Saf-Holland Se

XETRA:SFQ

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, ladies and gentlemen and welcome to the SAF-HOLLAND S.A. conference call regarding the preliminary results of the third quarter in 2018. [Operator Instructions]Let me now turn the floor over to your host, Mr. Stephan Haas.

[Stephan Haas]

Good morning, ladies and gentlemen. But first of all, thank you for joining the early morning conference call on the preliminaries for the third quarter 2018. We will first give you an overview over the preliminaries of the third quarter and then we will also talk about guidance refinement which we undertook.And with that, I would like to hand over to Mr. Borghardt. Thanks.

[Detlef Borghardt]

Thanks, Stephan. Thanks a lot for the introduction. Also, a warm welcome from my side. This is Detlef Borghardt speaking. Thanks for dialing into our today's call. I would like to jump into the agenda right away. So on Page 2, you'll see the overview about what we are talking today and what we will present. There are 4 bullet points. First of all, the refined group targets for the full year 2018 followed by the preliminary key financial figures for the third quarter of this year. We will dive into the business segments, talk about sales trends and their profitability. And of course, finally, at the end of the presentation, we will do an outlook for the remainder of the year.On Page 3 of our presentation, I would like to start with the preliminaries for the third quarter. This will be followed by the overview for the full year 2018. But let's concentrate on Q3 first. As you can see on the first bullet point, our sales growth in Q3 this year grew by 22.9%, which is enormous growth. With this, we reached again our highest Q3 ever that was also in Q2, the matter of fact. So we came in now with 30 -- EUR 340.6 million. Previously, it was 270 -- EUR 277 million. That means a plus of almost EUR 63 million. Organically. That's the second bullet point. Our sales growth increased by a tremendous 15%. So on this, this is one of the reasons why we have this call today because that will lead, and we are to come to that on the next page, to an adjustment of our sales forecast for this year, which will come in higher than expected.On the third bullet point on Page #3, this is the only, let's say, not so nice thing today, is we see that with the high -- very high capacity utilization, especially in our plans in North America. There is still a burden from increased operation cost -- operating cost to the realignment of this new warehouse production network. On top of these, steel prices is another burdening factor. But nevertheless, our profitability improves. In fact, we can see successive profitability improvement in Americas also in Q3, and that's what we promised earlier this year. We will talk about that later more in detail.Next one, the higher-than-expected sales contribution from U.S. This is nice, but unfortunately, that came in with a clearly below group average margin. Also on that, we will talk later more in detail.In Q3, our 2018 adjusted EBIT came in at EUR 27.1 million and the adjusted EBIT margin at 8%. The year before was 7.5%. That includes an extraordinary income of EUR 4.4 million from a settlement of a U.S. medical plan. We will talk about that later also more in detail. So if you adjust that, we call it the clean adjusted EBIT margin, came in at 6.7%. This is excluding the EUR 4.4 million which I mentioned before. On the next page, Page #4, I would like to talk about the 2018 full year guidance, which we refined as well because of the Q3 numbers. So based upon the preliminary Q3 2018 figures and expected further developments for the balance of the year, we refined our sales and earning target for the full business year of 2018. First, based on the dynamic organic growth in Q3 2018, what I talked about, and the continued strong demand for SAF-HOLLAND product globally, our organic sales growth will reach 9% to 10% in the full year 2018. We said before it will be between 5% and 7%. And this is also very nice to see that the significantly better-than-expected performance of the latest acquisitions we did this year. This is mainly Orlandi, York and the company, Axscend. We are now expecting that these acquisitions will contribute EUR 65 million to EUR 7 million (sic) EUR 70 million to our group sales. We said before that will be EUR 60 million.On the next page, Page #5, that's the second part of the full year 2018 guidance. I would like to talk about the earnings here. First bullet point, stronger-than-expected sales development in the Americas region, which currently, however, contributes below-average margin to the group results. We have continued burdening effects on steel price in U.S. but also in other regions, for example, in Europe. We see now, and that's the third bullet point, the adjusted EBIT margin in the full year 2018 including the EUR 4.4 million extraordinary income rather trending towards the lower end of the 7% to 8% corridor. Before, we said it will be between 7% and 8%. And please take into the conversation the usual seasonal effects in the last quarter of the year, which is always weaker than the Q3. That was the case in the past. Yes. With this, I would like to hand over to Matthias, who will talk about the development of our sales in the regions and the development on organic and FX rates in more in detail. So Matthias, please.

[Matthias Heiden]

Yes. Thank you, Detlef, and good morning, everyone, also, from my side. My first task on this Page 6 is to go into further detail around the overall 22.9% growth that we see if we look at the bridge from Q3 2017, namely the EUR 277.1 million in revenue, to the EUR 340.6 million that we saw in the quarter that we just closed. The 22.9% growth has different components. As usual, there is an organic growth FX and M&A. The organic growth amounts to 15% in the third quarter of 2018. And then we have still some negative translational FX effects, a bit more than 1% or EUR 3.7 million in total. And then we have a more than 9% contribution from the acquisitions. And on this, I would like to go into a little bit of detail. You remember from the half-year mark that we decided to help you on your way in the financial analysis and talk a little bit about the acquisition data in detail, which we will not disclose on a permanent basis. But again, for the third quarter, happy to share that York contributed EUR 20.1 million in revenues; Orlandi, approximately EUR 5.3 million in revenues; and Axscend, which was the smaller U.K. acquisition that we did recently in the digital space to support our SMART STEEL strategy, contributed EUR 200k in revenues. That gives you some additional perspective. If we then move to the next page, Page 7, that is, this is a look across the region and the organic sales growth. And here, the positive message continues that there is very strong organic sales growth across all regions. This is a confirmation of the strength of our product portfolio and our market positioning, including our dual go-to-market where we work directly with end customers and/or e-customers alike. And as you can see in EMEA, we continue to grow strongly at 4% in the third quarter. Here, I think it is fair to conclude that we are confident that we will continue to outgrow the clear market predictions that you see on our quarterly publications. The next update will follow in November because the 4% that we show are clearly above the market growth overall. Then in the U.S., this is something that Detlef already touched on in his opening remarks. A very strong organic growth of 18.6%, which I perceive to be particularly positive in the overall context of the challenges that we are continuing to face, that we are working on fixing. But to then perform 18.6% and to protect the strongest asset that the company has, namely its customers, is a strong performance. APAC/China, 66.9%, strong growth in the third quarter. Detlef will touch on the structural growth driver behind that on a specific slide that covers the APAC/China region. If we turn the page to Page #8, this is where I would like to spend a moment with you on the reconciliation of the reported EBIT to a number that we now call the clean adjusted EBIT for the third quarter to be fully transparent and provide you the information you need for the financial analysis. If we begin on the left-hand side with the reported EBIT of EUR 22.5 million for the third quarter, we have the usual adjustments that take us to the adjusted EBIT, mainly depreciation and amortization from PPA, slightly higher with EUR 2.8 million than in Q2, which had EUR 2.6 million at the time. This was due, number one, to an additional acquisition; and number two, to a small step-up effect that we had to book on PPA. But you'll recall my comment that we will return to a lower run rate in 2019, that some of these increases are temporary in nature. Restructuring costs amounted to EUR 1.7 million, for the quarter, which then takes us to an adjusted EBIT of 8% or EUR 27.1 million in total. This still includes the extraordinary income from the settlement of a medical plan in the U.S., which we took in with EUR 4.4 million. If we deduct that number, that takes you to the clean adjusted EBIT, which would then amount to EUR 22.7 million or 6.7%. Maybe I'll spend a moment now on explaining what happened with the settlement of the medical plan in the U.S. and why we included it in the adjusted EBIT. I think the explanation for this is relatively simple because the termination of the U.S. medical plan has the following background. This is a plan that the company has had for a number of years. I actually believe it goes all the way back to the Holland days. But it only has very few active participants enjoying the benefits of the medical plan, which you can picture to be a contribution towards medical expenses that people incur in the U.S. Very few active participants, but the accounting foresees the accrual to be billed every year for all potential participants. So that means regardless of whether you are 18 or 50, you have to accrue. So for the rather younger part of the potential population of participants, you accrue for a number of years, and that explains the sum of the release when you release it because we terminated the plan because of the very few active participants and a few potential active participants. And also, we consider this to be a sustainable cost-saving because in future periods, the accrual will not need to be made. And given that the accruals were booked as part of the operational results in personnel expenses in the past, we release the accrual as a credit to personnel expenses this time, which is why in terms of the financial reporting, which we also aligned with our auditors, it forms part of the adjusted EBIT. That is the background to the settlement of the medical plan.With that said, let's return to more operational focus and a report from the region that Detlef will begin with the Americas.

[Detlef Borghardt]

Okay, Matthias. Thanks for the deep dive into the -- our EBIT world. I would like to talk about the Americas first, coming to the other regions later on. On Page #9, you'll see on our headline that in the Americas, we still see a burden from realignment of our plant network and the high steel prices but all this in a very strong growth environment, and this is important to notice, our successive improvement in North America continues. Let's talk about sales first. Starting with this first bullet point, the soaring customer demand, and that is really soaring, and I will talk about it in a second more in detail. And out of that, our net order intake coincide with completely strained industry supply chain. Our sales is well above our expectations. Our organic sales growth was 18.6% to EUR 130.5 million. If we deduct the negative exchange rate effects, it was minus 1.3%. The sales reported, and you can see that on the graph on the left-hand side, up 17.3% to reach EUR 129 million compared to EUR 110 million in the previous year, and that was, all of that, EUR 6 million up versus Q2 2018. So we see improvement quarter-over-quarter but also compared with last year. Talking about the profitability in Q3 2018, our adjusted EBIT came in at EUR 6.5 million, previous year was EUR 5 million, including the medical plan, which Matthias just described very much in detail and immediate annual cost savings of EUR 0.4 million. Our so-called clean adjusted EBIT margin improved versus Q2 2018, and I believe that is really important to notice, to 1.6% compared with 0.7% in Q2. Our additional operating expenses came in with EUR 2 million compared with EUR 2.3 million in Q3 that were -- due to continued startup inefficiencies and the realignment of the new production network in the U.S. As you might remember, we closed 2 factories last year, from 7 down to 5 now. So the steel price burden was EUR 3.9 million, in Q2, it was higher with EUR 4.3 million, and as quarterly average steel price index remained at very high level. I will talk about steel price more in detail on the next page, but before I come to that, I would like to talk for a minute about a pretty intensive customer trip or business trip I did last week. I came in the day before yesterday. After 10 days traveling to there, starting on the West Coast going down to the East, I saw almost a dozen of our top customers, the biggest customers in terms of sales. And so all that we describe here focus in terms of sales but also in terms of profitability. It's pretty much the same for every player in the market, in the commercial vehicle market, in North America. It means order intake extremely high. Most of our customers recorded all-time high levels. Extremely stressed supply chain. Everybody runs not with 80% or 90%, which is normally optimum to run operation. Everybody is well above 100%, and that always means you turn a big wheel, but profitability, all of that, is not as it should be. Secondly, it is all about the OE surge. Secondly, the aftermarket, everybody has problems to serve this aftermarket network because there were e-customers -- the demand from the e-customers were so high, and we need to keep their production lines running, and we cannot deliver the aftermarket first and then jeopardize the production of the OEMs. So that means we are, I would say, in a basket of -- in this market, everybody has the same challenges, so everybody is happy about the market. Everybody is happy about the order intake, but it is really difficult to make money with turning this big, big wheel. But the good news is the very good news. Everybody is, for this year but also for next year, very positive. I have seen -- there was nobody talking about any decrease in order intake, nobody about -- talking any clouds or dark clouds on the sky. Everybody says the next -- definitely the next 6 to 9 months next year are almost booked for all truck and trailer OEMS. So that means all through 2019 will be, according to what I heard the last 10 days, will be an extremely good year, and that we will continue on this high level as we have seen now this year.Yes, I can talk about later on in more detail if you like, but I would not like to take too much of your time. I would like to turn your attention on the next page, #10, talking about the steel price. You'll see there's a so-called HRC price index. HRC stands for hot rolled coil index. And as you can see, you'll see the number in 2016 on the far left, the price for a ton was roughly between USD 350 and USD 400. Now we saw the peak in July, August this year with more than USD 900 up to USD 950. You see it come slightly down now, which helps, of course. But -- and I believe we talked about that also in the last calls all the time. We can increase prices only 2x with most of our customers in U.S. because we have contracts, long-term contracts, some of them 3 up to 5 years. So that means in the middle of the year and the beginning of the year, we can increase or decrease prices according to the steel price index. So we did it in July. We reported on that, and the price increases are in place, but we have a trailing average of the last 3 months when we do a price increase or decrease. And so therefore, as you can see, the steel price was higher and higher, was increasing and increasing. That means we have some issues to pass on all the price increases already now in Q3. This is to come in Q4 but also in 2019. If the steel price will continue to go down, and that is our expectation and also expectation for most of the market participants, then we'll see the full effect in 2019 for sure. Again, this is the way how we work for many, many years now. That is very well introduced. Everybody knows how that works, and it works perfectly well, but there's always a delay, and we have to live with it. But this is -- we would like to be very transparent here, therefore we show that for the first time this graph so you can follow that. And as I said, this will help our P&L in the next couple of months and quarters also. Yes, with this, I would like to hand back to Matthias, and I would talk later on about the other regions.

[Matthias Heiden]

Yes, thank you, Detlef. I'm afraid it's all about EBIT again. If we look at Page 11, and from Page 11, we would like to do 2 things: number one, on the right-hand side, provide full transparency and insight into the burdening factors that we have also reported about in the previous quarter; and on the left-hand side, make sure that we all understand again the impact of the extraordinary income, namely the settlement of the medical plan, the EUR 4.4 million that we show, because we want to ensure that for the sake of full transparency, we're not going for the number on the left-hand side, the starting point of the slide, the EUR 6.5 million adjusted EBIT, which would have been a 5% margin in the Americas region but we are actually taking for reporting purposes with you now to show the consecutive improvements quarter-over-quarter. The clean adjusted EBIT, the 1.6% or, in total terms, the EUR 2.1 million for the quarter for the region, this number is still impacted by the add-on operating expenses coming from plant inefficiencies or freight expenses and so on, which are now down to EUR 2 million for the third quarter coming from EUR 2.3 million in the second quarter or EUR 3.9 million in the first quarter as well as the steel price burden of EUR 3.9 million down from EUR 4.3 million in the second quarter. If you bear in mind the EUR 2.1 million clean adjusted EBIT, that translates into 1.6%, and turn the page. And on Page 12, you see that we continue to improve quarter-over-quarter. The margin has moved from a negative margin in the first quarter and an even more negative margin at the low point that we hit at the end of last year via a turn into positive territory in the second quarter to 1.6% in the third quarter. This is not where we can be happy or stop the journey, and Detlef will comment on the journey in just a second. But this is where we stand if we exclude the EUR 4.4 million for the moment. And we are very confident to continue that journey because Detlef will give you some additional insights as to where we stand and how we intend to do that on the next page, which is the Management Action Plan.

[Detlef Borghardt]

Yes, I'm happy to do so. I'll talk about the so-called MAP, Management Action Plan, as Matthias said. On Page 13, you see a couple of bullet points there. There's one new one. This is the first one. We implemented the so-called Task Force. These are roughly 30 people from Germany going to the U.S. that started in August, helping our colleagues over there in analyzing the processes, streamlining and see what additional potential we can gain. Just to remember, everybody in this call, we did a very successful plant consolidation in 2015, '16 here in Germany. We closed a huge factory and consolidated the remaining 2 ones here in our Bessenbach headquarter area. And this was a seamless exercise, and that was very well executed. But I have to say there have been 2 differences to the plant consolidation with the North America. First of all, all the people which we transferred from the plant we closed to the remaining 2 plants came with us. That means we lost (sic) [ didn't lose ] any employee. We didn't lose any know-how or, we call it, tribal knowledge. That is a big -- or was a big difference in North America. Nobody of the -- our workers followed the equipment. That means all of them find new jobs in the Michigan area, and we have been forced to hire additional new people in the plants. Maybe with the consolidation of the remaining plants, that's the one big difference. The other one is, at that days, when we did the plant consolidation in Europe or in Germany, the order intake was pretty much stable. It was very easy -- not easy but easier to plan in North America. It was just the other way around. Order intake when went through the ceiling. And so we have been really surprised with this high, high capacity of our equipment, the capacity utilization. So -- but nevertheless, the know-how we gained doing the plan consolidation in Germany, we use now also to help our colleagues in the U.S., and we see that will help to be faster with the factories in -- with the remaining factories in U.S. coming up to speed. On top of that, our sourcing optimization runs. The measures are in place. We also are going to install a so-called APO, A-P-O. That's an advanced product optimization. That's an SAP tool or is it a fix to SAP, which help us to align sales and orders in production and with the entire supply chain processes. We implemented this in Germany roughly 4.5 years, 5 years ago. The system is really a very helpful tool, and as I said, we started that in U.S. now as well, and that will help us also to increase speed. The optimization of the scheduling process and the enhancing capacity utilization is part of the APO implementation. Hence, this is very important, the next bullet point, employee training programs. What does it mean? We -- all participants in the North American -- or in the U.S. market are facing the challenge of a higher turnover rate as we do. That means we need to train our new people which we get on board, and this is up and running and that also helps to improve our profitability.We are going to install additional trailer axle manufacturing line. We are also talking about a new welding line, but this is to come for next year. Why is that? We see increasing market share in the trailer market. The disc brake is a hot topic in North America. We will see much more order on that. And for this, we need more capacity. So that means our story is absolutely intact. The disc brake is raising and raising. And also, the demand for our air suspensions and mechanical suspension is on a very good way. I've heard that also the last 10 days during my trip here, our products are more than well received, both on the OE but also on the fleet side, and therefore, we need to have more capacity, which is a good problem to have. Focus on the aftermarket, as I said, that is continuing. That also goes in line with the next focus on profitability. Price increases are going on. I talked about it already and, we are intensifying our price pass-on processes. That was about Americas. Let's turn your attention to the other regions, talk about EMEA first. That's on Page #14. We see a very solid organic sales growth, and that allows for operational leverage. Summary. We'll talk about sales first. In Q3 this year, our sales grew by 7.9% to EUR 155.5 million. Previously, it was EUR 144 million. On organic basis, adjusted for Forex and the acquisition effects that was mainly Orlandi, our sales were up very solid 4% year-over-year. And the aftermarket, and there is very nice developments, is still growing. It grows now 6.3% on an already very high basis so that helps, of course, to help to drive the EBIT development. That leads me then to the lower part of the page here. In Q3, our adjusted EBIT rose by 20 -- more than 20% to EUR 17.5 million. Previous year was EUR 14.5 million. Previous year was already a very nice double-digit adjusted EBIT margin of 10.1%, and now it increased to a very nice 11.3%. Again, positive mix effect, that means a lot of aftermarket is part of it. And we really see the benefit out of the plant consolidation we did 2015, '16 here, and we see the operational leverage. Also, the factory in Turkey is part of it, and we are running that in 2 shifts, which helps as well. So therefore, with Europe, with EMEA region, we are more than pleased both on the sales but also on the profitability side. Also, I'm very pleased with the final region, APAC/China, which is on Page #15. It's the highest percentage organic sales growth within the group, colluding, as we see, York acquisition. As you can see, talk about sales first. We rise -- rose the sales from EUR 23.1 million in Q3 2017 to EUR 56 million now in Q3 2018. Organically, and that's the third bullet point on this page here, our sales grows by 66.9%, which is also a very nice effect. We talked about that also in the past why is that. Main reason is our products are well received, and they're absolutely in line with the new trend in China and in the -- coming out of the APAC region but mainly in China, for premium product. That means air disc brake and also air suspensions. And we, as one of the market leaders globally in these 2 product ranges, we benefit from that, and we will go on benefiting on this trend that goes absolutely in our direction. On the profitability side, you see the adjusted EBIT in the region increased to EUR 3.1 million. Previous year was EUR 1.4 million. The expected temporary margin dilution from York is in scope of consolidation in the segment, and the adjusted EBIT margin conclusively came in with 5.5%, at a little bit lower than 6.1% in the last year without the acquisition of York.Yes. With this, I would like to hand over to Matthias to the last 2 pages.

[Matthias Heiden]

Yes. Happy to take it home. Thank you, Detlef. If we go back into the overall P&L for a second on Page 16, then I'll remind you of a number that is not on the slide, but as I stated earlier, the clean EBIT of EUR 22.5 million end up in a pretax profit of EUR 19.5 million, which is significantly higher than in the third quarter of last year, namely by more than 77%. Why is it that? Well, of course, in between, we have the finance results which we do not disclose in full today which we will do in November. But be reminded for your initial analysis that we repaid a bond earlier this year, which obviously helps in the quarterly finance results and, thus, supports pretax profit. If we then continue further down the P&L, we have lower taxes that lead to much improved net income by 104% or EUR 15.3 million in total. The lower taxes are really of mixed bag of effects, which we're still analyzing in detail. Some of which -- just to give you some initial understanding, some of which come from the U.S. because with the return to profitability in the United States, we benefit from the lower tax regime, number one; and number two, we can use some of the tax assets to lower our income tax at the same time.Given that we have a constant number of shares, this positive development then translates into an improved undiluted earnings per share number of EUR 0.34 per share, which is double the amount that we had in Q3 last year. With that, we can already turn to the last page, which is Page 17, which is the summary of the refined financial targets for 2018 and the confirmation of our midterm planning 2020 ambitions. The numbers on the sales side -- or the refined guidance on the sales side was elaborated on by Detlef already: the fact that the organic increase is now assumed to be 9% to 10% rather than 5% to 7% and that we also refined the contribution from our M&A activity, namely and mainly to say Orlandi and York, which are now deemed to be EUR 65 million to EUR 70 million rather than EUR 60 million. If we translate that, and I'll just repeat it because that might be a good transition to the Q&A anyway. We then translate that towards the adjusted EBIT margin that is now rather tending to the lower end of the 7% to 8% corridor, and I repeat and emphasize, including the extraordinary income of EUR 4.4 million which we explained during the call. This is taking into consideration, as a reminder again, our strong growth in the U.S. where we have the focus on OE customers, our strongest asset, which comes at a lower margin than the group, which does contain a small dilution from the York acquisition. But it also takes into account the usual seasonal effects that we see in the final quarter. And with that said, and the rest of the page not being refined, I think we can close the formal part of the presentation here and open up for Q&A. And I believe, today, we have sufficient time for that.

[Stephan Haas]

So the floor is open for your questions now. Please go ahead.

[Operator]

[Operator Instructions] The first question comes from Alexander Wahl.

[Alexander Wahl, Analyst]

My first one is you revised your adjusted EBIT margin guidance only with Q2 results, and what we have seen now is actually another profit warning that was hided by a positive one-off gain. So the message from headwinds from higher steel prices and also the remaining plant inefficiencies seems to be roughly in line with what you indicated is likely already at Q2. So can you just elaborate a little on where the actual outcome difference from what you expected at the beginning of the quarters and also your view on Q4, please?

[Detlef Borghardt]

Could you precise a little bit your -- this is Detlef Borghardt. Could you precise the question a little bit because we've -- I believe, we covered that pretty much over the last, I don't know, 16 pages. Where do we have -- let's say, what is your main question regarding the difference?

[Alexander Wahl, Analyst]

My main question is basically -- I mean, in August you've had 7% to 8%, probably tending towards the midpoint. From -- when I look at the magnitude that you showed us, all the headwinds resulting from higher steel prices and plant inefficiencies, that is roughly in line with what you indicated from a magnitude perspective. So I would just like to know what incrementally changed that basically led you to revise your guidance again. I think it's obviously not the steel price and the plant inefficiencies there.

[Detlef Borghardt]

No. It has a lot to do, and I will start -- try to answer your question, and Matthias will be happy to chime in here. The issue is, which is on one hand really a very good problem to have, that is the increased sales in U.S. We didn't expect that it will be that much that our plants would produce that many, okay. So I'm quite happy with the performance of our U.S. plants that despite all the labor shortages, all the things we talked about or I talked about in the last 30 minutes, despite that, we have been able to ramp up production. So we did really much more sales than we expected. But -- and this is the other side of the coin here or the middle, but these additional sales came in with really low margins. And this is an effect we see always for decades. If a market is hot or extremely bullish and if we need to produce with full throttle, then the sales we get out of that, the mix, is not really the best one because we produce a lot of standard products, standard fifth wheels, standard axles, without any features and benefits or very few feature and benefits. It means the pricing on these product is not that -- how to say, not that sexy, okay, if I can use this word. But we have to do it, okay, because the OEM force us to deliver, and contractually, we need to do that and we will do that and we will not stop any production line, also OE, although we know that traditional sales is not good for the overall profitability because the margin is low. But -- and that's the other thing. And we are always long-term oriented. If we bring in this high population to the market, that means we've come into the market, axles, suspensions, fifth wheels, et cetera, landing gears, you name them, we benefit later on in the aftermarket. That will take, as you know, 3 to 4 years, really, before this came in or come in, but it doesn't matter. So therefore for now, this is not good for the overall profitability. Very clear, the mix is not in our favor. But in the long run, that is good for the profitability of the company because we see more of the market. But that was something we haven't seen in Q2, okay, that our plans in U.S. will contribute that much more than we thought plus the mix which was not really in our favor. I hope that answers your question.

[Alexander Wahl, Analyst]

More or less. Maybe a second question. Also, this morning, Volvo released figures and also provided an outlook for 2019. It sees European truck demand to fall by roughly 5% in 2019. I know that you are not that exposed to trucks in Europe. But given that there's at least some correlation between trailer demand and truck demand, how do you see this forecast? And what is your current feedback from clients?

[Detlef Borghardt]

Yes, that's a very good question, and I have to be sorry I forgot that to mention when I talked about Europe because that's something we just discussed yesterday, and we'll mention that. But okay. Now you're asking of that, very good. Yes. We all come back now -- came back from the IAA in September, late September this year. Most of you in the call visited us as well. Thanks for that. And what we have seen after these 9 days of IAA that on the truck side, you might be right, okay. Or the forecast might be right that the market will normalize, okay. If it is minus 3% or minus 5%, I don't know, nobody knows. But as you mentioned, that is for us not that important because only 3.5% of our total sales are in relation to the European truck market. But on the trailer side, and this is, I believe, very important to mention, we talked to, I don't know, many -- how many hundreds of customers from Europe and the neighboring countries, including Russia, et cetera. The expectations are positive. I would say it's very positive, okay, but we see no -- not any clouds there that the market will be less next year on the trailer side. So yes, there is relation between truck and trailer. You are right. But that is always not at the same time. There's always a delay. Sometimes truck is faster or trailer is faster. Nobody knows. But on the trailer side, I really can -- or we can report, all the market participants are more than positive also for next year, which is surprisingly, okay, I have to say. Personally, I thought it will be weaker, the outlook will be weaker. But there was no confirmation at all on this, on my view on that. So truck side, maybe. Trailer, we don't see a weakness, which is, of course, for us the most important market here.

[Matthias Heiden]

And Alexander, if I may come back to your original question because I heard a little bit of hesitancy between line when Detlef asked you the question whether it was fully answered. Let me try again. Apart from the strong U.S. top line growth at a way below group average margin to highlight some of the other impacts that are causing us to refine the guidance towards the lower end of the range. I also mentioned York, which is growing stronger than anticipated, which comes at an improved margin compared to Q2 but still at a margin that is below group average, which is nothing unusual given the emerging territories that York mainly operates in and that a lot of these sales are also on the OE side, number one. Number two, on steel prices, nothing to hide behind, but we just need to be transparent about this, that the relief doesn't come quickly, and it will still impact us in Q4, which is why we also included the chart around the price development. And number three, just to put this in perspective again so that it doesn't get lost, we were fully transparent around the medical plan, but let me just stress that this is a result of the Task Force that Detlef described. And I made it clear in previous conversations that the Task Force is working across all processes of the enterprise. So that includes the finance processes, and it includes digging and turning every stone in established processes, in accruals and so on, not, and I stress, not for the sake of window dressing but for the sake of improving the operational performance of the enterprise. There is a clear difference between the 2. And that is why we also referred to the fact that the release of the accrual is lowering our cost basis on a sustainable basis. Now I certainly understand that EUR 400k per year are not perceived to mean the world to a P&L the size of SAF-Holland. But it is a proof point over the activities that we are undertaking, and there is more to come as Detlef described. But these methods take some time to be implemented, and this mixed bag of factors has led us to refine it towards the lower end of the range. Maybe this gives some additional light to answer your question.

[Operator]

The next question comes from Tim Schuldt.

[Tim Schuldt, Head of Research & Executive Director Research]

This is Tim from equinet. Actually, I have 3 questions which relate to each other. Firstly, it would be -- I would be interested to understand completely if you reach additional revenue at the moment in the U.S., are you actually booking any operational contribution margin or marginal contribution margin on that extra revenues? Or is it actually hurting your, also in absolute terms, your results? That's actually my main question. The other 2 are just smaller housekeeping ones. Firstly, the add-on operating expense of EUR 2 million in the third quarter, is this including the additional freight costs? Or is -- are these coming on top? And then lastly, with regard to the steel price, you mentioned an impact of EUR 3.9 million in the third quarter. Is that gross or net of price increases?

[Matthias Heiden]

Yes, should I take all of them?

[Detlef Borghardt]

If you like, I can jump in.

[Matthias Heiden]

Yes, okay. Then maybe I'll start at the bottom. With the steel price, that's the gross impact. Then on the operating expenses, yes, does include the freight. I tried to explain it. There is still additional freight in and out to be paid. I had described in previous calls that we're monitoring this on a daily basis. The run rate is coming down slowly but surely. But the one thing to be mindful of in this context is that by now -- at least, do not take this as an excuse but put it into the context of the overall industry situation that Detlef described when he talked about his trip. By now, we are in good company when it comes to production challenges because the entire industry supply chain is overwhelmed with the volume at this point, and it's all about getting it on time to your customer across the supply chain. And this is also still leading us to pay those freight expenses, but there are also many others by now who are faced with the same challenge. So what I'm trying to express, in other words, is not all of these add-on operating expenses are necessarily homemade by SAF-Holland by now. But it is a not really a good point to do a deep dive into separating that out. But I think it's fair to mention that as a description of the situation. When it comes to the additional revenue from the OE sales, thanks for the question again. In absolute terms, U.S. EBIT is up. So the answer is yes, it does come with a contribution margin. But that contribution margin is clearly below the group average. So we're not -- because I think you implicitly wanted to ask that question, we are not protecting market share or protecting OE customer relationships by negative contribution margins.

[Tim Schuldt, Head of Research & Executive Director Research]

Okay. Another question. It's actually a little bit different what I had in mind. The idea is, let's say you get another EUR 5 million on top in terms of revenues or extra demand from the OE side and you cannot do that without cutting back on aftermarket business, for example, so you might win a bit on the -- you might win on the OE side, you lose lower margin business elsewhere. So the question is really, is additional demand now coming in, is this actually in absolute terms good? Or is it actually costing you money? Not because you want to protect market share but because you have to cut back on more profitable business.

[Detlef Borghardt]

Yes, okay. That's more clear. Yes. First of all, there is no -- for us, there is no way out. That means the additional demand which came in now, again, and we didn't expect that it will be so high, there is no way for us to decline that. It means we cannot talk to our -- we cannot say to our big OEM customers, "Thanks for the additional order, but we are not going to serve you." Okay. And I have to mention all of our customers are on allocation already in U.S. That means we tell every OEM how many fifth wheels, how many axles, how many suspensions they get from us every week. And all -- and again, that was one of the outcomes from my visit here. And all are demanding more, okay. So if we would have more capacity already now, our sales would be even higher. So -- but these additional OE sales, as I mentioned earlier and also Mathias elaborated on that, is from the product-range-wise, is margin-wise not that good, okay. These are standard products, high volume. And then again, that helps in sales, but it doesn't help in the average contribution margin because all these additional all sales is below the average. And of course, so that kicks in then into the EBIT. But of course, on the other hand, and I believe I mentioned that as well, our processes are improving. We are getting better. We are having higher output as I mentioned, surprisingly, that the plants are already doing that on that high level, and that will help. And so that means for the next couple of months to come, if the higher order intake will continue, and that's what we see, that also rekicks in then with better processes in the factories and higher efficiencies that rekick in also in this higher margins and higher profitability.

[Operator]

Another question comes from Nicolai Kempf.

[Nicolai Kempf, Research Associate]

Nicolai Kempf here from Deutsche Bank. I have 2 questions. The first one is on the free cash flow. You expect a recovery of free cash flow in Q3 and Q4, but given the strong organic growth rate and also the payment [ cut off each ] customer, what can we expect for the coming quarters?

[Matthias Heiden]

Nicolai, can I park that question until November 8 in total?

[Nicolai Kempf, Research Associate]

Okay, yes.

[Matthias Heiden]

Not because -- don't get me wrong, I'm not trying to avoid the answer. I'm still literally in the process of doing the analysis with the team. I think we will see improvements quarter-over-quarter and we will see positive seasonal trends. But as of today, given exactly what you just described, it's a little difficult to pinpoint the answer to not disappoint you again or to come up with a wishy-washy answer. So if you don't mind me parking it until November 8, I promise we will come back, and we have to come back to it anyway.

[Nicolai Kempf, Research Associate]

Yes, okay. So then second question would be in APAC. Looking at the margins there, what can we expect going forward? More like 6% or like 7%?

[Detlef Borghardt]

If I may answer, I'll try to answer the question. This is, today, not about giving any forecast or guidance for the next quarter or even for next year. We are working on that. It would be nice to see even higher margins. It depends really on the product mix, and so therefore, and also depends on how York will develop further on. It's on a very good way, and very happy with the acquisition so far. Also, our post-merger integration, or so-called PMI, process is working very well. We see already results, and Mathias talked about it. You can see that the margin is already improving after we acquired the company. So therefore, let's see. We have some other activities to come the next couple of weeks until the end of the year, especially including sourcing. That might help as well. That is so far our know-how on that. We know how that works. And now having York as part of the SAF-Holland Group, our sourcing power is much, much higher than York as a stand-alone business, so that will help. But on the other hand -- and please don't forget that all the additional -- all the sales we do in China, that is more or less 100% without any aftermarket. It's all OE related. So this is to come after 2 or 3 years. You know that is our policy. That's our strategy. So that means if we do more sales in China, and we will do more sales in China, the margins are not at the, let's say, company average level, so we need to have some patience on that. But on the other hand, we see a new factory which we are going to build right now and which we'll ramp up production in Q2 next year. And we are pretty much on track with the planning here and that looks good. That will also help to boost our output that will boost our sales. On the margin side, EBIT is 6% right now. That's great. If we can get more, we will work on that. But again, today is not about guidance. On the long run, and that's what we always said, our China EBIT business will be in the range of the overall company across margin also for EBIT. That is clearly our target, and I see no reasons why we are not going to achieve that.

[Operator]

Our last question comes from Philippe Lorrain.

[Philippe Lorrain, Analyst]

It's Philippe Lorrain from Berenberg. A couple of points for me. I just wanted to make sure I understood that correctly. Did you say that you are currently pushing back a little bit of aftermarket sales in the U.S. because you have to serve your clients on the OE side so just this last year? So that's the first question.

[Detlef Borghardt]

Yes, pushing back is probably not the right wording. We are not yet where we would like to be. We still have a huge backlog in the aftermarket. It's getting better, okay. And we also have a lot of big pressure from fleet and also from aftermarket dealers from our master distributors. They need to get parts, and we are working on that. Again, the backlog is decreasing, but it's still huge, and we are always running behind because the OEM, as we said many times, the demand is increasing and increasing and increasing. I also believe our market share, especially on the trailer side, is increasing. So we are running fast, as fast as possible. I definitely would like to do more with the aftermarket because that will help, of course, our profitability. But it's a challenge. So we are not pushing back, but we are not reducing the backlog as we would like to do.

[Matthias Heiden]

But I think it's fair to add that this is not limited to SAF-Holland when comes the aftermarket backlog, but that it is characteristic for the situation the industry is in right now, in particular, North America.

[Detlef Borghardt]

Yes, very true.

[Philippe Lorrain, Analyst]

Yes, okay, I get your point, but that means it's really a margin drag that you have from the mix here as well because the aftermarket can't grow as it should.

[Detlef Borghardt]

Absolutely. And that is one of the reasons why we are sitting here today and doing this call, because our expectation, our planning was different, okay. We said the aftermarket backlog will be done in the next couple of months, okay. That's when we presented Q2. It is obviously not the case. But on the other hand, also luxury problem to have, the order intake for the aftermarket is increasing as well. So everybody is, as I said, turning a big wheel. The utilization of the fleets on trucks and trailers is so high, you cannot get trucks and trailers. That means every single truck and trailer, doesn't matter if it's just 1-year old or 20-year old, is on the street. That means they need aftermarket. They need spare parts. They need to repair the vehicles. So there is a high demand in every corner.

[Philippe Lorrain, Analyst]

Yes, understand that. And that leads basically to the next question. I mean, you seem to be pretty confident on whatever might happen next year in terms of production. And I have to say, frankly, looking at the trend in Class 8 orders, looks like the peaks of the cycle is probably going to be 2019 and not, as some people were expecting, at the beginning of this year, 2018. The capacity utilization is still going to be very high there, probably, across industry and also on your side. So what -- how confident are you that you are not going to end up adding capacity, really, at the peak of the cycle, and then when there is trend -- perhaps a contraction a bit later, that you suffer from under capacity utilization?

[Detlef Borghardt]

Yes, that's a good question. Of course, everybody's talking about that. First of all, you are very right. Everybody is running, as I said already earlier, running at full steam or full throttle. Capacity utilization is well above 100%, which is not good, okay, in terms of profitability. When is the peak of the cycle? Nobody knows. As I said, both on the truck and trailer side, 2019 will be, according to what I heard the last days, will be very high. We don't see any normalization. I see that the backlog from the truck and trailer guys is around 6, 9 months. Some of the trailer guys are already sold out for 2019. I've heard several comments last week from a customer in face-to-face meetings. They stopped selling now because 2019 is done, okay, and they refuse to place any orders or to confirm any orders for 2020 because nobody knows about pricing. So that means, about capacity utilization, as I said, we will do something on the trailer side, very clearly, because -- and that is the overall trend. It has nothing to do with cycles, okay. The overall trend is towards air disc brake. We are the global market leader on the trailer side on that. Nobody is doing then many trailer axles than we do. We know how that works. We are very good in that in Europe. We are the market leader here on air disc brakes with trailers. And on the U.S. side, we will take a big piece of the pie. That is clearly our plan, our target, and it shows that we are going the right direction. So that means despite the market might normalize in 2020 or 2021 or whenever, we intend to grow market share. That means we need more capacity. The same is on the fifth wheel side. We know we are the market leader with more than 50% on fifth wheel in North America, and that's for more than 40 years. We are very good in that. We are running at full capacity. We increased capacity in our Wylie plant, and I visited last Saturday. So that is well done. And most of the capacity increase we do also help us in efficiencies. So that means we can run this new equipment on 2 shifts or 3 shifts. If we only run it on 2 shifts, it will still be very efficient. So that means we will agree with the number of people on the workfloor. And so therefore, even though the market will go down, we will adjust -- we can adjust our cost very, very fast. And long-term trends, and that is also -- and then I'm done with my long speech here. We see the driver shortage in the U.S.A. That means the ratio between truck and trailer in U.S. will increase. That means we will see many more trailers than trucks. And that is our biggest business, as you know. That is driven by the e-commerce. That is still ongoing, as we call it, the Amazon effect, or you can call it whatever you like. But the demand, especially for trailer, will be high in the next comes -- the next years to come. On the truck side, I believe so too, but that's something we will see. So I'm not afraid about 2020 or 2021. We will invest in additional capacity, and we need that.

[Philippe Lorrain, Analyst]

Okay, that's a great point. I still have a couple of questions here. For these operating costs that you, have these add-on operating costs, which are around EUR 2 million in Q3, would you mind sharing with us, basically, what you kind of expect perhaps going into Q4 and also going into next year? From which point do you expect these add-on operating costs, basically, to completely fade out?

[Matthias Heiden]

Very difficult. I'll take a stab at this. Philippe, [Foreign Language] I'll take this as by saying initially it's very difficult to confirm this because by now, as I said, we are in such good company that there are 2 parts: one caused by our own inefficiencies; and number two, items caused by external factors, by the supply chain. So for our own inefficiencies, we should see a further reduction, which I perceive to be or expect to be significant in nature in Q4. And then during the first weeks of Q1 at the latest, we should be done. The reason I'm saying that, if I now say we're coming down to 0 in Q4 and I show you a number in Q4, then I get hundreds of questions. But my point is we will see a further improvement in Q4. I hope that's a fair answer that helps you.

[Philippe Lorrain, Analyst]

Yes, okay. That's good. And I do expect then that this kind of fades out gradually probably across, let's say, next year because we then see the full effect of your reorganization across the U.S.

[Matthias Heiden]

Absolutely. But let's make sure because that's also our own ambition, right, that this phasing out doesn't take too long, or rather, the amounts that are phasing out are not too high, right. Because if we now leave it by saying phaseout, that sounds as if we will see significant amounts still wandering through the P&Ls of 2019. That is something that we aim to avoid. But rest assured, we will keep up the transparency and try to explain if there are such costs and why also in the future if need to be.

[Philippe Lorrain, Analyst]

Yes. Okay, sounds good. And the last question is basically just on your aggressive growth targets. I mean, you print 10% organic growth in H1 then a 15% in Q3. Now you guide for 9% to 10% for the full year. So that seems to point towards a, let's say, deceleration to say the least in Q4. But at the same time, you are pretty confident on the market. So how do we have to understand that? Because you raised prices, yes, on some products. The volume seems to be -- the volume trend seems to be pretty supportive. So is it just like the visibility is not as great, let's say, and that's why you don't want to be perhaps too bullish by going into, let's say, guiding for 12% increase? Or how do we have to understand that?

[Detlef Borghardt]

Yes. The point is -- and that is always the same that in the last quarter of the year, we have a couple of days where we still simply will not work, okay. That means the factories all over the globe more or less are closed. That means Thanksgiving, Christmas, whatever. And we are running in full capacity. That means for every missing shift, for every missing day of production, we will have less output, okay. So that means we are basically limited in growing sales even more. And as said already, that in, for example, in U.S., the demand from our customers, regardless of which product is this and which product is higher than our, actually, outputs or what we can do, therefore, everybody is on allocation. So we are limited because we are running under full steam at all places, and we don't have that many working days in the last quarter.

[Philippe Lorrain, Analyst]

Yes, but I guess that was also the topic for Q4 last year, so it's rather on a sequential comparison that, that might happen.

[Matthias Heiden]

I think that's a fair conclusion. Yes.

[Detlef Borghardt]

Oh, by the way, just to add one point, I forgot to mention it. I saw also last week the -- an outlook from, I believe it was, ACT or FTR. I do not remember correctly. But they said if the peak will be 2019, and you said that also, okay, then for 2020, the outlook was that 2020 will be the same number than 2017, which was a very good year. So that means that they see a normalization, okay, in 2020 then. But this not really a disaster because, again, this is a number from ACT, which is available for everybody. And I look to that for the very first time after they said the peak will not be this year, it will be next year. Then for 2020, if it goes back to 2017 level, good results. That was just an additional comment there.

[Operator]

There are no more questions so far. [Operator Instructions]

[Stephan Haas]

Okay, so if there are no further questions, thank you a lot for joining the conference call today. And we will meet again on November 8. So we will publish the full set of figures and the interim report where we will also do, as usual, a quick conference call. Thanks. Take care. Bye-bye.

[Matthias Heiden]

Thanks, everyone. Bye-bye.

[Detlef Borghardt]

Thanks a lot. [Foreign Language]