Good morning, welcome to Sodexo first-half fiscal 2018 results conference call. Today's conference is being recorded. At this time, I would like to now hand the conference over to the Sodexo team. Please go ahead.
Thank you very much. Good morning, everyone. Welcome to this first-half fiscal 2018 results call. On this call today are CEO, Denis Machuel, and CFO, Marc Rolland. As usual, the slides and press releases can be downloaded from our website, you'll be able to access this call on our website for the next 12 months. The call is being recorded and may not be reproduced or transmitted without our consent. I remind you that this presentation contains statements that may be considered as a forward-looking statement, as such, may not relate strictly to historical or current facts. These statements represent management's views as of the date they are made, we assume no obligation to update them. You are cautioned not to place undue reliance on our forward-looking statements.
I remind you that the next announcement will be the third quarter figures on Thursday, 5th of July, please get back to the IR team if you have any questions after the call. I now turn you over to Denis Machuel. Denis?
Thank you, Virginia, good morning, everyone. This is Denis Machuel, I'm here with Marc Rolland, our CFO. We spoke to you a few weeks ago when we announced analytical results, our revised guidance for the year. Marc and I will provide you today with more details on the results themselves and provide clarity on how we view the second half of the year. We will outline our action plan to achieve our fiscal 2018 objectives, secondly, how we will embed the improvements as part of our long-term strategy to return Sodexo to sustainable growth, which we will talk about in greater detail at our capital markets day in September. Let's start with some of the highlights of the first half. As we announced two weeks ago, Sodexo delivered an organic revenue growth and an underlying profit margin below our previous expectations.
Organic revenue growth was 1.7% or 1.9%, excluding the impact of the change in calendar from weekly to monthly reporting in North America, and this represents one less day in the first half. The underlying profit margin was 6.1%, which is down 70 basis points, excluding the currency mix effect of the weakness of the Brazilian real. This performance is disappointing and, having recently taken up the position as CEO, I want to assure you that we don't waste any time as we are already implementing a clear set of actions that will address these issues, both in the short and medium term. While the areas of underperformance are clearly a focus for us as a management team, I would also like to stress that business overall is financially strong, with EUR 125 million of operating free cash flow for H1.
I'm happy with the markets in which we operate and Sodexo's position within those markets. We are well-placed to win more business and to grow sustainably as long as we operate efficiently and maintain a relentless focus on clients. Now let's look in more detail at revenues at On-site Services and Benefits & Rewards. On-site Services revenues rose 1.6%. I'd like to highlight that excluding North America, On-site Services revenues were up 4.4%. Businesses and institutions benefited from a modest pickup in France and ramp-ups in the energy and resources business. Overall, this performance more than offsets a decline in education and flat sales in healthcare. Benefits & Rewards Services revenues grew 2.9% on an organic basis, with strong growth in Europe and the USA. A weak performance in Latin America was due to a decline in interest rates in Brazil and continuing high unemployment.
In terms of profitability, underlying operating profit was EUR 627 million, which is down 15% or -7.4%, excluding the impact of foreign exchange. As I mentioned earlier, underlying operating margin was 6.1%, which is down 80 basis points or 70 basis points when we exclude the currency mix effect of the weakness in the real in Brazil, in particular. Our decline in operating profit is attributed to a mixture of factors, some that we had anticipated and some that we hadn't. We had anticipated some margin decline due to the deconsolidation of several businesses and due to lower interest rates in Brazil. I remind you, we were committed to reinvesting the savings from the Adaptation and Simplification Program into accelerating investments in new offers, establishing new growth initiatives, investing in sales and marketing, and enhancing our digital capabilities. I can assure you that all this has been ongoing.
What we hadn't anticipated was the margin decline from education and healthcare businesses in North America, despite the fact that we had anticipated weak sales performance. The poor execution of planned measures to increase efficiencies that were made to compensate the weak sales this year has created a shortfall of about 25 basis points. On top of that, a further shortfall of around 25 basis points came from the slower than expected ramp-up of profitability in a small number of large contracts. The positive elements are that net profits are up, helped by much reduced restructuring costs and an exceptionally low tax rate. Our balance sheet remains healthy, with a net debt ratio of 1.1 time or a gearing of 49%, thanks to our strong free cash flow of EUR 125 million.
In the first half, we spent EUR 674 million on acquisitions with the largest being Centerplate, as you know, which I can confirm is being integrated really well into our organization. Since January, there are already significant synergies identified and implemented. The sales team are working hard and well together, and more and more food purchasing synergies are being achieved as we speak. Overall, net acquisitions contributed 1.3% to revenues. Regarding M&A, we have the means to remain acquisitive, but we will examine any potential target with rigor and discipline to ensure that we don't disrupt the action plans, which are the key priorities for us at present. Furthermore, in underscoring the confidence in the group's prospects, the board approved on Tuesday a EUR 300 million share buyback program, which we will aim to execute by the end of this fiscal year.
I'll now turn over to Marc to talk more about the financial performance. Marc?
Yes. Thank you, Denis, and good morning, everyone. I'm very pleased to be here with you this morning. Please note that as usual, we have defined all alternative performance measures in the appendix. In particular, I would like to highlight that our P&L has changed to include an underlying operating profit. You will find the detail of the other income and expenses, which are reported below the underlying operating profit in the notes to the appendix. If we move to the P&L on slide 10, the revenues are at EUR 10.3 billion. They were down 3.2% or up 3% excluding the currency effect. The currency impact was significant this period, accounting for between 6% and 9% at each line of the P&L. I remind you that this is a translation impact only, as all our costs and revenues are local. I shall focus on performance excluding currencies.
The underlying operating profit reached EUR 627 million, down 7.4% excluding currencies. As previously noted, the margin fell 70 basis point. Denis has already explained the shortfall. We shall go into the detail by segment in a minute. Other income and expenses amounted to EUR 73 million, which is well below the EUR 153 million from last year. As you remember, last year, we had the final tranche of the cost of the adaptation and simplification program. This year, the major elements are EUR 7 million of restructuring costs, EUR 31 million of depreciation and write-offs of intangibles, such as client relationships and rents, EUR 18 million of losses associated with scope changes, and EUR 14 million of acquisition costs, in particular, Centerplate. As a result, operating profit was EUR 554 million, up 4.1% excluding the currency impact. Net financial expenses decreased by EUR 12 million to EUR 44 million for the first half fiscal 2018.
The blended rate for our debt at the end of the period was 2.2%, broadly stable. Last year's first half included an early redemption indemnity of EUR 11 million, and this year there is a EUR 7 million one-off interest income related to the reimbursement of past dividend taxes. The effective tax rate fell to 25.9% from 32.6% in the first half last year. This was due, on the one hand, to a positive one-off of EUR 43 million from the reimbursement of past historical dividend taxes in France. On the other hand, to a negative one-off of EUR 23 million linked to the effect of the realignment of deferred taxes, as well as a deemed repatriation tax in the U.S.A. resulting from the tax reform.
The effect of the lower tax rate kicks in progressively for us, given that we shall have a blended rate for this year due to our year-end in August. Turning to cash flow on slide 11. Operating cash flow grew strongly on last year to EUR 650 million from EUR 523 million last year, mainly due to substantially lower tax outflows, as I have just mentioned, the exceptional dividend tax reimbursement, but also the cashing in of some CICE receivables. The change in working capital was broadly flat relative to last year, reflecting the typical seasonal impact. Net CapEx was slightly higher. As a result of all these factors, free cash flow grew from EUR 30 million last year to EUR 125 million. Net M&A spend in H1 was double the amount for the whole of last year at EUR 674 million.
Last year's dividend increase of 14.6% is reflected in the dividend paid out this past February of EUR 411 million. As a result, our net debt grew nearly EUR 1.1 billion during H1. Despite the seasonally higher level of debt at the end of the first half and the significant amount spent on acquisitions in year-end, the group's financial position remains very strong, with a net debt ratio of 1.1 times and a gearing of 49%. Operating cash stood at nearly EUR 2.4 billion, of which EUR 2 billion is related to the Benefits & Rewards activities. Slide 14 shows the significant currency impact, due in particular to the weakness of the dollar, the real, and to a lesser extent, sterling relative to the euro. Scope changes were +1.3%, which is a net of acquisition contribution and the disposals of Vivabox and entities in the region Africa, Middle East.
This will increase progressively in Q3 and Q4 as the negative effect of scope changes diminishes and as the contribution of Centerplate will be for a full quarter from Q3 onwards. Organic growth was 1.9%, excluding the 53rd week effect. On-site services were up 1.6%, and Benefits & Rewards is up 2.9%. On slide 15, let me just make sure that this 53rd week is clear for all. Last year, we had 52 year-ends, and we had 370 days in the year in comparison to your fiscal year 2016, which had 52 weeks or 364 days. This year is a normal calendar year and 365 days, and it compares to a prior year, the fiscal year 2017, which had 370 days. We are therefore down five days versus prior year.
Quarter by quarter, the 53rd week impact gives us one less day in Q2, one more day in Q3, which means flat versus last year after nine months, then five less days in Q4 and for the full year. On top of this, we have classic calendar impacts which vary from quarter to quarter and particularly in schools and universities, and they can have significant impact when holiday change slightly. To this point, North America universities will be affected by five less board days in Q3 due to the calendar shift. Let us now go into the detail by segment and region. Business & Administration represents 54% of our on-site services revenue. B&A organic growth was up 4.5% and is positive in all regions.
North America, was up 2.7%, boosted in particular by increased activity in airport lounges, as well as significant project work in Q1, solid same-site sales growth. In Europe, which represents 50% of B&A revenue, the recovery in tourism in France is definitely there. We are pleased also with the growth in government and agencies, although we have not yet felt the effect of the loss of the [STI] account in the U.K., which will start to have a significant impact in Q3. Energy and resources continue to remain very weak in Europe, down 17%, we've just lost a contract in Norway, which means that it is likely to stay very negative for a while.
We had a very strong performance in Africa, Asia, Australia, Latin America, and the Middle East, with organic growth of 12.4%, reflecting the ramp-up of new contracts signed last year in energy and resources, good development in same-site sales in most of the countries in corporate services. Moving on to Healthcare & Seniors, revenues remain stable at EUR 2.4 billion. In North America, which is 66% of the business, revenues declined by 1.6% due to a lack of new business. While retentions remain stable in H1, same-site sales have been much weaker than expected. Given the current level of new business and several recent losses in the period end, we expect revenue performance to deteriorate rather than improve over the next few quarters. In Europe, revenues were more or less stable, down 0.2%. Contract wins in the U.K. did not compensate site closures elsewhere.
Retention and same-site sales growth are good. Growth in Africa, Asia, Australia, Latin America, and the Middle East was particularly strong at plus 16.6%, with a lot of site openings in Brazil, solid growth in Asia. Looking now at the next slide, education revenue for the first half fell 2.7% on an organic basis. I remind you that North America accounts for 77% of this segment, this is where the performance is poor, due mainly to a very low prior year retention. As a result, organic decline in sales in North America was 4.1%. Same-site sales growth remains solid, the retention rate in universities is improving, although I remind you we are only just entering peak sales season, so decisions are still rare. In Europe, organic growth was plus 2.7%, with strong growth in U.K. schools due to new contracts, particularly in the private sector.
France and Italy benefited from two extra school days each, which boosted same-site sales growth in Southern Europe. In Africa, Asia, Australia, Latin America, and the Middle East, organic growth remains strong at 15.8%, with the ramp-up of several new school contracts in China, Singapore, but also India. Turning to Benefits and rewards, organic growth was 2.9%, and on-issue volume up 5.6%. Clearly, published revenue was severely affected by currencies and the effect of the disposal. I remind you that Vivabox is a very seasonal business around year-end. As a result, the 5.1% impact on H1 revenue will be less significant in H2. In Europe, Asia, and U.S.A., organic growth in issue volume and revenue was strong despite a solid comparative base in the previous year at +5.9% and +7.1%, respectively.
This performance was driven by solid growth in issue volume in most countries in Europe, and in particular by double-digit growth in Romania, Czech Republic, and, for instance, Turkey. Activity in India was temporarily affected by the mandatory transfer from paper to card and the loss of a large client. Revenue growth was stronger than issue volume growth due to the solid growth in the incentive and recognition activities, particularly in the U.K. this period. I remind you that incentive and recognition activities do not generate issue volume. In Latin America, revenues fell 2%, while issue volume saw growth at 5.3%. Growth in Chile and Mexico has remained strong, but Brazil is more challenging. Face value are continuing to increase, but this is offset by lower interest rates, which are currently around 6.5%. No improvement in unemployment and the market, which remains very competitive.
Now turning to operating profit on slide 22. Our underlying operating profit in the first half was EUR 627 million, a decline of 15%, of which 7.6% is related to the currency effect. The underlying operating margin was 6.1%, down 80 basis points, or 70 basis points if you strip out the currency mix effect. Digging deeper into the performance by segment, excluding currency impact. Business & Administration operating profit decreased by 2.2%, and the operating margin was down 40 basis points, reflecting some high-margin account losses and delays in the ramping up of profitability of a small number of recent large contracts. These large contracts are complex, the ramp-up phase is always challenging, and we sometimes encounter issues. In Healthcare & Seniors, the underlying operating profit fell 1.3%, and the margin was 20 basis points lower at 6.1%.
The lack of growth in North America was expected to become compensated by the result of the SKU rationalization program. However, the program has been delayed about six months. It is now just starting to contribute. On top of that, we have weaker than expected performance in some large contracts. Remember also that it does compare to a particularly strong first half last year. In Education, underlying operating profit fell by 8.9%, and the margin declined by 60 basis points, reflecting the decline in revenues in North America due to net losses last year. This was exacerbated by a sharp increase in labor inflation since January and poor execution of the performance improvement plan. These execution issues have been rectified during the course of the second quarter, but not enough to offset the issues during the first quarter.
Finally, turning to Benefits & Rewards Services, underlying operating profits fell 11.5% after adjusting for the negative effect of the weakness in the Brazilian real. The margin was down 320 basis points, and it was expected. About half of this is due to the reduction in interest revenue due to the decline in rates in Brazil. The other half is linked to the combination of accelerated migration costs due to the number of countries moving from paper to card, particularly in India, Czech Republic, as well as France, and the impact of the growth in the newer mobility and expense management activities, which is a lower margin business than the traditional full meal activities, and which is also investing in its development.
To summarize, the margin deterioration we have experienced across our on-site services businesses was primarily a result of internal execution issues and not a reflection of any fundamental weakness in our operating market. We have identified the areas where we need to improve performance, as Denis will outline shortly, have a comprehensive set of action plans in place. In Benefits & Rewards, the margin deterioration is due to the fall in interest rates and the investments we are making in the new businesses. Thank you for your attention, I will now hand over to Denis for the outlook.
Thank you, Marc. Let's turn now on our revised guidance for the current financial year. As we said two weeks ago, we are anticipating organic revenue growth of between 1% and 1.5% and an underlying operating margin at constant currency of around 5.7%. Let me spend a few minutes explaining the drivers behind this new guidance. We have already gone through the H1 performance with Marc, I'll focus on the factors we believe will have an impact more specifically on H2. Let's start with first organic revenue growth. First, the level of signatures has been particularly low these past few years, and especially since the beginning of the financial year. Therefore, there is less revenue to flow through relative to our expectations. We have really looked into this to identify the underlying trends. There is a mix of reasons.
In healthcare in North America, we've been losing same-site sales by losing small pieces of contracts. In education, there will be a negative calendar effect in Q3, as May will lose five days of term time before the summer holidays in North America. From Q3, we will also start to feel the U.K. Army contract losses. In energy and resources, we will have substantially less contribution from ramp-ups in the second half due to a lack of recent signatures. As a result, we are now expecting second half growth to be only marginally positive. This creates a significant shortfall in revenues and therefore in gross profit relative to our expectations.
Added to this, we will have the compounded effects of the delays in the ramp-up of the efficiency programs, and in this respect, we will see a further deterioration in healthcare before the efficiency program delivers enough results, probably only next year. As far as the large contracts are concerned, we are expecting an improvement in the second half, but we will not reach the level expected six months ago for H2, and it will take longer. All of this has added up to a more cautious view for this year. However, the right actions and the necessary time to execute them will address these issues. Let me set out the remedial actions that we are taking both immediately and in the medium term.
On slide 27, you can see the immediate action plan, which has been designed for North America, but which is also being implemented more generally across the regions as and where it makes sense. This plan is based on improving efficiency quickly, but in a smart enough way so that we can generate sustainable efficiency for the future of the group. In terms of food cost management, the SKU rationalization, which Marc was talking about, that has started far too slowly within healthcare, but which is currently ramping up, will also be generalized to the rest of activities in North America. Work is also being done on the food supply delivery frequency on our sites, and there is a big push to further increase supplier and SKU compliance by our sites.
We are also accelerating purchasing synergies with a specific and very active action at Centerplate, as I said earlier. On the labor front, we are revisiting scheduling to be demand-based in education, and this is going to be generalized across the segments in North America. This has significant results in both reducing labor costs and at the same time better responding to consumer needs. We are going to drive this down onto every significant account or site. We also have specific programs on improving overtime management and temp labor rationalization. We are also looking at a much longer-term program to re-engineer our full-time/part-time mix in labor. In addition, we have an action plan across the group to reduce discretionary spend everywhere and fast. From a more strategic view, we are accelerating a plan to completely redesign our SG&A expenses.
While doing this, we aim to simplify the organization to right-size the teams at global and local levels. We are also in the process of consolidating our back offices for recent acquisitions, but also for a marginal point of view. This is not new, and some of the projects are really getting on the way at the moment. The fourth leg in terms of efficiency is to address low-performing contracts. We are composing detailed action plans for each of these contracts. We intend to enhance claim management and launch client renegotiations to rapidly return to the planned trajectory in terms of profitability. I have imposed to a member of the executive committee that he becomes personally responsible for each contract. Finally, we are also strengthening the teams in North America. The teams that we put in place two years ago have not functioned properly.
We need to rebuild our talent pool over there. For instance, we've sent two of our most experienced CFOs out to Gaithersburg, our North America headquarters, for healthcare and for education, where both segments are based. In addition, Satya Menard is now transitioning into his new role as CEO of education. As I speak, the healthcare team in North America is being restructured with a new regional CEO. We brought in very strong new people from outside, and we've also transferred experienced people from within the group. There's a lot to do, and much of this is getting back to the basic discipline of retaining our clients, cross-selling, being compliant with group purchasing, large catalogs, standard menu systems, et cetera. These immediate actions that we're taking are good business practices, and they will become embedded in our long-term strategic agenda.
I've said before that there needs to be more discipline and rigor in everything that we do. Believe me, discipline is the new watchword across the organization and will be at the center of my strategic agenda for the next few years. What is this strategic agenda? As you can see on slide 28, we will focus on four core pillars to return the group to delivering strong and profitable growth. Our key priority in the immediate term is to improve operating efficiency across our businesses. At the same time, we will revitalize our growth capabilities by reigniting our approach to sales and marketing to have compelling go-to-market strategy, and therefore ensuring that we're better placed to capitalize on the attractive growth opportunities that are available to us.
Critically, the investments that we will make in developing our new business capabilities will be financed out of our operating efficiencies and savings. This will, of course, be underpinned by strengthening our talent pool across the organization. Also retaining and improving our leadership position in corporate responsibility, which is a key factor of differentiation for Sodexo. In order to execute successfully against these strategic priorities, we will redesign the way we operate and reinvigorate the way we sell. To enable this, we will do that through the group-wide implementation of a new program management program, which is called STEP. As you can see in slide 29, the STEP program will ensure that we refocus on basic operational drivers in our business, like retention, targeting, cross-selling, increasing spend, managing overtime, sales per hour worked, et cetera.
Refocusing on managing the centimes or the cents or the pennies or whatever, which is essential in our business. This will drive performance and financial results. We will come back to you on this in much more detail in September at our Capital Markets Day. I wanted to provide this initial preview of this program, which we'll be launching in the next few weeks. On these seven areas of focus that you see, we have already piloted STEP 3, labor efficiency. To give you some color, we have an initial focus on North America, on France, and the U.K. We will onboard Benelux, Med, and Brazil before the summer, with Asia Pacific and Nordics to follow. Typically, we choose a number of KPIs to analyze and follow up the cost of labor.
Average cost of an hour worked internally, share of agency staff in total personal costs, et cetera. To monitor as well more efficient use of labor. Typically, the revenue per hour worked, the share of overtime in internal hours, et cetera. To summarize, it's true that we have challenging that we are facing at the moment, our business remains solid, and we are well-placed with attractive growth markets. However, there are clearly areas where we must improve, where we need to take a more disciplined approach to ensure better execution. We need to refocus our teams on operational excellence. To do this, with a specific focus on North America, we have a clear set of immediate action plans. We have a refreshed management team, and we will be driving STEP. STEP is sort of a back-to-basics program.
At the same time, we are reinvigorating our performance-based, our client-focused culture, and our client portfolio. While we pursue our global multi-service contract strategy, we also must reinforce our focus on winning local contracts, on winning mid-size contracts, and also food service contracts, of course. A more efficient business will enable us to invest in our capabilities to ensure that we are best placed to take advantage of the multiple growth opportunities that are available to us, thanks to our quality of life positioning, which is the differentiation. I'm absolutely confident we will build our performance back to where it should be. Thanks a lot for your attention. Of course, Marc and I are open to answer your questions. Operator, over to you.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star one to ask a question. We'll now take our first question from Simon Lechipre from Raymond James. Please go ahead.
Good morning. I would ask three questions, please. The first one on your share buyback announcement. Does that mean you do not see any M&A opportunities in the short term? I was also wondering if your target of a net debt to EBITDA of around 1.5 times is still valid. My second question is on healthcare in Europe. You mentioned in your press release some contract losses. Could you maybe give us some details on those contracts? Also, is there any read-across we can make with the situation in North America in healthcare? My final question, you operate in a very large number of countries. Do you think it could make sense for you to exit some countries where maybe you do not have enough scale to have sufficient margin level? Thank you.
Thanks, Simon. To answer your first question, we have a very solid balance sheet. The share buyback program will not prevent us from doing acquisitions. Of course, on acquisitions, we will be very focused to ensure that they are not disruptive to our short-term action plans that will deliver revenue and margin growth. We will remain acquisitive because we have the balance sheet that allows us to do so.
On the ratio, net debt to EBITDA, the share buyback is actually increasing this ratio by 0.2 times. When I project additional M&A for the end of the year, I think we should probably be around 1.5. We have got room because we guided for 1 to 2. We can do further acquisition in the future. There is no issue around that.
Regarding your second questions, I want to be very clear. There is no systemic difficulties in healthcare. Yes, it is true we have lost some contracts in Europe, but they are not major ones, and we can recover, and we still conquer some also interesting contracts in Europe. The situation in North America is specific, as you have understood. As I said earlier, we are re-engineering our people structure there. We put a new regional CEO. We address that separately. There is no link between the two. As far as your third question, we have already pulled out recently of some countries. We are scanning the countries where we are to ensure that wherever we are, it makes sense. It generates profitable growth, or has perspective to generate on the short-term profitable growth.
We have no taboo in revisiting potentially the number of countries where we are.
Okay. Thank you very much.
Our next question comes from Jamie Rollo from Morgan Stanley.
Thanks. Good morning. Three questions, please, but maybe I'll ask them individually. First, just drilling down into the margin performance in Business & Industry. You have pretty good organic sales there. You put the 40 basis point margin drop down to two things. Could you talk about the loss of those high margin accounts, who you lost them to, why you lost them. On the other factor, the lower expected ramp on recent contracts, was that just due to poor collection of signings? Was that due to competition? When should those contracts reach sort of margin maturity? That's the first one. Thank you.
Yeah. On your first question, in Business & Industry, there is a natural rotation of contracts. You win, you lose, in the recent case quarters, we've been losing contracts, some of them were very decent margin. While we resigned contracts and did some growth, the balance was more towards very large contracts, those margins takes more time to ramp up, the margin is slightly less than the one we lost. The portfolio churn we experienced was actually negative to our margin. Now, we are aware that, Denis mentioned it, that we need to balance more the win rates between very large, medium, local, food, non-food, single, multi-services, and so forth, so that we have a more positive rotation of our portfolio.
At the same time, we signed in the past few years, very large contract, and we had difficulties in some part of those contracts to ramp up our margins. When you take a large contract, you can have dozens of sites, hundreds of services. While we do master, I will say, 80% of the services and 20% of the sites, there is 20% where it is more difficult. Some services are more difficult. What we see is that probably we had been too ambitious in the ramp-up plan, and we are not delivering as per our ramp-up plan. Which means that the margin basis erosion is visible. But they will ramp up, and we are seeing them ramping up.
What we see is what we mentioned about difficulties on the large contracts. It's only a small number of them. As Marc said, given the size, the magnitude, and the number of services that we operate, it takes a bit of time for the ramp-up. What we see overall is that on the longer term, those large contracts are delivering the profit that we expect. They are also virtuous in terms of the level of excellence that they force us to achieve, which is very good because we deliver the values for the clients. We are positive on that, but it's true that there are small numbers that we need to fix.
Is that loss of contracts, the first point, is there a sort of trend there on who you're losing them to? Do you see that continuing, or is it just an unusual period?
No, I wouldn't call it a trend. It so happens, but this is not a trend. As I said earlier, the focus on retaining our clients is very important, and I'll put a specific emphasis in the way we will look at retention.
Okay. Then the second question on the full year margin guidance of 5.7%. I think my math is right. That implies about a 90 basis point margin drop in the second half after a 70 basis point drop in the first half or constant currency. In the first half, about a third of the drop was due to the Vivabox sort of scope issue and interest rates, which sort of shouldn't continue into the second half. Is it therefore fair to say that OSS margins, which were down, I think, 50 basis points in the first half, those should be a lot worse year-over-year in the second half? If that's the case, won't that annualize into the first half of 2019?
The slow ramp-up of all our performance improvement plan or SKU rationalization plan in H1. By the time they were turning into H2, they were supposed to be delivering kind of full steam ahead. Right now, because they are delayed, the compounded impact in H2 of those delays is significant in H2. Same with the ramp-up of contracts. We were expecting some of the contracts to ramp up, those large contracts. Because they are delayed, again, the compounded impact on H2 is significant. For me, the main issue is the fact that we've been very soft on growth, and that we have a significant shortage of revenue in H2 versus what we were expecting at the beginning of the year. As we said, the expectation now for H2 is around 1%.
We were expecting 3%-4% at the beginning of the year, given the pipeline we were seeing. That revenue gap is also a margin gap, which is significant. In H1, we had 1.9%, which was comparable to last year, 1.9%. The key question for the coming year is our win rates in H2. For instance, we have a good pipeline in universities and If we find better in universities, it will help tremendously next year. We are not expecting improvement short-term in healthcare North America, because we've seen some losses and the same-store sales is weak. Fundamentally, with the SKU rationalization plan kicking in and whatever we are implementing in plan, we should see the margin stabilizing in next year. I hope I've got you the picture here, but it's a mix of revenue loss and delays in the implementation plan.
Sorry, if I could ask the question a different way, does your full-year margin guidance imply OSS margins will be down more year-over-year in the second half versus the 50 basis point drop in the first half? Is the down 50 a reasonable guide for the second half? It seems to me your guidance implies OSS gets worse in the second half, the margin.
I think it's about the same, 50-60 basis points drop in the second half.
Okay, thanks. Just a final one, sorry. On the STEP program, it sounds a bit like Compass's MAP program. They started with a real focus on cost for several years, as you're doing, then switched to a sort of sales focus several years later. I was wondering about, I know we're going to discuss it more in September, but when we should start to see the real focus on sales at Sodexo. Are you considering, for example, lowering your internal margin or return targets? Thank you.
Yeah. Well, I think we've already worked somehow on cost. I wouldn't compare what happened 12 years ago with Compass. What is true is, we will focus on sales now. This is something which is important. We know, Marc mentioned it, growth brings margin. We want to reignite growth, we think that it's absolutely not contradictory to re-engineer and re-energize our sales force and our sales energy, at the same time, work on some of our fundamentals of operational efficiency.
Thank you very much.
Our next question comes from Julien Richer from Kepler.
Good morning, everyone. Three questions for me, please. The first one, if we look to your peers, they have a geographical-based approach. According to them, it's a better way to meet demand. Do you see your business segment-based approach as a threat for revenue growth in the short term? Although I understand the fact that in the long term, it has a positive impact for big contracts, et cetera. In the short term, do you think it's a liability? Second question on the new management team in North America. When do you expect the team to be fully in place and to start having an impact on the business?
Last one, in terms of labor inflation in North America, is inflation impacting the same way both Facilities Management and the canteen activity, i.e., do we have the same capacity to pass this inflation through to clients at the end of the year or during the anniversary of the contract? Thank you.
Thank you, Julien. On the first question, we are convinced that our segmented organization is bringing value. I want to highlight the fact that, we have global segments, but in each country, in each region, we have a CEO for each segment, which is responsible for developing the local business. That CEO has all the power, and his objectives, and he's assessed on his capacity to retain our clients, to develop the clients, and come up with the right offers. This CEO benefits from the global segments as an inspiration, as a support, as marketing support, et cetera. We run more than 90% of our business on a local basis. It's true that this global organization has also allowed us to embark into these large contracts that bring value, as I said earlier.
I think it's important that you understand that the vast majority of the way we run our business is local, with local CEOs responsible for growth and everything that goes with it. On the second question, the new management is in place. Of course, there will still be some adjustments. As I said, we have to renew the talent pool, so it's work in progress. We have done some significant moves, as I said, in healthcare, in education. We will also look at the performance of our sales teams, of course. We will look at the performance that we have at site and regional level. This will be an important program that will cover the months to come. It's a very important focus that we have. We focus on the performance.
On the labor, the key topic of the labor is not so much FM or food, it's whether your contract is a fixed cost or fee contract.
If it's a fee contract, if it's a real fee contract or a fee contract with a maximum price. When we look at the hourly labor, as I mentioned last time, the average hourly labor experience in the U.S. over the past four or five months was 3.5%. It varies a lot from geography to geography. Actually, within North America, there are pockets of hourly labor, which is very high, for instance, in California or in Texas. It's not so much what you do, but where you do it and what type of contract you have. I take the case of education. In education, 80% of our contracts are what we call fixed price contracts. They are PNL contracts.
When you suffer a surge of inflation, you suffer it immediately while you are passing it to the clients through retail increase or board plan increase at the next occasion, at the next revision. It takes a few quarters, and the revision is an annual average. While you may have a surge of inflation, which is immediate. We will pass inflation to clients because I think we have a very good track record in the U.S. to do so. When you have surge of inflation, our passing inflation to the client is based on average analyzed, and so you get squeezed a little bit for a while, and then it catches up the next few quarters. It is nothing to do with FM, it's got to do with more the nature of the contract.
It depends where you operate, and there is a time lag when you have a surge, but we will pass it on.
Very clear. Thank you.
If you find that your question has been answered, you may remove yourself from the queue by pressing star two. Our next question comes from Richard Clarke from Bernstein.
Good morning. I've got three questions, please. The first one's just on looking back at the simplification and adaptation program. You spent EUR 245 million on that over the preceding two years. It seems like a lot of your plan today is to continue to enact that. Do you need to spend more? How much is new beyond that? What happened to that EUR 245 million? Is there any way to claw any of that back, given that it seems like that hasn't delivered what you would have expected it to? Second question, somewhat related. On slide seven, you set out what you expected and what was kind of unplanned. If we look just at the expected proportion, was flat margin guidance ever realistic for this year, given what you expected? Is the shortfall all to do with sort of the surprise sort of unplanned points?
The last one is on, you mentioned when you pre-released a couple of weeks ago that you needed to change accountability within the business. Has there been any changes to the sort of incentive plan around the way that these regions forecast or what they're going to be incented on that you can talk to today?
On the simplification plan, as I mentioned in the previous year, the plan was very detailed, and we can track the number of initiatives and the savings versus the cost committed to some initiatives. We see the savings, and they are there. I will say the simplification plan was more a cost reduction plan. We gave the opportunity for the team to cut costs here and there. What we are aiming to do, and this is what Denis referred to, is we need to redesign the way we operate in certain areas and certain functions. It's not just about trimming costs, it's about rethinking the way we operate. We can bring tools, we can bring new processes, new way of working and so forth. In some places, we've accumulated years of experiences without truly challenging the way we were delivering those services internally.
This is what we have to do, is what we call zero-based redesign, so to speak. When I look at the simplification program, it was more cost-cutting, and it delivered. The past few years, our margins have gone up. We committed to make some reinvestment, and while they are not factored in the margin this year, but the savings are there. What we now plan is more a redesign of the way we operate, and then therefore allow us to generate pockets of SG&A that we should be able to reinvest in what will make a difference in term of growth, offers, tools, digital. We need to do investments in IT, for instance, and we plan to reallocate the future savings into such investments. Your second question, on expected versus unexpected. There were a number of things we were expecting.
For instance, we knew we had lost business in universities. We knew it will have a volume impact in GP. We knew, and we told you that the interest rates had dropped significantly in Brazil and that we will suffer EUR 15 million. We had committed to a number of investments, and we are delivering, and we are implementing those investments. At the same time, we had very ambitious, and maybe not as robust as expected plans in universities and in education in general and in healthcare, for instance, and we've been late. Now we see that those plans are back on track, but we are late a solid six months on those. Those were the unexpected. We had a lot of performance improvement plan, which did not deliver in the first half. We are focusing on putting them back on track and delivering.
Richard, as far as your third question, Definitely, we are redesigning the way we incentivize our people. I want to put more empowerment and accountability from site level above. It's very important. We are currently redesigning our global incentive plan. We are also rethinking the way we incentivize our sales team, this will kick in from next fiscal year onwards. Yeah, I can tell you the focus on accountability will be strong.
A quick follow-up on the first part. Just wondering, you spent the EUR 245 million on the simplification program the last two years. What is going to be the cost to deliver the new plan in terms of exceptional costs and restructuring costs over the next couple of years?
We'll give more details on that in the Capital Markets Day. It's a bit too early. We already have some broad views, but we just embarked a few weeks ago on that. We have a perspective on our side, but it's too early. We will give greater details in September.
Okay.
What is sure is that. Yeah, sorry. Go ahead. Yeah, sorry.
No, that's it. No. Thanks. That's clear.
Our next question comes from David Holmes from Bank of America Merrill Lynch. Please go ahead, David Holmes. Make sure that you're unmuted.
Sorry. Hi, it's actually Angus Tweedie from Merrill Lynch. Just a couple of questions, please. Firstly, could you discuss the client investments on your balance sheet? There's been a bit of a move in those, about a EUR 40 million negative change year-over-year. Could you explain what's driven that and what those relate to? Secondly, on the BRS margins, could you just talk through the phasing a bit more? Particularly, how we should think about the investment costs for the new mobility initiatives and how those move over the next couple of years, and particularly in 2018, how we can think about the phasing of the drag from the Brazilian FX and the acceleration in the Indian migration. Thank you.
Yeah. On the balance sheet, I will look into more details, and I will tell you, we can have a broader conversation next week when we meet. As far as I'm concerned, there is no massive changes, and I think it is related to the integration of Centerplate we did early January. No, I don't see anything very specific other than that. Also, we must be careful because our balance sheet is actually very much impacted by currency impact at the same time. I'll look more into it, and we can discuss in more detail next week.
As far as benefits towards margins, I think there are several factors that impact this margin. We have the fall of Brazilian interest rates, and overall, for the past few years, we have seen this decrease in interest rates that has impacted our profitability. The diversification that we do at the moment in incentive recognition and in mobility has an impact on profitability. We know also that those activities, while generating top-line growth, do not operate at the profitability level that we have on the traditional meal and food business. That has an impact, and their growth rate will, of course, have an impact on the overall profitability. The card migration that we see in several countries, this of course, has a cost. We think that on the longer term, when we move to card, this generates margin improvements. It generates efficiencies.
Operating in a full digital model is much more profitable than operating a dual system. Typically, we hope that in some geographies, particularly in India, for example, we just got out from this dual system where we have paper and card, and we hope that this will generate improved margins in the future.
Can I just follow up on that? In terms of just thinking about the timing this year, if we had 320 basis points underlying margin contraction in the first half, of which about half was due to the new mobility and diversification, is it fair to assume, say, a similar amount in the second half will be impacted by that? Therefore, of the remaining 160 basis points, let's say, is it fair to think about half of that in the first half was due to Brazilian interest rates and the other half is due to the acceleration of this Indian migration?
Yeah. I think this is what I commented in the H1 results. Out of the 320 basis points, we can say broadly half of it is due to the interest rate drop, and interest rates are not going up anytime now, you can expect the same. What we said last time we spoke, that we were expecting a EUR 50 million impact, seven and a half per semester, and this is what we observed. The investment in mobility and expenses management are going to be broadly the same in H1 and H2. I will say the paper to card migration too. I think you can factor in the same impact or similar impact in H2.
Okay, lovely. That's really helpful. Thank you.
Our next question comes from Tim Ramskill from Credit Suisse.
Thank you. Actually, my first question is sticking with the same theme. If we look at the sort of more medium-term outlook for the margins within Benefits and Rewards, just picking up on some of your comments there about the lower profitability of the other solutions. I guess margins in this business were as high as 39%. They're probably going to end up this year about 30%. What would you expect the kind of medium-term trajectory of margins to be? Could they be sustained at 30%, or do you think they'll be drifting down over time? That's my first question. Second question, you observed that kind of growth brings with it margin, and obviously you're very focused on trying to improve the growth of the business. I wonder if you could just talk about whether growth will also bring any changes in CapEx for the business you believe.
Also whether if you do start to see a ramp-up in growth, whether there'll be any negative mix effects. Again, as you talked about, contracts tend to be sort of lower margin in the early stages of their life, and therefore, if growth comes, will that be a margin headwind as well? My third question is just sort of couple of numbersy points. Can you just remind us on the scale of the U.K. contract losses as they sort of start to kick in through Q3, and then also the sort of the mention you make of low-performing contracts and the opportunity to renegotiate there. Could you give us some sense as to sort of how significant that portion of your business is that you believe is in that low-performing category? Thank you.
Thank you, Tim. For BRS, what we told you the past few quarters is that it was more and more difficult for us to give you a guide as a margin rate, because when we were at 39% for the activity, we were almost a pure player in meal and food activity. Today, when I look at the meal and food activity, the margins are the same as they were five years ago or three years ago. There is no change. The margins are very healthy, very big. We are also expanding, and we've been doing this the past year in incentive and recognition, in mobility and expense management, in fuel and fleet, and so forth. We said the past few quarters that those activities are quite good in terms of margin for the group average, but they are dilutive for BRS.
We will more in the future, what we want to do is guide on BRS as an EBIT growth or UOP growth, not so much as a UOP margin. I think you must expect dilution of margin because of the diversification. What we have to come to you is what is going to be the average growth of the underlying operating profit of BRS in the coming years, and this is what we will do in more details, I think, at the Capital Markets Day. Anything to change about CapEx? I will say no. The message is to the team and is the message to you is we are not CapEx-averse. We are approving regularly bids with large amounts of CapEx. It's up to us to win them and to spend those CapEx. As I said, we've been around 1.5% of revenue for a while.
I will not be shocked if we were getting to two, we are not yet at two. We are nothing against CapEx on this topic.
Sure. We have space.
Yeah.
Which is pretty good. The teams know that. It's more how we reignite growth and sales energy that will leverage that possibility on CapEx spend for clients. As far as the negative mixed effects of contracts, I think I would take a global approach on that because it's true that when you, as I said earlier, when you start large, complex contracts, of course, it has an impact on the profitability because the ramp-up is sometimes difficult. That's why we also said that we have to also put a very important focus on mid-size local contracts, but also food contracts, single service. They balance pretty well with those large ones. When we operate those smaller ones, they are easier to operate, they're easier to mobilize. The ramp-up of profitability is better.
That's also how we have to look at as far as our contract development.
As far as your question on the U.K. contract, we mentioned this a few times. The government and agencies, HCI, which is a procurement body for government contracts in the different sector and so forth, launched massive tenders and all the contracts were re-tendered in the past few years. We said, we want our share at the very early stage of the process, and we actually lost existing contracts at the very end of the tendering process. Right now, and up to Q2, we had, I will say, the positive impact. I'm expecting Q3 to be down by Q3 and Q4 to be down by EUR 45 million-EUR 50 million because of those losses and now starting as a negative variance in H2. I think we can retain EUR 45 million-EUR 50 million.
As far as the low-performing contracts, we don't comment on those ones. We mentioned the impact that it had on the 25 basis points shortfall that we got on the profitability. We don't comment on this, you know that we have clients behind, and so we are cautious in the way we talk about that.
Okay.
Again, we're talking a small number of contracts.
Okay, great. Marc, just to be absolutely certain I'm clear on this. The U.K. business, that's EUR 45 million-EUR 50 million in H2, a similar amount, obviously, therefore, in the first half of next year.
Yeah. Slightly less because we've got some impact already in Q3 that we don't see because it's covered by wins. I'm expecting some impact to, or let's say slightly less next year, but of the same magnitude, yeah.
Okay. Thank you very much.
Our next question comes from Najat El Kessir from Berenberg.
Good morning, everyone. Just quick one, you are operating in about 80 countries, which generate about 85, and only four countries generate about 85% of the group EBIT. Do you see any scope in terms of rationalization there? My second question is in relation to the low-performing contract. Can you at least tell us in which region or which segment you are seeing those non-performing contract? Thank you.
Yeah. For your first question, yes, we are in 80 countries. We have shut a few in the past, I would say six to nine months. As we said, we are reviewing the portfolio. We do not have to be everywhere. We clearly do not have to be in all the places where we are. We want to stay in those places if it makes sense in terms of growth and in terms of profitability, because what we want to do is focus on the big picture and the 80/20. If those countries are distractions or we see them as distractions, no disrespect for those countries, we will refocus on what matters to us. As we said, for a while, North America matters to us. We have made an acquisition with Centerplate. We want to grow bigger in North America.
If we have to reduce the scope, we will reduce the scope. It gives us rationalization opportunity, obviously, because you have got less travel, less things to do, less entities to consolidate and to supervise.
As far as the low-performing contracts, again, they are a small number. I'd say there is not, again, this is not a systemic place where we have them. They can be across several geographies. I won't comment the places exactly, but there is not one region where it's happening. Again, it's a small number. In these-
[audio distortion]
In these regions, we have good contracts as well.
Thank you very much. Can I just follow up with one more question? Could you please quantify the impact on your margin from the immediate action plan that you have highlighted in terms of improving food cost management, optimizing the SG&A? Could you quantify each of the four areas that you will be working on, how much would you expecting in terms of impact on margin?
What we've said for this year is the action plan that we've put in place are included in the guidance that we gave. As far as their impact on the future, again, we will give more details as we move on. I will re-insist on the fact that the growth will come from better operational efficiencies, and will come from a re-ignition of ourselves. This, in turn, will bring margin improvement.
Thank you very much.
Our next question comes from Sabrina Blanc from Société Générale.
Yes. Good morning, everybody. I have three questions, please.
I'm sorry, we cannot hear you.
Good morning. Can you hear me?
Yeah, much better.
Thank you.
Thank you.
Yes, I have three questions, please. The first one is regarding the North American market. Can you come back on the Q2 performance and the impact of the calendar impact and the loss of the contract that you have mentioned? The second question is regarding the impact of reduction of discretionary spend. Can you give us some more color on that and how you estimate that you can retain, attract people? Regarding this last point, can you come back on the new regional CEO, where it come from? Then specifically on the education segment also, please.
Okay. The new regional CEO in healthcare is coming from GE. Has a strong experience in the healthcare sector. It's a very energetic woman whom we trust very much. Has already had an impact on the teams. I think we're very confident in her success. As far as the reduction of this discretionary spend, sorry. It's quite simple. We reduce traveling. That has an immediate impact. It impacts also on the quality of life of the people, actually, because when you do more video conf, you have better quality of life. Of course, we look at all the unnecessary spend. We reduce consulting. We do the traditional watch out on all those things that can be done immediately. It's also a sign, a signal that I set internally on being frugal in the way to move forward.
I have absolutely no fear of us not being attractive or capacity to retain our people. The good people in Sodexo, they are numerous, they are motivated. They are motivated by who we are, by our values, by the perspective that we can offer them. It's not because we do a program of reduction of discretionary spend that also goes in many other companies that we will reduce the motivation of our people. On your first question, the calendar impact that we are calculating for North America is more an organic growth restatement than a margin restatement. We are talking about only one day. The one I spoke about, which is going to be significant, is in Q3 universities in number of board days, so it is in Q3, it's not in Q2.
When we go back to Q2 performance in North America, what I said earlier is that we had observed a gap in Q1 in universities, but they had what was perceived as a robust performance improvement plan. It's true that it improved in Q2, but it did not compensate the shortfall of Q1. While at some point we were expecting that the action plan was actually going to be giving us a neutral variance versus last year for H1, it did not. In healthcare and seniors, I would tend to say Q1 was actually very reasonable and comparable to last year, but the SKU rationalization plan did not produce in Q2, they started adding a soft same-store sales and some losses and not enough wins, so the margin started to dip.
On top of this, as I mentioned, we had the labor inflation, the hourly labor inflation, which was really visible as the semester evolves. It was actually getting more and more visible in January and February and so forth. It's a mix of things in North America. Some of it was in Q1, we were working on it. Some of it came from Q2, like healthcare, the inflation really started kicking in in Q2 more than in Q1.
Okay. Thank you very much.
As a reminder, please press star one to ask a question. Our next question comes from Geoffrey Halun from Deutsche Bank.
Hey, good morning. Geoffrey speaking from Deutsche Bank. I would have two questions, please. The first one is, have you seen any impact from the strikes in France so far? Maybe with seeing less people attending the canteens in the B&I segment. This is the first questions. The second question is, you have gave comments regarding your medium-term targets three weeks ago. Just wondered if you confirm this target as you said three weeks ago. Thank you.
Okay. As far as the impact from strikes in France, yes. It's just the beginning, and hopefully, this won't last too long. We see an impact. It's still difficult to quantify. We see an impact in a few % of course, people not being in the office and not going to the restaurants that we run. This will have an impact. Very difficult to anticipate at the moment. I hope this won't last too long for us, but also for the country. As far as your second question, our priority is to concentrate on our short-term action plan and the execution of STEP. Okay? Of course, I'm absolutely convinced that we have long-term attractive market opportunities, so that such type of targets that we had is not unrealistic.
You have to be conscious that we haven't achieved our long-term guidance for the last few years. We have achieved the operating profit target but not the revenue growth target. What I want first is to demonstrate that we get results and prove you that we can get back to significant growth. As we move on, we will give you more insights on our execution plan, on what we do to reignite growth, on how we strengthen our execution, and how we look at the future at the Capital Market Day. That's going to be the move.
Thank you very much.
There are no further questions over the phone.
Okay. Well, thank you very much for attending this call. I just want to reiterate the fact that we are very conscious of the situation, that we have a clear action plan that is being put in place, that will deliver results, that we have a big focus on reigniting growth as we move on, ensure that we improve our operational efficiency and we have great perspectives. I'm absolutely confident in our markets. We will share more information as we move on. Looking forward to interacting with you live in September. Of course, we have the Q3 result in July. Thanks a lot for attending the call.
This concludes today's call. Thank you for your participation. You may now disconnect.