quarters, in Q4. And that decline is getting little bit more sharper now, which means that that hits our margin, that’s how you should - that’s the short version.

Mikael Holm

Okay. Thanks. And just a follow-up, I guess that implies that that we should not be too optimistic on the coming quarters then as I guess you will face this comparisons in the coming few quarters then?

Alf Göransson

Well, without making too much of a forecast. But the pattern we’ve seen in Q4 will of course remain in the coming quarters in that respect, yes. And then - but I mean, we don’t - I mean, then at the same time, I mean, you lose something, you have to win something else. So hopefully, we will get something else to - but we will have tough times on the top line in the coming two quarters that we have already said a quarter ago, and that still remains as fact.

Mikael Holm

Okay. Thank you.

Operator

Thank you. Our next question comes from Andrew Farnell of Morgan Stanley. Please go ahead. Your line is open.

Andrew Farnell

Hi, guys. Just seeing if you could just add on the client retention in the U.S. market, can you just talk about what you think it’s been driving that?

Alf Göransson

I think that we are doing it - we, as I said initially, we’re doing a really good job. I mean, we deliver well. We have a very good team with strong organization, very stable, very mature, very consistent. I think we’re simply doing a good job. We also have more to offer our customers. We have a better story to tell. We have more excitement going forward.

So I think many customers, at least that’s my perception, feels that we are the best partner for the coming years as well, who can really create value for the client in the coming years by adding technology, trying to do things in the different way, try to make it more efficient and improving the security without increasing the cost.

I think we are the best equipped in the market to do that today and globally. And that I think many customers appreciate. And then they keep the contract, they extend the contract, and then, we can continue to work with improvements we can offer. So I think for many things, but in general, I think we have a good strategy and that is what hopefully I would imagine supports the client retention in the U.S., where we have come very far also in all these respects.

Andrew Farnell

Okay, fine. And just on the wage bargaining point, I think you mentioned Spain. You expect to recover some of that in 2017. But is there any other markets where you’re seeing any wage inflation that is difficult to recover or where you’d expect it to come through in 2017?

Alf Göransson

Not really. I mean, unemployment is still relatively high, and as I said before in that category or that segment of the market, where normally relatively lower educated staff. So it’s always not too difficult to find people. We have some issues somewhere. We have some minimal wage increases. We have some more legislation in few places. But then - I mean, when that is the case then we have also an argument to go through the customer and ask for a price increase.

So at this point in time, I do not foresee any - it’s not a concern, I would say. I do not foresee any major issues on managing the price on wage parts in 2017.

Andrew Farnell

Okay, fine. And then just finally then on the receivables point, could you just give us a bit of better color around where this was - I mean, is there any particular region that was impacted? And from what you’re saying, it sounds like it was mostly driven by inefficiency on your part rather than from a client perspective. Is that a right way to think about it?

Alf Göransson

Yes. I mean, when it comes to - yes, I will say so. We did not do a good job enough to collect the receivables. The piece which is accrued sales, it’s a transition process which you need to do sometimes in order to move from one system to another. Where we fell behind primarily was in North America. And that’s where we have initiated quite a big project led by, as I said, the management and our CFO, Bart Adam. We started already now in Q4 and that continues now in Q1, to try to change the way we operate.

I mean, you can view how we send the invoice. If we can send the invoice before, did more electronic invoicing, put more focus on the cash management, considered if we can incentivize in different ways, many different things. And we have a project team working on that now in North America. We had in Q4 and continue in Q1 and we invest quite some money to do that, to improve that. So there is really kind of a taskforce project going on in North America to shake the money out of balance sheet and get back to the DSOs, where we normally would be and even better than that hopefully.

We also fell short slightly in Europe and in Ibero-America, and but not as much, but still not good enough. So there we also need to do the same things in different ways in the different countries.

Andrew Farnell

Okay, so just one more then. I mean, it’s nothing to do with the mix of the business changing, in higher technology, nothing to do with that?

Alf Göransson

No. There is one part which we call - which is called, I go back here on my slides here, and see if it’s - I mean, it’s called the net investments. And there of course you have one piece, which is in the CapEx, where we invest in our customer solutions, but - and also in the premises that was the piece, so that was the U.S. part.

But I mean, this we like a lot, because that is our strategy, it’s to invest that. But, okay, so that was negative deviation and more money invested compared to 2015. But still the big reason to why we fell short, and why we were disappointed was not that because this we knew. And this is a part of our business, we knew what we were doing, and we knew we were investing in this matter. Where we were disappointed were on the accounts receivable, and also that we had a relatively high accrued sales of the year-end, and that we just need to recover in 2017.

Andrew Farnell

That feels great. Thanks.

Operator

Thank you. Our next question comes from Ed Steele of Citi. Please go ahead. Your line is open.

Ed Steele

Yes, thank you and afternoon, all. Just two follow-up questions, I know you, Alf, you talked about wage price balance generally. Just specifically on the UK, what sort of shape you feel you’re in for the minimum wage hike in a couple of months’ time? And then secondly, please, what percentage of revenue was contributed by the refugee situation still in Europe, which I know decelerated but was still a contribution in the quarter, please?

Alf Göransson

Well, in the UK we had a minimum wage increase already in 2016. And that we compensated fully by price increases coming if whatever price - or if anything similar, when we have that in the UK we will do the same. And I think I will expect that the market in general will reason the same. But when you have changes in legislation on the wage side, or CBAs, you just need to follow that, and then pass that onto the market more - not more, not less. And that we did already in 2016, and whatever comes in the future we will do the same. So that I think is not a major concern.

Sorry, what was your other question?

Ed Steele

The other question was about refugee one-off revenue particularly in Sweden. I was wondering why now it decelerated as a contribution to the revenue line. What is the rough percentage at this point in the quarter, please?

Alf Göransson

The refugee sales in total sales in what, in Europe, or what do you mean?

Ed Steele

Yeah. But essentially to contribution to group sales or European sales, whatever you choose?

Alf Göransson

That number we have not disclosed. I mean still, I mean, the total refugee and terror related sales is relatively small part of course of a total division segment, the sales. But it’s relatively large part of the extra sales. But of a total it’s a very minor part. I’ll just kind of give you - just to give you a flavor of that, if we look on extra sales for the European division, I know, but just - I mean extra sales in the European division as a total is in the range of about 20% of total sales in the European division.

And it fluctuates around that number to give you give-and-take number. And then so out of that number it’s an important part, but it’s definitely a relatively small part of the total division sales. But of course, when you have a decline in that it has an impact, especially as you have been building margins throughout the year.

Ed Steele

Okay. Thank you. And going back a couple of years ago, the extra sales in Europe, what was it as it…?

Alf Göransson

Well, I mean, it’s kind of - it’s been, if you go back in - I mean, it’s fluctuating in the range of 18% to 20% over years. That’s where it is. And on the group level, I think we have talked about those as well. I can give you a little bit more on that respect as well. I mean, that number that fluctuates between kind of 13% to 15%, 16%. Now, we are on a relatively high range. We were in the range of 15% on the group basis of total sales for extra sales in 2016 and which was of course higher than in 2015.

Ed Steele

Thank you very much, Alf.

Operator

Thank you. Our next question comes from Sylvia Foteva of Deutsche Bank. Please go ahead. Your line is open.

Sylvia Foteva

Hi, good afternoon. Three areas of questions, please. Firstly, on the European run rate. Just to clarify, were the extra sales from refugees is coming down during the quarter? So was the run rate in December for example nearly flat as an organic growth rate for that division? And then should we think about H1 2017 as being somewhere between flat and 2% essentially?

Alf Göransson

Well, we not - we’re not going to give the forecast exactly what the organic growth going to be in the next two quarters. But it will be tough, we will have - it will be tough comparatives. And we also with one big contract in the retail, we lost in the end, we terminated that in the later part of November.

So we get the full effect now in Q1, the same in the Arlanda contract in Sweden, which was February 1 that ended. So we’ll have some tough quarters. But we don’t live from crying. We can explain that. But we have to win something else. And of course, we have hundreds - 100,000 people in Europe who like to win something else. So they will fight and try to compensate that by other contracts. But it will be tough in the short period of time, but hopefully we’ll recover well in the second half of 2017.

The run rate on the extra sales and especially the refugee related sales has gradually shrunk in the quarter. So it was less in November than October, and less in December than November.

Sylvia Foteva

Okay, great. Thank you. And then on the margins, you did say kind of talked about Q4 2015 and Q4 2016. But obviously, if a third of the drag on the margins was from the extra sales and that’s in the quarter when in Q4 2015 you had a lot of extra costs. So then the run rate in the margin potentially from that third of an impact should be much worse in Q1 2017, just ignoring the restructuring and Turkish momentum. Is that the right way to think about it?

Alf Göransson

No, but it was as I explained before. I mean, with some of that sales we have had a good margin. And that margin has been gradually improving throughout the year. And now, we are losing some of that margin, which is not only the refugee related extra sales, but also some other extra sales, which had good margin that we lost or we shrank, I should say in, Q4. And then of course that has some impact on the margin. I mean, still we are talking 10, 15 basis points, if we split that 0.4 in three pieces. So I mean we should not over exaggerate that. And still remember, from the full-year, we did improve the margin in the European division actually.

Sylvia Foteva

Okay. Thank you. And on restructuring, would you be able to mention which countries that involve?

Alf Göransson

It was some of it, it was now preferably not. I mean, it’s not major deal. It’s a little bit in many different countries, where we took some actions. Of course, it is to some extent related to the countries where we see a shortfall in the volumes for various reasons. We lose contracts or we have lower refugee sales. And then Sweden is, of course, one sticking out where we lose the big contract at the same time as we have the lower refugee sales. So Sweden would be one of them - is one of them.

Sylvia Foteva

Okay. All right, thank you. And then finally on North America, in Q3 you said that the AlliedBarton Universal combination was perhaps benefiting you a little bit around the fringes. Could you update us on that in the short-term?

And then if we think more about structurally about the market, where would you say that your market share or your combined market share of the top two players is now, if we look at the marketplaces, guarding plus solutions where you compete?

Alf Göransson

Well, I think, I mean, our market share in North America, we usually say it’s around 17%, 18%. And they are basically the same size as we are. Now, we are comparing little bit apples and pears. But generally speaking, so I guess the two together would represent in the range of a third of a market to something like that. We should not exaggerate benefiting from when other competitors are merging or restructuring themselves for different reasons or putting different companies together.

But I think that we see that and we are optimistic in that respect that we have a good strategy. We have our ducks in the right order. And we are really well equipped to take advantage of any customer opportunity. And we have compared to any of our competitors I will say in North America.

We have a competence in the electronic security field that no one can really compare with today, because we have a very, very strong position when we’re now combining the competence and the capacity we have within the guarding regions, at the same time using the competence from the SES business in North America.

So we are well equipped to take advantage of that. We see the same situation in Spain, when competitors are going out of business or getting into financial difficulties. We have a very strong offer. And then we can really - we can take advantage of that in a good way and support that we can grow faster than the market in average.

Sylvia Foteva

Okay. Thank you very much.

Alf Göransson

Thank you.

Operator

Thank you. Our next question comes from Paul Checketts of Barclays Capital. Please go ahead. Your line is open.

Paul Checketts

Afternoon, everyone. I have got three questions on the U.S. please, Alf. The first is, have you worked through the impact of the new tax proposals? If they are enacted and if we were trying to do something similar, are there elements of your tax structure that we should bear in mind that would mean the impact is perhaps less than the raw numbers would suggest? That’s number one.

And the second one is can I return to the healthcare question that came up at the start. If you did see an unwind of President Obama’s various healthcare programs, what do you think the impact would be on the business? And then, the last one is, I guess, Diebold or Securitas electronic security will start to be in the organic growth numbers in North America from February onwards, could you tell us what the level of growth, organic growth that business is delivering at the minute, please?

Alf Göransson

So, okay, I’ll start from the back. The SES business grew 4%, 5% in 2016 over 2015, in spite of all the integration work and back office transition from the divorce from the Diebold group, so that we are pleased with.

On the ACA, the Affordable Care Act, I mean, we had an increase in cost some years - a couple years ago. We pushed that through to a marketplace and compensated for that. Now, what can happen here is impossible to speculate on that and what will the impact be, and how will we act depending on - I mean, now we have put the system in place. Will it be taken away, should that be kept, will it be modified; it’s still lot of certainty. But, I mean, I don’t see and if it would have - if it would be less, then nothing happens, so to say. If it would be more, which it doesn’t look like right now, then we need to work in the same way as we did a few years ago to push any cost increase on to the marketplace.

So I think we can manage. But it’s impossible to know what’s going to happen with that. There is a lot of things said, but we have not seen anything yet, which we can make any decisions or any speculation based on - on the tax situation, if the corporate tax rate would be lower in the U.S., we will have - of course, it will be very beneficial for us, because we generate good profitability in U.S. So that in coming years that will have a very positive effect on the earnings per share. That’s for sure.

But year one, we will have a negative effect as well, because we would then have on the tax asset that we have in balance sheet, which are things like vacation or the social cost or pensions and things like that. We will have an impact that that tax asset which is a deferral, so to say, from the year to come when the tax is actually paid or declared. Then we will have an impact which would be negative.

So year one, it will probably be a negative net impact and then a very positive one depending on the pace also what’s going to happen and in the years to come. So in general, it will of course be positive for Securitas earning per share point of view, but it will have year one lightly a negative one-off impact just because of the valuation on the tax assets in the balance sheet.

Paul Checketts

That’s great. Thanks.

Operator

Thank you. Our next question comes from Viktor Lindeberg of Carnegie. Please go ahead. Your line is open.

Viktor Lindeberg

Yes. Thank you. Following up on the U.S. theme to begin with, you think on the EPS positive side from lower taxes. And do you think you can benefit actually from lower tax in the U.S.? Or would this be used to improve your competitive position in the U.S. or…?

Alf Göransson

No, no, no, that will benefit the earnings per share, because our business is not running this way. I mean, well, you never know over a long period of time, but certainly not in the short medium time. I mean, all that I think - I mean, the way we run the business is that everything that happens below operating profit level that is managed on a centralized way, so to say. So the business is run and evaluated in the U.S. based on the operating result.

Viktor Lindeberg

Okay.

Alf Göransson

So we will never access whatever the improvement on the tax rate. I mean, from that to be reflected in the pricing of our business, that’s not going to happen in the short to medium-term. I wouldn’t think so. Then you never know what competition would do and how things will look in a longer period of time, so that caveat has to be there. But I would not foresee that to be given away, so to say, in any way or form.

Viktor Lindeberg

Okay. Yes, because that was my follow-up question, because you could argue that it’s a sector or industry neutral and some may use it and then you had to defend your…

Alf Göransson

You never know. But, I mean, usually I will say that my perception is that when you have cost which are kind of operating cost that normally happens quite automatically or within a year or two, because that is kind of inbuilt into the mechanism of how you price things. When it’s social cost or if it’s benefits or subsidies sort of thing. I mean, we have seen in many countries in Europe, for example, where government give wage related subsidies to - depending on unemployment and things like that, then eventually year or two later, boom, it’s already in the pricing.

And then it becomes a part of your automatic adjustment of the operations, while taxes is a different ballgame, I think in at least how I - how we run our company and I think also many of our competitors would reason. I would expect that they will reason in the same way. It’s not as automatic as it would be on an operational expense. Of course, long-term, theoretically you are right. But I think it will take a while.

Viktor Lindeberg

Okay. That’s clear. And then, moving on to the technology mix that you now announced every Q4, and it’s definitely increasing now rapidly we see. But it’s not really fully visible in the margins for some of the reason that you now mentioned. But if you look at this more from a top-down perspective here on group level, are you satisfied with margin development in the technology business or is it something that is deteriorating faster in the old - call it old fashioned man-guarding business?

Alf Göransson

Well, I’m happy with this. That’s the bottom line. It’s still a relatively small share. It’s increasing well. We have an impact in North America. We have written about that. We have an impact in Ibero-America clearly, because we had two negatives. One is the Argentina Peso technicality of devaluation. The other one is the wage cost in the second half in Spain. Compensating for that is the increased relative share of electronic security.

We also explained why we are growing better than the market now in Q4 in Spain, because we have a good story. We can pick up business. We are strong. So we - it also supports us on the top line, not only on the margin side. And I think our growth rates in many other places is a proof point of that.

In Europe, less visible, but still it’s fair. It’s improving. But still the margin erosion in the guarding part, not only Europe but in general, is still there. And there we have to - until we have really - well, the day when we have a much higher share of foreign security on the total sales of a group then you will also start to see more leverage on the margin as that balance shifts in the group.

And we are on that path - and if you have some patience you will hopefully be enjoying that ride as well. So we think that we are doing the right things, and when we follow this in details and we split the pieces out, and we follow it on the monthly basis what is the delta between a guarding margin and solution margin, it works. It’s fair all the time.

Viktor Lindeberg

Okay. Final question for me, now a bit of a nitty-gritty question, but it seems the overhead costs are trending up now quite substantially in the quarter. Is there any one-off in that number or…?

Alf Göransson

We had some extra provisions for a couple of projects that we have one, few what we have written off. We have taken some cost for different things. We have some more provisions for different things. So we had some extras there, so the last quarter is not a representative quarter, I would say. So we took some costs that we cleaned out a few things there in the last quarter.

Viktor Lindeberg

All right. That’s clear. Thank you.

Operator

Thank you. Our next question comes from Karl-Johan Bonnevier of DNB Markets. Please go ahead. Your line is open.

Karl-Johan Bonnevier

Yes, good afternoon. If I might take a step back, I remember back at the Capital Markets Day you had in Stockholm quite some time back, you talked about reaching 18% technology penetration by Q4 2015. I guess, we are getting up to 16% now for the fiscal year of 2016. It must be quite pretty close to that target now on years after, aren’t you?

Alf Göransson

Yeah. The number was right, the year was wrong.

Karl-Johan Bonnevier

Excellent. And when you look at…

Alf Göransson

So we will be at the 18% of course. We are getting on closer to that, but we were too optimistic at the time. But also you have to remember you can have a theoretical discussion. But that if we hadn’t had the good growth in guarding businesses in 2016, we’d probably be very close to 18% already now. But we are happy to enjoy the good growth in the traditional guarding and in the extra sales just with guarding sales, because we are good in that and we can also make money on that. So we are well on the way, and again, happy with the development on our strategy.

Karl-Johan Bonnevier

And when you look at the market that is driving the 22% organic growth that you saw in technology solution during last year, is there anything particularly sticking out either from geographical point of view or your internal way of driving the growth?

Alf Göransson

Various countries are more or less successful on this journey. Some countries are doing extremely well, growing very quickly, others are little bit more slow. But that’s nothing unusual. That’s how our business works. I mean everyone is - not everyone is aligned all the time. But in general, I will say, I mean there is a good - a very good understanding. We measure this in different ways and we follow it in many different angles.

Every month we have competitions internally, where people compete of how they can and are rewarded, also depending on how successful they are on driving the strategy. So I think we have done what we can do. And I think we are proving by the numbers, that we are delivering on our strategy. And we just have to keep going like that for the years to come.

Karl-Johan Bonnevier

I remember when you did Diebold acquisition that one of the key short-term parameters of it was to keep, say, the Diebold growth going, so to say, during this year. Have you been able to do that?

Alf Göransson

Yeah, we grew 4%, 5% in the year, and in spite - as I said before, in spite of having all this integration work, all the management spent on that, getting acquainted with each other, meeting the new people, setting the structure to leverage the growth in 2017 and forward, and also transition in a lot of the back office systems, which taking a lot of frustration and a lot of time for many, many, many people to get, to disconnect from the Diebold group and set up our own systems.

Karl-Johan Bonnevier

How do you feel that you reached the milestone, so to say, during 2016 to really be looking at the growth opportunities for…?

Alf Göransson

The team has done a great job, tremendous amount of work, tremendous efforts, well managed all the way. Now, we are ready to focus on the marketplace.

Karl-Johan Bonnevier

Excellent. Thank you.

Operator

Thank you. Our next question comes from Henrik Nilsson of Nordea. Please go ahead. Your line is open.

Henrik Nilsson

Hi, good morning, all. All on the contract, can you comment on how the profitability in that contract compares to the European average?

Alf Göransson

It’s been better than average in the last period of that contract.

Henrik Nilsson

Is that substantially better than average or slightly better than average?

Alf Göransson

[Indiscernible].

Henrik Nilsson

Okay, thank you. And on the loss level in other segment, there was a couple of questions on that previously, had the write-downs in provisions. What is the underlying reason for these?

Alf Göransson

Which one - sorry, which…

Henrik Nilsson

In the other segment, you commented on some write-downs or provisions…

Alf Göransson

We had some provisions. There is nothing underlying. We had some projects which were - we had to which we wrote-off. We took some extra provisions to be - for business development related costs. Yeah, and - yeah, so we took some extra provisions and wrote a couple of things off. And we also had some more provisions for the incentive system. And, yes, and some other minor things. So don’t make too many conclusions of that, I repeat that this was extraordinary in the last quarter. It’s not the level that you should expect going forward.

Henrik Nilsson

Okay. Thank you. And a follow-up on the compensating for increased wage cost. Why is it that you’re able to compensate for wage cost in, let’s say, UK and the U.S., but you’re not able to compensate in Spain? And I think you mentioned also that the increased youth employment tax in Sweden, you’ve not been able to compensate for. Why is it different between the markets?

Alf Göransson

The Spanish market, I mean, you know that it has been in an extreme overcapacity. It was really overheated going back in - before 2008, 2009. Huge overheat - usually overheat in market and then it collapsed completely. And many companies have simply been fighting for survival, and when - to survive when you cannot lay off people, we’ve had tremendous restructuring cost, because the labor legislation is very difficult in Spain.

So then people reasoning that well instead of paying two or three years of salary or one year of salary for people it’s better to compensate - cover half of the cost and sell a guard for half a price. And then to compete with that, you’ll kill yourself if you start to go into that race. So it has been a very price competitive market and basically impossible to increase prices in Spain for quite a while.

Now, fortunately what’s happening in Spain - well, fortunately for us, but not for others, that is that many of those companies who have had that strategy, they have either gone bankrupt or in Chapter 11 now. And there are companies representing now today more than 10,000 employees, who are in those - who are either in bankrupt or in Chapter 11. And it will continue like that.

And so the pricing power will hopefully improve now going forward and that’s why we are driving this price campaign to ask for what we correctly should be compensated for, because of the wage cost we had last year. So that price campaign we are driving now. So Spain is very special, while in most - in all the other markets when you have everything in order and you have the wage increase then you have all - then we automatically ask for a price increase, because that’s the only way we can manage the profitability in this level. We’re not asking for more, we’re just asking to be compensated for the cost increase.

Henrik Nilsson

Okay. But that doesn’t explain Sweden, where I assume that it’s been a good…

Alf Göransson

Well, Sweden was a special case, because when we got that subsidy we never lowered the prices.

Henrik Nilsson

Okay, okay, thank you.

Alf Göransson

So I think explains that, because when we got that subsidy that was - we used that and it supported us, and then we even had the cost increase. I think it was not fair to go to a market and ask for price increase, when we didn’t ask for - when we didn’t reduce the prices when we got that subsidy some years before.

Henrik Nilsson

Yes. That’s fair. And one last question for me, please. There are quite a large differences in the share of sales and I suppose the momentum in sales of the solutions offering depending on the country. Can you elaborate on why there are such large differences on what you’re doing to improve the laggards?

Alf Göransson

It depends a lot on - mainly depends on ourselves. We have to look in the mirror if we are slow, and learn from the ones who are good. So it’s mainly internal and then, of course, we need to put the right people with the right attitude, with the right drive, with the right incentive in place to drive our strategy. It’s not easy. It’s not easy at all, but we have been successful doing that in many places. And where we are not, we just need to support, help push, put pressure and help the people to be successful.

And this is a big company with 2,500 branches around the world. So it takes a bit of a time to get all, to get everybody on a good speed. But that is developing well but there is still a big potential. I mean, in some countries today, we are in the range of 40%, 50% of total sales of the country in electronic security and technology solutions. So the potential is there. It takes a while to get there. But the potential is definitely there, to continue to increase at a good pace.

Henrik Nilsson

Okay. Thank you very much.

Operator

Thank you. And our next question comes from Rajesh Kumar of HSBC. Please go ahead. Your line is open.

Rajesh Kumar

Hi, good afternoon, all. Just trying to understand how much control you have over CapEx budgets in terms of how much CapEx budget have you committed with the customers already, and you have to spend. And second one is, within that CapEx spend could you give us a flavor of the split between labor cost capitalized and material?

Alf Göransson

I mean, we don’t commit with customers. We don’t make a budget in that sense. I mean, we love to spend as much as possible when it comes to CapEx in the sense so when we can invest in our customer sites, and we get about as a piece of the contract. We have given guidance before, that we think that we need, so to say, in the range of SEK 350 million, SEK 400 million, I think it’s what we have said in addition, so to say, with the growth pace that we are having. And, yeah, it’s not a reason to have any different view on that than we had before.

And we are not restraining anybody from doing that. What we are looking for when we are controlling that and running that is, of course, that we do not invest, over-invest, so we become a leasing company or a bank, or a leasing company of equipment for customers. That is not what we want to do. So there has to be a relative share of equipment at - in the customer contract. It’s still relatively low, because you have all the guarding and all the other things, all the other services, the monitoring, the alarm, the response, the fire and safety, whatever else is in there.

So the CapEx in relation to the total contract is relatively small, and we have put some restraints. If somebody has a major contract with a huge CapEx investment, they have to come with approval to me or if it’s little bit less to the divisional level. So there we have a lot of control mechanisms in place, so we don’t overspend or make the wrong balance or kind of exaggerating of course a lot, but not becoming some kind of a leasing company of equipment, that we don’t want to be. It has to be a complete security solution contract.

So I think those mechanisms are in place. The control regime is in place and it works well. It’s not being abused, it’s not being misused in anyway. The other question was the labor material. Yeah, it depends, of course, on the type of installation. The labor is a very, very small part. It’s basically mostly equipment. I don’t have a number, so I cannot give you a number, but the labor is a very small part.

Rajesh Kumar

Thank you.

Operator

Thank you. [Operator Instructions] As there are no further questions coming through, I will hand the call back to our speakers for the closing comments.

Alf Göransson

Thank you very much everyone. And we look forward to a good 2017. Thank you for calling in. Thank you and good-bye.

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