Good afternoon, everyone, and a warm welcome to our Q3 results call. I'm Magnus Ahlqvist, and I'm glad to be here today with our CFO, Bart Adam. Today we'll go through the third quarter results, then we will have a Q&A session. Let us look at some of the highlights of the third quarter. We have good commercial activity and solid customer retention in the quarter, these are the two primary growth drivers. We achieved 6% organic sales growth, we are very happy to share that we have solid growth across all business segments in Q3. The macroeconomic conditions in most of our key markets are favorable, like in previous quarters, we have achieved price increases that are on par with the wage increases in most of the key markets. The restructuring activity for Europe is now being implemented.
Looking at profitability, we achieved an operating profit margin of 5.6% in the quarter 13% improvement in EPS, this is before items affecting comparability. After a weak first half, we have good cash flow in the quarter. We are leading the security services industry, we have a strong focus on continuously improving our protective services offering. Looking at the sales of security solutions and electronic security, we had 22% real sales growth year to date when including acquisitions. During this quarter, we have continued with the integration of some of the technology acquisitions that we closed earlier in the year. Let us turn to the performance in the different business segments, we start with North America. We had solid new sales a 5% organic sales growth in the quarter, despite more challenging comparatives from Q3 in 2017.
From a customer engagement offering and commercial perspective, we are very strong in America, or in North America, I should say, it is another solid quarter from the team. It's also a very strong quarter from a profitability perspective. The nine-month margin is 6.1%, we had a margin in Q3 of 6.5%. We had good leverage and strong performance in guarding and risk management that contributed to the operating margin improvement. The Q3 operating margin also contained a positive one-off impact related to payroll taxes. All in all, it's a very good performance from a top-line perspective and also from a profitability perspective from the North America team. Turning to Europe, we have a combination of solid customer retention and strong commercial activity that are now generating good growth rates.
I emphasize this because we have now had two quarters with 5% organic sales growth in Europe, we are really happy about the fact that almost all the countries are delivering good growth. When looking at the margin in Europe, we have a slight decline compared to Q3 last year, this is related to some operational inefficiencies, particularly in France. The restructuring program that we announced in July to reduce costs is now being implemented, we have an expected payback time of about two years. Let us now turn to our Iberoamerica division. We had solid growth in the quarter, organic sales growth came in at 14%, this was primarily driven by very strong performance in Spain. Security solutions, electronic security account for 26% of our sales year to date, continued good momentum in terms of driving the strategy.
When looking at the profitability, we have very strong improvement year-over-year and operating profit margin of 4.7% in the quarter. Spain is the main contributor to the margin improvement, and in Spain, the guarding market is becoming somewhat healthier from a pricing perspective. We also have very good commercial activity and good momentum with our solutions and electronic security sales. Similar to the comment that we made in the Q2 results, we should note that some of the contracts that we have in Spain are more of a short-term nature. Argentina was burdening the results in Q3, and we expect challenging operating conditions during the coming quarters. All in all, it is a very good development by our team in Spain and our total Ibero-LATAM business.
With that, I am happy to hand over to our CFO, Bart Adam, for some more details regarding the financials part.
Many thanks, Magnus, and a good afternoon to all of you out there. Let's take a closer look now into some further financial details to the nine months and the quarter. We start with the income statement. As a first mention, I shall mention that as of July 1st, we have adopted now the IAS 29 standard. That is the standard that deals with hyperinflation accounting, and we have implemented this standard in relation to Argentina, as I said, as of 1st of July. The goal of the standard is very straightforward, and that is to provide more meaningful data recognizing the effect from the high inflation, and that both for the balance sheet and for the income statement. While the goal is easy, I would say that the implementation is very technical. It is, you could say, almost an art by itself.
I will save you from all the details. To cut a long story short, the impact of Securitas on our consolidated numbers is not very meaningful. The impact on the balance sheet is an increase in assets of SEK 390 million and the same amount, of course, increase in equity. That fully relates to the revaluation of the opening balance sheet on July 1st. During the quarter, we need to reevaluate the income statement as well. Again, the balance sheet, the conclusion of that is there is almost no effect on sales and operating results. The most significant impact is within the financial items line, actually, where you might not expect it maybe, but it is, which is positively impacted from the standard by SEK 18 million.
I can provide you further details if you're interested, but I think that would lead us too far here right now. We have also tried to make all of your and our lives simple, and when we have calculated the key ratios of organic growth % and real change %, we have treated the effect from IAS 29 similar to any currency change. That makes that the organic growth % and real change % are fully comparable to how these were calculated before the adoption of IAS 29. No impact on organic growth % or neither on real change % because of this standard.
Further details, we would be happy to share with you, there's also a lot available in note one and three to the report for the ones that are interested. Maybe one other thing to mention is that IAS 29 has been adopted without any restatements for historical periods, no changes in the historical periods. When we leave this technical matter now, again, to the numbers, as commented by Magnus, both the quarter and year to date show organic sales growth of 6% and the operating margin improved 0.1. We then move a little bit further down, we move to the acquisition related costs. You see that in the year to date, in the nine months, these were SEK 41 million compared to SEK 20 million in the nine months of last year.
From that SEK 41 million, there is SEK 25 million that relates to the Kratos acquisition in the U.S. We shall expect that the total estimated acquisition related costs for Kratos will be about SEK 75 million in total, and we expect that all of these costs will be recognized in 2018. We announced this before as well. You can count for Kratos with approximately another SEK 50 million to come in Q4 on top of this SEK 41 million that we have now in the year to date. We go further down in the income statement, you notice that our financial income and expenses are pretty much flat in the nine months versus the same period last year, and that is respectively minus SEK 287 and minus SEK 282 for last year.
Note, however, as mentioned before, that the financial income and expenses amounted to SEK 91 million in the quarter, as mentioned before, that was positively affected by plus SEK 18 million because of IAS 29. The run rate, excluding IAS 29, is around minus SEK 110 million, actually, in the quarter. It is impossible to currently say if and what the effect will be from IAS 29 in the fourth quarter, but as Argentina is only 2% of total group, we shall not expect anything too meaningful. The difference will actually occur because of the difference between the inflation that will happen in Argentina in the fourth quarter and the development of the foreign exchange rate in Argentina. We move to the tax line.
The applied tax rate for the first quarter and the nine months is 25.0%, and that compares to 28.5% for the first nine months of last year. The reduction is, of course, due to the lower U.S. tax rates as from 2018 as a result of U.S. tax reform. As you can see as well, the 2017 full year tax rate was 31.5%. That is, however, including a one-off tax expense of 3.1% that was booked in the fourth quarter last year. Excluding this one-off tax expense, it was 28.4%. We will have to continue to assess the tax rate going forward. There is this so-called BEAT tax in the U.S. as well, the Base Erosion Abuse Tax, which will gradually increase, actually, and we have to see how that impacts our tax rate going forward.
We plan to come back during the fourth quarter, or at the fourth quarter, with more information to this. You notice in the bottom a difference between EPS and EPS before items affecting comparability. I should say that the EPS before items affecting comparability for 2018 excludes the one-off effect related to the restructuring in Europe. That is the SEK 268 million that Magnus also mentioned. For 2017, for the first nine months, I'm sorry. I will skip to the next slide 13.
When we turn to the next page and take a look at the effects from the different currencies, the numbers mentioned here to the right, the foreign exchange rate in Swedish krona, they are the quarter-end rates. We see that both the U.S. dollar and the euro have strengthened quite a bit versus the Swedish krona at the end of Q3 compared to Q3 last year. That is respectively 8.4% and 7.8% up. You could say that the euro has peaked during the third quarter around SEK 10.7, but it returned back to the SEK 10.3-SEK 10.4 level at the quarter end. The U.S. dollar has been hovering around the SEK 9 during the entire quarter, ending at SEK 8.82, actually, at the end of the quarter.
For nine months consolidated results, nominal results were positively affected from both the euro and the U.S. dollar when comparing to last year. Our nominal numbers got some tailwind from the currency. The Argentina peso, however, as you can see here as well, reduced substantially compared to a year ago. That is -50% compared to last year at the quarter end. All in all, the net effects on the different lines in the income statement can be seen from the difference between total change and real change. You notice here that, related to sales, there's a difference there of 1%, total change at 9%, and real change at 8%.
When you go down in the income statement, actually, the gap widens a little bit, and that is because the impact of the Argentina peso is less when you go further down in the income statement compared to the EUR and the USD. Turning now to the next slide. We turn to cash flow and then later on to the balance sheet. We had a strong cash flow from operating activities during the quarter, still year to date, a bit below last year. We suffered there from a few negative effects that I also talked about in Q2. It's the same effects. It's the regulatory change in France, change of invoicing system in Netherlands, and the interest hike in Argentina causing some payment delays.
All in all, we are seasonal in our cash flows, and we expect that Q4 should be a strong cash flow quarter. Okay. I shall also add, of course, that the strong organic sales growth that we are seeing throughout now is, of course, consuming some working capital as well, impacting the cash flow negatively. The third quarter, I shall also mention, ended in a weekend, and that does not help the cash flow from operating activities during such quarter. We turn to the net debt. When we look at it stands now at SEK 15.7 billion, where it was SEK 16.7 at the end of Q2. We started the year with SEK 12.3 billion of net debt, and the development since then reflects the development from the operating cash flow, as just explained.
Also we paid out a bit more than SEK 1.6 billion related to closed acquisitions, all of which were, of course, disclosed earlier, and we paid also over SEK 1.4 billion dividend. The net debt, as you can see here also, was also impacted from the earlier commented foreign exchange development, and as you can see here on the slide, that added SEK 723 million in translation to the net debt since January 1st. You see that here for the period end, when you look at the graph at the far right here on the slide, the net debt in relation to EBITDA is still on a healthy 2.5.
We see here also the development over the years, and when we compare this quarter end to the year end from previous years, we are now at leverage asset of 2.5, and you can expect that based on some seasonality and everything else equal, this shall go down by year end. I can also mention that during the quarter, the annual extensive impairment test has taken place, and the result of this is that we do not have to recognize any impairment losses, meaning that the recoverable amounts exceed the book value of the different cash generating units. By this, I think I have explained what I'd like to explain, and I hand back to Magnus and be happy to answer any questions later on.
Thank you, Bart. Before we open up the Q&A, I would just like to share a few updates related to our strategic work and some of the focus areas. This is a slide that you have probably seen a few times before, where we outline the margin journey as we are converting from standalone guarding services to security solutions. This work is an important area of focus for us. Like in the previous quarters, we would like to give you a little bit of a flavor of what that is meant, and also to share a brief video. This time it's going to be a video about the work we do in our aviation segment. Let us have a look.
Airports are growing fast. The first step is to be sure that the airport is all the time safe.
We control each passenger, we control them with the passport for the security and for the safety of them.
We have intelligence on our cameras. The intelligence is going to tell us when there is a situation at the customer site.
The key point is to increase throughput of passengers. You can degrade less invasive control from the passenger. How to improve passenger experience during control.
The screeners are not on the area, they are on a remote position. The line never stops.
We're talking about customer friendliness, customer satisfaction, about crowd management.
We have also some technology to visualize the cargo. We use some dogs who smell the cargo, detecting some explosives.
We install radar installations.
Radar is detecting people, cars, trucks, planes, animals, everything. It can detect what you want.
The more sophisticated the technology becomes, the higher the profile of the people, the more training is needed, the more supervision is needed, and the recruitment becomes more and more important.
We are not, in this new business model, the manpower provider, but the solution provider for the customer.
The security was a cost. It turned into an added value for our customers.
It has to go together. Aviation specialization with the basics of Securitas, that would make the difference.
Good. Our aviation team are doing a really good job across a number of airports around the world. As you can see in this video, there is a holistic approach to providing the best security solutions as well as a strong emphasis on customer experience. I think that this is a good example that brings to life how we combine people, technology, and knowledge. Looking at the growth of security solutions and electronic security, we continue with healthy growth rates. Security solutions and electronic security accounted for 20% of group sales in the first nine months of this year. Now to a brief update related to acquisitions. During the last six months, we have spent a lot of time and effort on integrating some of the technology acquisitions that we closed during the first half of the year.
I'm glad to inform you that when we look at, for example, the acquisition of Kratos, Automatic Alarm, and Alphatron, all of this integration work is going in a positive direction. In September, so last month, we arranged an investor update in Stockholm, where many of you who are most likely on the call now participated. We did that to talk about our current situation, but also to give a flavor of our strategic thinking for the future. When looking at the near term, I see three areas that are important focus areas for us. First one is to developing the customer value proposition. Second one is continuing to strengthen our protective services leadership. The third one is about modernizing our IS/IT capabilities and enhancing local and global efficiency.
These are important themes internally, but also when you look at the first two, these are also two current topics that we have in a lot of the dialogue with our customers. At the investor update, we also shared our views regarding our strategic phases. We have a strong foundation with the best protective services offering in the market today. We are leading the development of the security services industry. When we talk about modernization, this is very much related to building the platforms and the capability to ensure that we not only lead the industry today, but that we develop the highest value to the customers also in the future. This next phase is all about Securitas driving the development of the industry and being the leader in intelligent security.
With that, I would like to wrap up our part before we open for the Q&A. I would like to highlight that it is a good quarter. We have the best offering in the market. We have good commercial activity, and importantly, we have high customer retention across all the different segments. The reason I mention that is that this is one good indication as well of the satisfaction of the customers, and that we're not only good at winning customers, but that we also develop the relationship over time. These factors have helped us achieve strong growth across all segments and 6% organic sales growth year-to-date, but also in the quarter, and a positive development in terms of the operating margin. With that, Bart and I are now happy to open up for questions.
Thank you. Ladies and gentlemen, if you have a question for the speakers, please press 01 on your telephone keypad and you will enter a queue. After you're announced, you can ask your question. The first question comes from the line of Mikael Holmgren from DNB Bank. Please go ahead. Your line is open.
Hi. Mikael here at DNB. A few questions. The first on France. You mentioned certain regulatory changes burdening the margins in the quarter. Could you describe a bit what that was? Also in North America, where you had this one-off gain related to the payroll taxes, if you could quantify how large that one-time effect was. That's the two questions.
Hi, Mikael. Magnus here. I will take the first question, and then I will let Bart comment on the second. When it comes to France, we make a few references related to internal factors, and those are problems that we are dealing with. We've had some inefficiency, and we also made a leadership change during the summer. We also have a new leader for our French business as of Q3 this year. Those issues we are dealing with. The reference we're making to the external factors is that there are a few, and one is related to the so-called CICE subsidies. CICE. That are basically reduced this year and then eliminated towards the end of this year. This is essentially the outcome of decisions that have been made by the French government. Another change which is impacting us is training related rules as well.
There is also now a fixed period in terms of training requirements, and this also then has some impact on our cost as well. I should mention that regulatory changes is something that we are used to dealing with, and the important part here, of course, is that we are working with our customers so that the customers understand the impact of the changes, and that we are then also able to recover that impact also through price increases. That is absolutely the ambition here as well. They are fairly fundamental changes that are affecting the entire sector, and that is also part of the reason why we talk about them in the report. Bart, do you want to comment on the U.S. tax related one-off?
Yes. Absolutely. That relates to the overhead that we pay on top of the wages to the guards in U.S., and there was a positive one-off there in this quarter. The impact of that, as you recall, we never mention anything. Well, if you say something, it's around 0.1% normally in the margin, and it's no different this time. The short answer is 0.1% to your question. We improved in this quarter 0.3%, 6.2% to 0.5%. In the year to date, we improved from 5.9% to 6.1%. The underlying is somewhere then between 0.1% and 0.2% improvement, you could say, in the U.S. that we see in the quarter.
Okay, perfect. I also have just a final question on the cash flow, looking at the changes in accounts receivable and changes in other operating capital employed, where you have this build up over the latest 12 months. You mentioned three, four factors explaining this. Looking ahead, will any of these reverse? I guess this is a bit of a plateau effect where you go up on a higher level, then it's analyzed. Will something of what you have seen in France, the Netherlands or Argentina, will this reverse become a positive impact in 2019?
French ones shall not reverse. That is, unless they would change again the legislation. That is just a one-off change, so we will not recover from that. In the Netherlands, as we go forward with the system implementation, we should benefit from that, and we should get to a normal level again in the Netherlands. That we hope that it will improve by year-end. The interest hike in Argentina, we should also recover from that. Because customers pay slower now than they used to do because of cash shortage in the Argentina economy. That should also normalize at some point in time. More difficult to predict when that should happen.
Okay. Thank you.
The next question comes from the line of Aymeric Poulain from Kepler Cheuvreux. Please go ahead. Your line is open.
Yes. Good afternoon. Two questions, if I may. The first one is on the French restructuring charge, the SEK 268 million. It seems a bit higher than the range you flagged in the interim results. Could you explain why this amount increased? Also looking at the size, you mentioned a three-year payback, that 0.6%
Margin improvement on a two-year basis. Quite a material effect to expect going forward in the European division. Could you enlighten us on the pattern of improvement that we should expect over the next two years, just to get a sense of the acceleration of earnings we could expect from that initiative? Also the cash expense, when we should expect the cash impact to be seen? That is for the restructuring question. The second question is on the U.S. You mentioned the one-off item. Inflation, wage inflation is still rising quite fast there, and at the same time, your organic growth is slowing a bit in Q3. Could you help us understand the mechanics of pass-through and how you approach that equation of a slowing organic growth and continued cost pressure? Thank you.
Thank you for the questions. First of all, just to make a clarification. We announced the restructuring program related to Europe, the SEK 268 million, those relate to the Europe-wide restructuring program. Maybe to give some more background to that, we took that decision, we announced that in conjunction with the Q2 results. That is a program that we are undertaking because we are not happy with the margin development. The fact is that in some countries, our cost has been growing at too high of a pace. That program is related to 13 different countries and affecting mostly people, vast majority in management and support functions. Not frontline team members, but management and support. A little bit more than 300 people are affected in that program.
We do not go into detail in terms of which individual countries are affected, but it is a safe assumption, obviously, related also to some of the references you make related to France about operational inefficiency, that France is part of that program as well. I think that is one part. There was also a question related to the margin improvement. Do you want to clarify that part?
Yes. I would just like to mention, if we say a two-year payback, that means that the annual savings will be around half of that amount. With a restructuring cost of SEK 268, you should count with half of that amount as annual savings, the mathematical impact on the margin comes straight from dividing that by SEK 45 billion. You will end up somewhere, I think, between 0.2, a bit higher than 0.2%, something like that. That is, of course, meant to reverse the negative development that we see on the cost level right now. That should reverse some of that negative development.
There was also a question about the U.S. as well, I think you made the reference point to the fact that the growth is slowing a little bit. We had very strong comparatives from Q3 last year, where we benefited in terms of a lot of extra sales related to the hurricane. That is the main reason. If you look at wage inflation, we don't make any forecasts about the future, but we have a good track record, our North America team also good in terms of working with our customers when there is a need to, or when there is a pressure, that they're also then able to pass those increased costs on to the customers as well. That is something that we have been good at doing for quite a long period of time.
What I should add as well is that the wage inflation as such, if you average that out over our business, that has not been on the very high percentages that some people think it might be. We have said before that on average throughout the cycle, we have around 2% wage inflation year-over-year. Then in very good times, we have been higher than that, more on the 3%, closer to the 3%, it's also like that at this time of the year. We are more, if you analyze it, close to the 3%, but it's not like the very high percentages that some people talk about. It's somewhere between 2%-3% in our case, averaging out over the entire territory of U.S., as we are everywhere in the U.S.
Then we have been able then, as mentioned, to compensate that with the right price increases.
Okay. Thank you. Would you be able to quantify this comp effect from the hurricanes last year? Just as a reminder.
Since we mentioned it's definitely more than 1%, somewhere between 1% and 2%.
Okay. Thank you.
The next question comes from the line of Rajesh Kumar from HSBC. Please go ahead.
Hi. Good afternoon, gents. Thanks for taking the question. You mentioned that your U.S. wage inflation is running at 3%, which is quite an interesting statistic given that some of your competitors are clearly talking about 4%-5%. The Bureau of Labor Statistics data, which you guys have-- not you in particular as a team, but I think Securitas management team have referred to in the past, is recording much higher numbers. What is it that we are missing in terms of the difference between your exposure to the wage inflation versus what we are seeing in the headline statistics or your competitors' numbers?
It's difficult to comment on competitors' numbers and how they get to that conclusion, but we can only see what we see in our own business. We are throughout the U.S., so maybe it's also depending on where exactly you are in the U.S. Maybe also connected to which customer segments you are exactly exposed. Maybe also comment impacted by how we have been dealing with wage increases historically. We have been increasing also wages during worser time periods, economical time periods. Maybe all of that you have to take into consideration when you compare these numbers. The wage statistics as such, our own conclusion on this is that over the long term, they are correct and they reflect absolutely the right picture.
Short term, if you compare month after month, they are probably impacted by also some movements we do not really understand, and they are not so reliable if you want to look at it at a really short term. Also, the same statistics will show that in some quarters there have been wage reductions of minus two and minus three and minus 4%. We have never seen those either. If you average it out then, how it looks like on a long period, they are correct, and I think our comments have been in line with that statistic all the time.
Understood. That's useful to understand. It's just a lot of different types of companies which employ staff in the kind of wage bands you have are talking about higher wage inflation. What intrigued us is that how you are managing to achieve the lower rate as a team at Securitas. You're clearly doing something right and something different, and that is a bit I was trying to get to the bottom of.
Yeah. What I would like to say is that we are trying to treat our employees always in a very fair and a very constructive way as well, and we are also trying to add other components to their environment and to their working conditions as well. Of course, wages are important, don't misunderstand, but it's also other things, and we also try to work on those things, not just year after year, but over long time periods.
You think your churn rate, as in last year reported, was running north of 70%. Has that reduced from that level or has it stabilized sequentially? We don't need to know the number, but just qualitatively, if you could quantify that for us.
Essentially, it's in the same range.
It's in the same range. Okay. That's what I wanted to know.
Just as a short explanation to that, what we have seen is that we have two different populations in our employee base. You could say people that churn quite fast, that stay with us for six months to a year, younger people maybe people that are in between jobs. We have the other bandwidth of people that stay for a long time period with us that really say, "Look, I am a security guard, I like this work, and I will remain a security guard." It's the latter part which gives the stability to our operations, and it's thanks to these people that we can have the churn in the other people.
Perhaps you have a larger proportion of younger people in the mix, which is why your inflation numbers are also slightly lower than the broader market. That could probably explain the whole dynamic.
That is part also of the whole equation, yes.
I promise this is the last one on the margins. When we look at the U.S. margins, you've kindly given the payroll contribution of 10 basis points. If I take your slide 16, where you show the detail of how guarding versus security solution differs, and if I take the magnitude of the difference approximately, and apply it to your U.S. business, then the man guarding business margins seems like they went back by 15-20 basis points. If I then take out the benefit from the payrolling gains you've had, that could be more like 20-25 basis points. Could you elaborate on what's going on there? Or is it just the hurricane comp?
Yeah. I'm not sure if we have totally understood your calculation. It's a bit difficult to understand it like that.
It's a straightforward one. Your U.S. margins were what, 6.2% going to Sorry, let me open your slide, which in the U.S. you have shown your margins going from 6.2% to 6.5%.
The margins on electronic business, which was 15% of North America last year, is now 18% of North America. That is something like 600 basis points higher than the man guarding business. If I take your 10% margin assumption on the electronic security, which has gone from 15% to 18%, then that implies the rest of the business margins went from 4.75% to 4.56%.
Okay, I see where you come from.
Yeah. What I'm trying to understand is that a one-off hurricane comp effect, or is it a phasing of wage inflation pass-through, which we might see, basically help your margins in the coming quarters. What is driving that on an underlying basis?
You're right in your calculation, there is a misconception or another thing you need to know, that is that the Kratos business, which we acquired, had a very low margin, as we also explained at the acquisition, that it would not be accretive to our EPS, at least for this year and next year. That is the explanation. There is where it goes wrong from the start.
Okay. If we take that out, your margins are flat.
In the U.S. guarding, we actually have seen some traction in our margins.
Okay. The margins have gone backward, you offset it by expanding your electronic business overall.
Yes, because the additional volume we put on came with close to no margin.
Understood. Thank you very much.
The next question comes from the line of Paul Checketts from Barclays Capital. Please go ahead.
Hi, gents. I've got three questions, please. Can I just return to the wage inflation in the U.S. question? Do you feel that you've passed on all of the wage inflation you've experienced in the U.S.? I know we had that conversation about the margins, just summing it all up, is that where you see it? That's number one. The second is, your comment about labor shortages becoming more prominent. Which countries are you seeing the most acute shortages, please? The last one is, in the cash flow, you have the SEK 508 million inflow from other operating capital employed. Can you just explain what that was, please? Thanks.
On the first question in terms of the U.S. and are we able to pass on the wage inflation? Yes, is the simple answer. Our team is doing a good job in close dialogue with the customers in making that happen. On the labor shortage, this is something that we are seeing in a number of countries, it's obviously related to strong macroeconomic environment. We also see fairly low unemployment rates. This is something that we just have to deal with. We are fairly used to dealing with wage cost increases, it's also not necessarily only a challenge for us. There is also quite a lot of opportunity. One is that we like to pay our people. The important thing there, of course, is that we are just able to also convince the customers of the value.
We also have a strong offering and alternative solutions. When we see these kind of patterns, and also many of our customers are seeing and feeling the pressure as well in terms of finding people. They are also more actively looking for alternatives. I think that we are quite well positioned as well because we're always able to not only talk about price wage, but also to be able to look into alternative solutions. That's something that we also quite actively encourage in the customer dialogue.
Labor shortage?
That was second.
Yes. Okay. Yes, we are looking here into the details of your question on the other operating capital employed, suggest we come back to that during the call.
Thanks very much.
The next question comes from the line of Karl-Johan Bonnevier from DNB Markets. Please go ahead.
Yes, good afternoon. Most of my questions have already been answered in a good way. Just to check with you on Kratos. You mentioned, as you said before, that it was supposed to come in with a margin dilution effect, have you really seen that in this quarter? Is there some seasonal effect in their numbers that will turn up more aggressive in other quarters?
You want to take that part? Okay. On Kratos, we mentioned at the time of the acquisition that it's going to not be margin accretive during the beginning, and then the question was in terms of impact in the current quarter.
Yeah, in the current quarter, we have been consolidating the business as of the beginning of the quarter, basically. The integration is going well. It's a lot of focus on that. Our people are doing a very good job, both organizational-wise. The intention with this acquisition was to strengthen our regional or local organization. We have now joined the two organizations, the existing one and the acquired one, and that has really strengthened a lot our local regional infrastructure throughout the U.S., which is really good, which will help us also to really help further local customers. The second focus point has been on the integration of the IT, the systems, where we are transitioning over to our own systems from their systems, and that is going according to plan as well.
Some more work needs to be done. We think that by end of January, we will basically be done on all of that work to a large extent. Then we can go into a little bit more, again, business as usual mode, so to say. Impact as such, we have added the sales volume from the acquisition, but as I said, with close to no profitability. Then, of course, we have incurred some of the acquisition-related cost, as mentioned before.
If I interpret you right, most of the, let's say, the big part of the synergies that you saw in the acquisition will basically be realized now during the second half of this year?
The synergies, they will come in. The integration only happened as of July, so to say. The synergies will start to kick in as of next year.
You are doing the actions basically now to realize that so we'll see them come through-
Yes.
-from early 2019 basically.
Yes. All the restructuring costs will basically be taken this year. Absolutely. The upside should come next year.
Thank you very much.
Just to emphasize one point that Bart touched upon is that with the Kratos acquisition, we are building stronger proximity in the different regions and closer to the customers. Really complementing the strength that we have with our current SES business. It is progressing in a good way.
Excellent. Thank you.
Going back to the earlier question on the other operating capital employed. It's not just one line within this other that has moved, so to say. It's a couple of lines together, I think it's also largely related to the integration of the Kratos balance sheet, actually. Where, for instance, things as deferred income have increased, provisions have increased, prepayments have increased, which is typically for this type of business. It's different lines. I think we can go to the next question now.
Yeah.
The next question comes from the line of Henrik Marby from Nordea. Please go ahead.
Thank you. Good afternoon. You mentioned these costs in Europe that has been rising a little bit too fast in 12, 13 different markets. Why did these countries let costs run away to begin with? What was the root cause for the issues that you need to handle right now?
If you go a few years back, coming back to end of 2015, that is where part of this situation started, that was very much because we were ramping up quickly related to the refugee demand that then really peaked during 2016, we've seen a gradual decline in 2016 or in 2017 and also now in 2018. We said that a few times before, that was work that we did a really good job, but it also took quite a lot of time and attention from the organization. It's also then been the nature of a lot of that business. It hasn't really been contract portfolio. It's also been a bit of a challenge to also scale down when the demand or when some of those shorter-term contracts were then terminated. That is one.
The second one is that we are also investing quite a lot in our protective services offering and the strategy, this is something that we have to balance. There also came a point where I felt, and we felt as a team, that now the development is not strong enough. That's why we decided in, what we communicated with the Q2 results, to take a much stronger grip. That is what we are now doing, that is why we're also then addressing the costs in number of the countries. We obviously then doing that in countries where we get a real impact as well, but also those countries where we had an issue in terms of the cost development. It's not across all the countries in Europe, but it is a focused approach on these certain countries.
Okay. A follow-up on that. You've been investing now in solutions and Vision 2020. Have you maybe over-invested in certain markets in those strategies? Or are you mainly cutting in other parts of those businesses now?
It's difficult to comment or assess market by market. The important thing is that we are on a journey from standalone guarding services to really have a strong offering in terms of protective services. One of the reasons that we are winning a lot of business in Europe, in North America, Ibero-America, is because we have a strong offering. We have a good footprint, we have a strong offering, and there, I think we are well ahead of all the competition. That's obviously something that we're building to be able to deliver now, but also to make sure that we are stronger tomorrow.
Okay. Thank you. One detailed question, if I may, coming back to the CICE changes in France. Can you please give us when it first came into effect, the first part of that, and when do you expect the new cut will come into effect? Also, can you give us any comments on how big impact the new change will have? You mentioned by the year-end, or is that by year-end fully, or is it November, December?
I believe that the CICE scheme has been in place for many years in France. At the beginning of this year, there was a 1% reduction, if I have all the facts correct. Then towards the end of this year, this program is then eliminated. It is a situation that there were some previous plans to then compensate some of that impact with another scheme towards the beginning of next year, but that has now been communicated that that's not going to come into effect until, I think, the fourth quarter of 2019. That is the reason that we're watching this carefully.
The important thing is that we have an open dialogue so that we're able to balance, so that we are able to then, as we always do, drive an aggressive and constructive dialogue together with the customers so that we're able to pass on the cost and balance those with the price increases.
Okay. When you say reduction of 1%, is that on top line or is it of the SCIS program or reduction of 1% of what? The change by year end, you say it will be cut fully. It will be cut fully from which level?
Yeah, we can come back to you on that. I think it is from eight to seven or nine to eight or something like that%, but it's better that we come back and confirm that in detail to you.
I can confirm to you, actually, it is a reduction from a system base, basically a subsidy system where you get based on the lower wage categories, you get a certain reduction of those wages.
It's that percentage that you get as a reduction on those wages that will reduce going forward. That has reduced already this year. The strange thing is that, the system has been reduced already this year. The existing system will cease to exist in November this year, and a new system will come in place as of January next year, January 2019. It will further increase that system, the new system will then further increase during the third quarter of 2019, as it looks like right now. To compensate for the gap, because there will be a gap between the present system and the new system, as Magnus said, we will then fill in that gap with the price increases that we are discussing with our customers as we do every year.
It's all related to political decisions as well, and we don't have full visibility of all of those. I just wanted to make that remark as well. We are on top of the situation and we will manage it as well.
Okay. Thank you very much.
The next question comes from the line of James Winckless from Jefferies. Please go ahead.
Hi, guys. Most of my questions have been answered as well, if I could just revisit the outflow from accounts receivable, a bit higher than at least what we are looking for. You mentioned a few factors being timing of payments in Argentina as well as just timing at the end of the quarter. What should we think about in terms of expectations for Q4? Is it at least possible that the reversal of some of these could translate into an inflow like you've seen in a few quarters in the past? Is it more likely that you finish the year at a higher base receivable than the prior year, and then these factors tend to reverse in the medium term? Thanks.
No, the planning and what we expect is that we can bring down quite extensively the DSOs from where they were end of September towards end of December on the level they were last year. The change will be, so to say, connected to any growth that we have seen during the year and connected to any acquisitions that we have acquired. Coming back to the DSO as such, this should go down considerably between September, which ended on a weekend, and year-end, which does not end on a weekend.
Okay, thanks.
The next question comes from the line of Andrew Grobler from Credit Suisse. Please go ahead.
Hi, good afternoon. I've got a few, but hopefully quite quick ones. In Iberia and America, could you just split out the growth rates between Spain and or Iberia and Latin America, firstly? Secondly, the proposals in Spain for the minimum wage to go up by 22%, what impact do you think that would have on your business? Third, just on Kratos, that was just as a matter of matter, about a 20 basis point headwind to U.S. margin during the quarter. Over time, do you expect Kratos to get up to divisional margins? On SCIS , you mentioned the change in the system, and there'll be no SCIS for December. Can you quantify how much or what headwind that will be just in Q4 for the December reality that had not been there?
On the same theme, what you think will happen to group tax rates next year as SCIS moves from being a tax credit to a taxable subsidy? Lastly, just a bit of clarification. In an earlier question, you talked about the U.S. and adding volume with no incremental margin. I wasn't quite sure what you meant by that. If you could just clarify, that would be great. Thank you.
We're busy writing down the number or the questions here, so we remember all of them. Maybe I can start with your second question, and that was related to the minimum wage increase in Spain. Obviously, when something like that happens, it's always going to be a challenge and opportunity at the same time for us. The challenge is to convince customers of being able to also then accept the increase in the price. The opportunity for us is that we have a very good offering. When you look at the Spanish team, Protective Services offering a solutions which is very strong. We also have strong alternatives, and I think that is the way that you have to look at it from those two perspectives. There was a question related to the growth rates as well.
You could say that the average for the division is pretty much the average for both Iberia and then Latin America. Iberia is a bit lower than that, and Latin America is a bit higher than the average. That is how you could see it.
Okay.
You had a question on Kratos and when we could bring that business back. Well, actually, the whole idea is that we will add in the capabilities and the employees from Kratos to our own existing infrastructure. With that, we will go after the market, of course. As you know, the electronic security business, it's a bit more volatile. It's not really portfolio business all the time. It's more volatile. You need to have a good sales machine in place, and we will include now the Kratos organization into our own sales machine, and how we follow up and how we set targets. Based on that will start to drive the performance. We estimate next year will still be rather a year of buildup, but the real impact and the benefit from that should come in as of 2020.
What else do you have? The problem is I can write down very fast, but I cannot read my own reading.
On CC, as we change from one system to another, there will be no CC in December. Can you quantify what impact that will have on European profitability? Lastly, in an earlier question, you talked about the U.S. and adding volume at no margin, and I was just a bit unsure what you meant by that.
Yeah. The CC, I think we should not quantify that. We prefer not to quantify. The group tax rate from CC, we will come back during the Q4 with that information. Adding volume in the U.S. without any incremental margin, that's fully related to the Kratos volume.
It was no reference, just so I'm clear, that you weren't adding new man guarding.
No. It was fully relating to the Kratos volumes.
Okay. Thank you very much.
The next question comes from the line of Carina Englund from Handelsbanken. Please go ahead.
Yes, good afternoon. I have one question left that wasn't answered. The development in Argentina you are seeing to be weak and was already weak in Q3. Is this weakening as we're going into Q4 or should it stay at the same level as in Q3?
Yeah. I think what we have commented is that it is a challenging environment, and we also expect challenging operating conditions going forward as well.
As you also know, we do not guide on the quarter-on-quarter. We can give you the general direction, and then the quarter is always depending on many more things than just this thing. It doesn't look better today than it did yesterday, let's put it like that, in Argentina.
Okay. Thank you very much.
The next question comes from the line of Bilal Aziz from UBS. Please go ahead.
Good afternoon. Just one question and I suppose one quick clarification from my side, please. In Ibero-LATAM, you've benefited from some short-term electronic security contracts now for nearly three quarters. Do you expect these to change to more firm contracts if you've had them for a while right now, or will they fade away at some point? Just as a clarification, can you perhaps explain why the move to IAS 29 does also not impact organic growth in Ibero-America as well? Specifically, does the number in Argentina not have to be adjusted for the higher inflation component as well?
I can take the first question. The reason we highlight the fact that they are short-term contracts is because that's the nature of that business. To be prudent, that's the reason that we keep disclosing that. We do not know how long we are able to keep that part of the business.
Referring to your IAS 29 question, what happens there is that during the quarter, you basically need to inflate the sales from Argentina with the inflation %, and that you apply. The next thing that you need to do, you need to normally, when you consolidate a country into your income statement, you do that on the average rate, the currency rate of the quarter. In this case, because of this accounting standard, we need to bring it in at the end rate of the quarter, which is obviously lower than the average rate in Argentina as the currency rates are going down in Argentina. The net effect of that, the increase because of the inflation and the decrease because of this foreign exchange average compared to quarter end rate, basically will give you the net.
The net of that is actually that the sales have decreased with minus SEK 65 million in the group then because of this effect. As explained also, in the organic sales growth, we have taken that out from any organic sales growth calculation. We have basically no impact from this implementation on the organic sales growth calculation. That is how we have implemented it. Organic sales growth calculation as such is not a standard. It doesn't follow an IFRS standard or anything. It's our own standard, you could say, and we have implemented it this way. It could be that it is the other way around next quarter, that the top line is so to say helped from these two effects. Again, we will not have any impact on our organic sales growth. We believe that was the best way of presenting it to you.
You could say organic sales growth in our case, what it represents is basically either volume increases or agreed price increases with the customers. That will be paid for. The real hard terms in our contracts, the changes there with our customers, that is what we are getting reflected in organic sales growth. Everything else, currency, inflation is taken out.
Okay, I understand. Thank you very much.
We have a follow-up question from Rajesh Kumar from HSBC. Please go ahead.
Hi. Thanks for taking this question. Just one quick follow-up. If we take out the Kratos benefit from the revenue growth, of the 5% organic growth you've reported in the U.S., 3.5%-4% looks like it's coming from electronic security. Is that about the right level of number or is it too high an estimate?
Too high an estimate. I think you include now the Kratos volume into that number.
Kratos was about 280 according to the numbers you've given. SEK 280 million. It looks like it's 3.5% on electronic security when it goes from 15%-18%.
No, that is the thing. This number from Kratos is not at all included in our organic growth.
True. That is why you take it out from the two numbers you've given, 1,356 and 2,025. In 2025, you reduce the Kratos contribution of SEK 280.
What I can say to make it simple is that our guarding business was growing organically, and that also our electronic security business, the business we have had, was growing organically. Somehow there must be a misconception. I suggest that you come back to us with the detail of that, and then we can check your calculation because it's difficult to follow just on the phone. I can confirm that both the guarding business was growing at a good, reasonable percentage organically, and that also our existing electronic security business was growing also at a reasonable organic growth percentage.
Guarding, basically what I'm trying to work out is, if the guarding was growing more than 3% or not. If your wage inflation is 3% then you pass through the wage inflation.
I can confirm to you that the guarding was growing faster.
Okay. Understood. Thank you.
That's enough for the questions. I'll hand back to the speakers.
Okay, I think we are ready to conclude. Thanks a lot, everyone, for dialing in. Wishing you a good weekend. Thank you.