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Edited Transcript of DPLM.L earnings conference call or presentation 14-May-18 8:00am GMT

Half Year 2018 Diploma PLC Earnings Presentation

London Jun 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Diploma PLC earnings conference call or presentation Monday, May 14, 2018 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* John E. Nicholas

Diploma PLC - Non-Executive Chairman

* Nigel P. Lingwood

Diploma PLC - Group Finance Director & Executive Director

* Richard Ingram

Diploma PLC - Former Director

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Conference Call Participants

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* Henry Carver

Peel Hunt LLP, Research Division - Analyst

* Julian Charles Cater

Numis Securities Limited, Research Division - Analyst

* William Kirkness

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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John E. Nicholas, Diploma PLC - Non-Executive Chairman [1]

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Good morning, ladies and gentlemen, welcome to the Diploma interim results presentation. For those of you who don't know me, my name is John Nicholas, I'm the Chairman of the company. I don't normally get a speaking part at these events, but as you know, I think you probably all know, Bruce Thompson, our Chief Executive, retired last week.

So I'm delighted this morning to introduce you to his successor, Richard Ingram.

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Richard Ingram, Diploma PLC - Former Director [2]

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Good morning.

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John E. Nicholas, Diploma PLC - Non-Executive Chairman [3]

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Richard will be talking to you a little later this morning. But as he has only been with the company 3 weeks, we thought it was appropriate that Nigel would handle the results themselves.

So he will be dealing with the bulk of the presentation and then handing over to Richard at the end. So that's the end of my speaking part. Over to you, Nigel.

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Nigel P. Lingwood, Diploma PLC - Group Finance Director & Executive Director [4]

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Great, good. Thank you, John. And good morning, ladies and gentlemen. So the contents of this morning's presentation is set out on this slide. As John said, I'm afraid you'll have to bear with me, I'm doing a lot of these parts. So we'll do a quick overview, then we'll go into the business review, briefly talk through the financial results and outlook. Then Richard will come along and introduce himself.

So before I turn to the half-year results, let me remind you of Diploma's strategy and business case.

Diploma has a clearly defined strategy and a consistent track record of profitable growth. Strong free cash flow and high returns on capital.

We achieve this by focusing on these 6 characteristics. GDP plus underlying revenue growth, which we see at the moment around 4% to 5% in the current markets. This is achieved through a focus on essential products and services, funded by customers' operating budgets rather than capital budgets.

This leads to stable and resilient revenue growth and margins and reduces this cyclicality.

We focus on sustainable and attractive margins. These start with good gross margins of around 30% and above. And these are sustained through quality of customer service, depth of technical service and value-adding activities.

We have an agile and responsive organization and operating structure. We want our managers to act like entrepreneurs, working close to their customers, with high service levels and responsive to their local market conditions. This decentralized model achieves economies of scale by managing clusters of businesses, not high-cost divisions. We also select value enhancing acquisitions to accelerate the organic growth. These acquisitions take us into new but related strategic markets, and accelerate growth to our stated objective of double-digit over the economic cycle.

Our businesses generate strong free cash flow, with cash conversion in the 90% and above.

This provides the cash to fund the acquisition strategy and provides healthy and growing dividends.

And finally, everything we do is focused on creating value to shareholders. We achieve this by consistently delivering return on capital above 20%, so that's a fully loaded capital with all goodwill intangibles grossed up, in effect a return on total invested capital.

So now let's look at the half-year results for the 6 months ended 31 March. During the half year, Diploma achieved an 8% increase in reported revenue to GBP 234.9 million and a 9% increase in adjusted operating profit to GBP 40.6 million with adjusted operating margin moving up 10 bps to 17.3%, which is the same as we achieved in the full year of 2017.

Acquisitions completed in the last 12 months contributed 5% to revenue growth, and this was mainly from Abacus healthcare, a business we bought last April in Australia. The currency headwinds from strengthening U.K. sterling, particularly in the first quarter of the year, reduced revenues by 4%. So we had a creditable 7% growth in underlying revenues.

With only a very small level of bank commitment fees, the adjusted PBT was also up 9% at GBP 40.4 million. Free cash flow was good at GBP 17.7 million but 14% below the same period last year, as the businesses increased their investment in working capital in response to the stronger underlying trading conditions.

We spent GBP 3.3 million on acquisitions, with activity continuing to be constrained by the generally stronger trading conditions, which are encouraging owners to postpone their decisions to dispose of their businesses. However, our pipeline of acquisition opportunities remains healthy.

We ended the period with net cash of GBP 17.7 million. And we, of course, have substantial committed debt facilities of up to GBP 60 million available to fund acquisitions when the market improves.

Adjusted EPS was up 12% compared with just 9% in adjusted PBT. This reflects a benefit of the reduction in the U.S. tax rate [in Amster] late last year.

And finally, we have increased the interim dividend gain, this time by 10% to [GBP 0.77], reflecting the strong financial position and confidence in the group's growth prospects.

So with that summary, I will now move on to look at the performances of each of the business sectors.

Beginning with Life Sciences. Where revenues increased by 16% to GBP 67.4 million, benefiting from the acquisition of Abacus, which we acquired in April last year, which itself increased sector revenues by 11%, while the stronger U.K. sterling reduced revenues on translation by 4%. So this leads to a 9% increase in underlying revenues of this sector. The increase was largely driven by good performance in the healthcare businesses, where revenues benefited from good growth in consumable revenues, particularly in the clinical diagnostics business and new supply products introduced in the surgical business during the last 6 months.

Adjusted operating profit increased by 14% to GBP 11.7 million, with operating margins falling 40 bps to 17.4%. This reduction in margins reflected an investment in costs to support the introduction and penetration into new markets of the new product lines we've introduced over the last 6 months, and also some one-off costs that were borne in the first half of the year, in connection with combining the Australian diagnostics businesses, Abacus and DSL, which should be completed over the next few months.

Now looking further into some of the developments of this sector during the past 6 months. Beginning with healthcare businesses, which accounts for about 84% of the Life Sciences sector. Diploma Healthcare businesses operating [calendar] Australia, achieved underlying growth of 9%. This was against the background of continuing budget pressures caused by the ongoing restructuring and amalgamation of the various procurement entities or group procurement offices.

These activities lengthen the sale process by introducing strict requirements on large frame contracts which must be met before allowing suppliers to approach buyers in the diagnostic and surgical departments.

In Canada -- Canadian healthcare, underlying revenues increased by 11%, with another period of strong consumables in [Somagen], the diagnostic business, and the benefits from the introduction of a premium range of rigid and flexible endoscopes in the surgical business.

These new scopes and related surgical instrument sets provide further growth opportunities by penetrating the large and growing urology and gynecology sectors of the surgical market.

In Australia, healthcare was success -- in Australia healthcare, we successfully combined the Abacus business, acquired last year, with our existing and smaller DSL business to form Abacus Dx, a large broad-based clinical diagnostic business, Life Sciences and Patient Simulation business supplying to pathology laboratories across Australia.

During the first half, Abacus Dx delivered strong double-digit growth in revenues on a like-for-like basis. The electrosurgery and smoke evacuation business in both Canada and Australia in the core surgical business have continued to be under pressure from the large medical device companies entering these big-budget and increasingly commoditized sectors and driving competition and consolidating the market through acquisition.

However, we continued to react by introducing new replacement products. And in Canada, we've seen pricing stabilizing in the market albeit at slightly lower levels. In Ireland, the TPD business delivered solid underlying growth, helped by strong capital sales of agitators and separators used in the NHS blood and transplant service and capital equipment used in the microbial testing segment in the biotechnology business.

Finally, the environmental business, which represents about 16% of Life Science sector revenues, delivered 6% growth on an underlying basis. We saw strong growth in high-end elemental analyzers in Germany, where they're used in the testing of nitrogen and sulfur in the petrochemical industry.

Revenues for the sale of continuous emission monitoring systems, or CEMS, sold by the U.K. business reduced slightly because of order placement delays. But overall service revenues in both businesses, Germany and the U.K., continue to grow and now account for over 30% of revenues.

Moving on to the seals business. Revenues in the seals sector increased by 5% to GBP 99.2 million, with the small acquisitions of Edco and PSP last year increasing sector revenues by 3% while the stronger U.K. sterling in the first half of the year led to a currency headwind of 7% on translation of the results of overseas businesses revenues.

So this leads to a 9% increase in underlying revenues in this sector, helped by strong North American markets and improved international markets, particularly in the second quarter of the period.

Adjusted operating profit increased by 11% to GBP 17.1 million, with operating margins increasing about 100 bps to 17.2%.

There's a lot of operating leverage in many of these seals businesses, as we've explained before. And we did expect to see a benefit from this as revenues grew stronger in North America and improved in the international seals business. However, the improvement we were hoping to realize from this stronger trading was held back slightly by softer gross margins, particularly in the U.K. and the smaller -- particularly in the U.S. aftermarket and the smaller U.K. aftermarket businesses where there was a lag in passing on supplier price increases and increased rate cost from expediting inventories into the businesses to avoid disappointing customers.

Now again, looking at the developments of the seal sector. The North American seals businesses, which count for about 62% of the sector revenues, increased underlying revenues by 12% as confidence continued in the U.S. economy.

The aftermarket reported in the -- reported an 11% increase in underlying revenues, with both the U.S. and Canada seeing strong demand across many sectors of their market. There was a significant pickup in (inaudible) activities in the broader oil and gas markets and large infrastructure projects drove demolition and construction markets.

The HKX attachment kit business, which is generally more cyclical, continued to recover from weaker activity seen over the past 2 or 3 years and delivered a 20% increase -- 26% increase in revenues, again, driven by strong demand in the U.S. as contractors continue to focus their heavy equipment needs on non-plumbed machines which drives the demand for the HKX attachment kits to be fitted.

The HFPG industrial OEM businesses in North America also reported good growth, up 14% in a very strong industrial market which tracked the growth in the U.S. manufacturing PMI data. This business continued to look for opportunities to deploy high specification and regulatory complying compounds to target new projects with higher levels of added value.

HFPG has also made good progress in developing the cluster of industrial area and businesses in the U.S. with a senior management team directing the key functions of sales, supply chain, technical and finance, but still maintaining the distinct identity of each business.

A key part of this initiative is the ongoing implementation of a new ERP system to serve each of these businesses, which we expect to go live in the final quarter of this fiscal year.

Now turning to the international Seals business, these businesses account for 38% of sector revenues. And underlying revenues increased by 3% on a constant currency basis, and adjusting for the acquisition of Edco last year.

In FPE and M Seals, who have their principal operations in the U.K. and Scandinavia, they delivered underlying growth in revenues of 6%. In the U.K., despite some improvement from the oil and gas market, underlying revenues were relatively flat, as the construction market continued to show modest levels of confidence.

However, Edco, the new -- newly acquired business delivered good growth on the like-for-like basis. And in Scandinavia, underlying revenues increased by 10%, with a very good performance in Sweden, driven by new project activity for established customers and new project wins for new customers.

Kubo in Switzerland benefited from the improvement in industrial activity in Switzerland that began about 9 months ago, and delivered a 9% increase in underlying revenues. The stronger business confidence combined with sales initiatives began last year and a buoyant market in Austria all helped deliver this good result.

Now Kentek and WCIS continue to experience difficult trading conditions. And underlying revenues decreased by 4%. A combination of weak end user markets, competitive pressures and customer limitations caused by the international sanctions contributed to a weaker performance in Russia, which more than offset a modest increase in the Finnish and Baltic revenues.

In WCIS, in Australia, the business has been significantly impacted by cost reduction initiatives in its major customer base in New Caledonia. However, in Australia, a new management team is making good progress with broadening its sales coverage, and these are gaining traction with some good contract opportunities coming through in the second half of this year.

And finally, turning to controls. Revenues in the control sector businesses increased by 6% to GBP 68.3 million, with a small acquisition of coast completed in October '17, adding 3% sector -- to sector revenues. These are predominantly U.K. businesses, so movements in currency had a negligible impact on revenues.

So a 3% increase in underlying revenues as well for this sector against a very strong comparative [6 of 16%] last half-year, which included some major activity -- project activity in Filcon, which unfortunately did not repeat in this half-year.

Adjusted operating profit increased by 1% to GBP 11.8 million, with margins reducing by 80 bps to 17.3%.

The interconnect businesses continue to pursue their strategy of broadening its customer base by targeting cable harness houses across the EMEA region. And to do this, they used some strategic pricing to penetrate these customers.

This strategy has led to softer gross margins in the first half, but the businesses remain confident of recovering this margin in the second half through stronger sales and gradually moving margins up, supported by higher levels of value-adding activities.

In Clarendon, their current focus on driving growth in the U.S. market requires additional investment in the U.S. business, which combined with the lower operating margin of Coast, acquired early in the year, diluted operating margins.

And again, looking at developments in the control sector. The interconnect businesses account for 58% of sector revenue, an increase to underlying revenues by 2%. Strong growth of 9% in revenues of IS-Group and Cablecraft were held back by the absence of that major project activity in Filcon.

The IS-Group with its principal operations in the U.K. delivered steady growth in its core markets of defense, aerospace, motorsport and industrial, and this was boosted by targeting these cable harness houses across the EMEA region as well as supplying the traditional network of European subcontractors.

Cablecraft delivered good growth in revenues and its continued focus on end-user customers, including electrical panel builders and contractors updating the U.K. rail network. Cablecraft are also benefiting from increasing e-commerce revenues and are undertaking a project to substantially upgrade its website and e-commerce capabilities.

In Clarendon Fasteners, which accounts for 22% sector revenues, underlying revenues increased by 8% even against a very strong prior year competitive. The overall aerospace market remains buoyant and Clarendon continue to strengthen its relationship with the major aircraft seating and cabin interior manufacturers and their subcontractors.

They've also expanded their presence to support customers in the U.K., Europe and increasingly Asia and in particular, Thailand. At the beginning of this financial year, Clarendon acquired a small Speciality Fastener businesses based in California, called Coast. This is strategically important as it provides a base in the U.S. for supporting Clarendon's existing aerospace customers in the U.S., and it gives Clarendon access to major fastener suppliers that principally only supply to U.S. customers.

And finally, last but not least, fluid controls, which accounts for 20% of sector revenues, they reported a modest 1% increase in revenues. This was largely contributed by [Abbeychart], which shows strong growth in its core coffee segment, but weaker sales in the OEM, refrigerator and contractor markets served by [Hawko] offset much of this growth.

So, I will now briefly run through the financial results and conclude with the outlook.

So I think I have said enough about revenues and adjusted operating profit. You can see that after deducting some small bank commitment fees of GBP 200,000, we arrive at adjusted profit before tax of GBP 40.4 million, up 9% on a comparable period last year. Now below this line, we have acquisition-related charges of GBP 4.3 million, principally being the amortization of acquisition intangible assets. And then we have the adjustment needed to fair value the put options that are held by the minority shareholders in Kentek and M Seals.

And finally, this year, we've also introduced an adjustment for the incremental one-off cost arising directly from the transition of Chief Executive Officer to Richard from Bruce Thompson.

As you know, Bruce remains with the company until the 30th September, 2018 in an order to help with the transition process. So we effectively are bearing the cost of 2 CEOs until 30 September, '18. And it is one set of these costs that we're adding back to arrive at adjusted PBT, and are showing them below the line here.

Clearly, this will be a larger number in the second half of the year.

So with these items deducted below adjusted PBT, we arrive at reported or statutory profit before tax up 8% at GBP 35.4 million.

Turning to the tax. The group's effective tax rate has reduced to 24.5% on 31 March, '18 from 26.4% last year. This is in line with what we reported to the market in the January trading update. And of course, the driver to this reduction is the reduction of the U.S. federal corporate tax rate from 35% to 21% with effect from the 1st of January, '18.

So with around [26%] of the groups PBT coming from the U.S., this has resulted in the U.S. effective adjusted tax rate falling to [29.3%] compared to around [38%] in previous years. And it is this reduction, the effective rate, that drives the larger increase of 12% in adjusted EPS.

Looking at cash flow. Operating cash flow was 3% below the comparable period at GBP 31.9 million. You will see that this reduction is entirely due to increased investment in working capital, up GBP 4.1 million at GBP 11.2 million. As I explained, this increase is in response to the much stronger trading environment over the past 12 months. As we've seen before, it takes time to move into -- inventories to the level required to meet the current demand and avoid stock-outs and customer disappointment.

So at 30 September, we were running tight on working capital, which, as I said at the time, with a metric of working capital, the revenue of 15% was at a low rate.

This increase in the inventories is now being rebuilt in the business with GBP 7.5 million of this GBP 11.2 million relating to inventories. The working capital to revenue metric increased back to 15.8%, same as it was last year. And maybe we've gone a little bit too far putting inventories back in, but we would expect this investment to pull back in the second half of the year as historically it always does.

Tax paid at GBP 9.7 million was a little higher than last year, at cash tax rate of 24% against 25%. And you can see the initial benefit of the cut in the U.S. tax rate beginning to come through on the quarterly payments. CapEx was up 2 -- was GBP 2.3 million, up GBP 1.3 million against a very low -- unusually low number last year. In Life Sciences, the healthcare businesses spent GBP 0.5 million on acquiring new hospital field equipment and GBP 400,000 was spent on refurbishing and expanding the Kitchener facility in Canada for the combined surgical business, and on a new facility for the environmental business in the U.K.

In Seals, GBP 0.5 million was invested in the new ERP system, in the industrial area and businesses in the U.S., as I spoke of earlier, and on a smaller ERP system going into the Kentek business in Finland. And a further GBP 200,000 was spent on various warehouse equipment both in Seals and also in controls.

So after spending GBP 2.2 million to fund the company's long-term incentive scheme, we ended the period with free cash flow of GBP 17.7 million, 14% below the comparable period last year.

We spent GBP 3.2 million in acquisitions, GBP 1.2 million on acquiring the Coast business in the U.S. in October '17, and GBP 2 million on buying out the final 10% minority interest held in TBD, the Irish healthcare business.

So we ended the period with net cash of GBP 17.7 million, which strangely is also the same number as the free cash flow, so not a typo, we checked. Of course, the second half of the year is historically when the group generates most of its free cash flow. And this cash flow together with a committed bank facility of up to GBP 60 million provides the group with substantial resources to apply to acquisitions when the opportunities begin to arise, which I'm confident they will.

Turning to the balance sheet. Trading capital employed of GBP 268 million was in U.K. terms, broadly unchanged from 30 September, '17, but of course, has been impacted by the stronger U.K. rate applied to overseas balance sheets. The annualized return on capital or return on adjusted trading capital so the adjustment being to gross that capital back up remain strong at 23.9%, and more importantly, is well above our threshold of 20% and largely in line with last year.

A small closed defined pension scheme with a net liability of GBP 9.5 million is now being funded at GBP 0.5 million a year, up GBP 150,000 from previous years following the [actuary evaluation] completed last year.

An acquisition liability is now only relate to the put options held by the minority shareholders in Kentek and M Seals. Both at 10% and both with the option maturing at the end of this calendar year.

So at 31 March, we have total shareholders equity at [268.8]. And finally, before handing over to Richard, a few words on outlook.

The group is enjoying robust underlying growth and has a healthy pipeline of acquisition opportunities. We have a proven business model and growth strategy built on resilient GDP plus revenue growth, sustainable attractive margins and supported by value enhancing acquisitions to accelerate growth to double -- to target double-digit level.

In the first half of the year, the group has taken advantage of continuing strong global trading environment and have delivered a good performance despite currency headwinds.

Acquisitions, however, remain an integral part of the group's growth strategy. We've seen over the past 12 months that the generally stronger trading conditions have constrained acquisition activity as owners have become reluctant to dispose of their businesses with this background.

However, the pipeline remains healthy, and we're working hard to bring some of these opportunities to completion to before the end of this fiscal year.

So with this background and strong balance sheet, the board is confident that the group will make further progress this year.

Thank you. I will now invite Richard to address you. And then after, would -- we can take some -- we can both take some questions.

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Richard Ingram, Diploma PLC - Former Director [5]

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Thank you, Nigel. Thanks. Got that going in the right direction. Good morning, everybody. And first of all, I'd like to thank you, Nigel and John, for the very kind words of introduction at the beginning. And also, although he is not here to thank, Bruce, for leaving the company in such great shape at this point. It's nice to come in to a company which is in good shape, and I was talking to a few of you about that over breakfast.

What I'd like to do today is just to introduce myself in a few words, and of course, I'm aware much of that's transparent these days because you can go on Linkedin and see what I've done, but I'll just elaborate some of that. And then I'd like to talk a little bit about my very first reflections about the Diploma businesses. Now obviously, I joined the company on the 23rd of April, so I haven't had too much time to really absorb all of the activities and the nuances of the businesses. So this will be fairly high-level.

But I have been traveling in between board meetings and so on. So I have visited some of the businesses, and I have started to get some context and flavor as to what this company is about.

There we go. So few words about me. I started my career as an engineer. Probably need to read this chart from the bottom to the top, actually. But I started my career as an engineer in the oil and gas industry working for Shell. I spent 5 years there. I've certainly used some products which are supplied by Diploma today in the course of that activity.

Very interesting company, as I'm sure you know.

I have -- over the course of my career run a number of quite large industrial businesses. So when I left Shell, I went into the automotive industry. I worked for what was then originally Lucas, became TRW automotive, and then subsequently, as recently acquired by ZF.

And worked in a number of different activities, aftermarket distribution initially, and then advanced product development, some of the products you can buy in vehicles today, autonomous cruise control. We had great fun developing those in the mid-'90s. Just didn't have the computing power to make it work properly, but the general thesis was there.

And gradually worked through that. And then in around '99, I was working for TRW. And I moved from the automotive piece to the aerospace piece to develop the Airbus and Eurocopter business. And I actually spent a quite a bit of my career living outside of the U.K. in France and Germany in order to do that. Ended up in TRW, which subsequently became Goodrich, running a couple of different quite large aerospace businesses, engine controls and flight controls. And when United Technologies acquired Goodrich, I left and briefly worked for Zodiac. Zodiac, which is of course a client of Clarendon.

And in 2014, I joined Smiths Group to run the detection business and really the primary milestones there, it was a business in some difficulty, we were quite successful in turning around and improving the margins from mid digits to mid double digits, and also acquired the Morpho business from Safran and added that to the portfolio.

And as I said recent -- just a minute ago, I have released -- although I'm British, I spent most of my career until 2014 outside of the U.K. from about '95 to 2014, worked extensively with U.S. companies or for U.S. companies, and lived in Germany and France as well as the U.K.

So just a few words now on my observations around this Diploma business. And as I said before, not had too much time to really understand all of the businesses. But specifically, I have visited a number of them. So I've visited the IS business and the Clarendon business, which are in Swindon, to west of London. I visited Kubo last week, very interesting business. And spent a couple of days in Toronto with the Diploma healthcare group. So I have actually got a smattering of information, but rather more about some than others.

One of the things that attracted me to this business was the excellent record of value creation, really over a long period of time. And if you look back, you can see that consistence value [accretion] coming through in the share price. And I think in addition, the strength of the balance sheet in -- and the regular and strong cash flows gives us confidence that we can continue to invest in the right parts of the business to provide and fuel further growth.

From what I've seen so far, I think the portfolio is very solid. And these are businesses, and I think Nigel made it very clear, again, picking out the 6 elements of our overall investment thesis at the beginning. These are businesses which are not just bulk distributors of products at all. Each one has a specific service element. We try to keep close to the customer. And in some cases, we're doing for our customers what 20 years ago they might have done internally, but they've tended to move away from that model and they need specialists in particular fields which can help them. So we're providing technical information. We're helping them to select the right products.

And we understand how they create value. So Nigel was talking about the IS business and the so-called cable harness houses. So these are people who pull together very specific harnesses, they have to be exact lengths, they have multiple branches, they may need to be tested against thermal considerations or high altitude, whatever it is. And we can tell the customer exactly what to select and provide a great deal of that package so -- which helps them to get on with what they're trying to do, which is to provide a niche service to their end customers which may be Tier 1 OEMs.

And as I visited the businesses, I've been very impressed with the depth of knowledge displayed by our products and technical teams, particularly in the health -- for example in the healthcare business, I think, we have a number of people there who spent a great deal of time in surgery, understanding how surgeons provide healthcare and improve patient outcomes. And that's very important when you're trying to select a product range and sell to these customers.

So this brings me to the specific point of leadership in the business. From what I've seen so far, there is a very high degree of engagement across the business. Our leadership teams are capable very -- and have a very deep understanding of what they're trying to do. And they're very committed to providing to investors that steady performance improvement through growth and through profitability and cash.

So the focus really is on not just growth but sustainable, profitable growth in the businesses.

And I think some of those points come across. They understand that we're trying to focus on specific streams of revenue, which are typically generated from OpEx or where we provide capital equipment to our customers. That's because there is a stream of operational cash flows, operational revenues going to come behind in the form of some other stream of revenue, service or reagents in the case of healthcare, which flow as a consequence of the capital placement.

So I saw a number of examples where the businesses are focusing on delivering value. One example I'll just give you from the healthcare team is that we're introducing new products into the range which improve the performance in terms of the process for initial diagnosis of bowel cancer. And this really provides 2 things. One is, it prevents secondary operations which are not needed, where you go in the hospital, have a colonoscopy and discover you didn't really need it in first place. That's expensive and is also a very non-preferred outcome for the patient. So these are things which can translate into real value, good value propositions. And we -- what we're trying to do is create a position where the pricing of the product is not related to the cost of the project, it's related to the value that we create.

So finally then, a few words about structure. As Nigel said, this is a devolved business. We let the operating managers get on with running their businesses. And we need them to be agile and understand the detail of the customer core phase. That said, I do think there are operations to pull together some elements in a way which would enable us to leverage best practice across the businesses.

And in fact, we've already seen this happening in some of the businesses. So the U.S. Seals business is already quite far down the road of consolidating some of its operations where it makes sense. So the thesis area is to keep the front office very customer-focused where it's appropriate to do some work to consolidate back-office. And these are projects which are being presented by the executive management group to me, as these are not things that I have suggested, they are already working on them.

And they're activities which just enable us to continue to support margins going forward, without detracting from the business model that we have.

So as I said, I'm very happy to be here. Thank you very much for listening. I'll now hand back to Nigel, who will host the Q&A. Thank you.

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Questions and Answers

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Nigel P. Lingwood, Diploma PLC - Group Finance Director & Executive Director [1]

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Good. So thank you, Richard. So we'll, as usual, take Q&A. Before you ask the question, can you just state your name and where you're from.

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Julian Charles Cater, Numis Securities Limited, Research Division - Analyst [2]

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It's Julian Cater from Numis. Two questions on the Seals business, please. If I think about the capital markets presentation last year, one of the sort of target growth areas was the North American rental fleets you have. And I wonder whether you could say whether what success you've had over the last 12 months into penetrating those fleets? And my second question, still on Seals. If I look at the implied margin on the incremental revenues, that implied margin looks like it's comfortably in the 30%. I wonder whether that's just from the operational gearing in North America? Or whether there's been an improvement in the profitability of the International Seals businesses? And if it is just operational gearing, how much longer can you go without having to put in some incremental cost that sort of diminishes that operational gearing?

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Nigel P. Lingwood, Diploma PLC - Group Finance Director & Executive Director [3]

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So, wow, okay. So start with the first one. Yes, you're right, we have spoken I think the last 2 sessions on the opportunities we feel there are in servicing the rental fleets in the U.S. I think it's fair to say it's been a little harder to get into those portals than we originally anticipated, or at least our teams anticipated. But there's been some movement this year; we were talking about it in our meetings a couple of weeks ago. They are establishing, it's getting the right product into the portals and then pricing it correctly. And I think when we started going in, we weren't really getting the right product into the buying portals where the repairers of these fleets go to [collect] their product.

So we've changed that around. We've targeted the right product. And we'll tell you more in November. I hope we'll start seeing some real progress with that. So it's still very much a target area. But it's just a little slower than we originally anticipated.

Moving on to your question on margins. Yes, there is some operational leverage there. In the international markets, it's more than just operational leverage. We've seen some stronger margins coming through on the Kubo business, but also on the Kentek business. If you recall last year, Kentek margins were impacted by the relationship between the euro and the ruble. It's quite complicated but we were at a very low point in last half year. We've seen that come back. We expected it to come back. So those gross margins have got stronger. Kubo has got operational leverage but also stronger gross margins as well.

So -- and there was more opportunity to follow. We're working hard with WCIS. And we would be hopeful to see some strength in those margins coming through over the next 6 to 12 months as well. So I think there is opportunity in those businesses to move gross margins up.

I think we're pretty lean on costs. How much more operational leverage we can take? That is something that we're looking at all the time. Certainly, we are now looking at whether we should be moving -- or not moving, but looking at expanding our aftermarket facility in the U.S. where we've been there for longer than I've been here, 20 years or so. We've put in carousels. It's a really very busy facility. I don't think we feel we can put mezzanines. And we need to look at alternative sites. And that is a project that we're looking at. It's early days. But we'll probably come forward in November and talk to you a little bit more about that project.

But generally, as I've spoken before on gross margins, we have, during the budget process and over the last 6 months, really challenged people to look at what other costs are going into their gross margin. And by that I mean freight cost, where they are expediting, cut them out, discounts, rebates, et cetera, which were all good incentives when sales are broadly [or -- out] quite weak to get the sales moving. But in the current markets, where demand is strong, there is some capacity constraint in the suppliers. We shouldn't be giving away those rebates and discounts. There's a big focus across the group on trying to hold that back. 30 or 40 points bps on gross margin, it's the difference between us being [nearly] 18% and 17.3% today. So there's a focus there.

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William Kirkness, Jefferies LLC, Research Division - Equity Analyst [4]

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Will Kirkness from Jefferies. Got 2 questions, please. Firstly, just on M&A. You seem incrementally more positive there, I just wondered if you could talk about size and market locations and multiples? And then secondly, just on -- particularly on the Seals. Are most of the price increases through now for fiscal '18, when do you think you may see [a next round of potential] price increase?

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Nigel P. Lingwood, Diploma PLC - Group Finance Director & Executive Director [5]

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Let me take that bit first. So absolutely, in the first quarter of the year, we saw price increases, I think we spoke about it in November, coming through in a lot of the Seals businesses. There were capacity constraints, suppliers were pushing some pretty big price increases through. As I said during the presentation, we -- it takes time to update all our pricing, getting into the catalogs, getting onto the e-commerce sites. We were probably a little slow in doing that. Most of them are now through. In fact, they're all through in our businesses in terms of product price increases. I believe we're now looking at some increases in freight rates, particularly with oil hitting what, $77 this morning. But we're going out to try to get some freight rates increases, which is important. With the aftermarket in the U.S., we collect a lot of income out of freight revenue recharged.

So, yes, the price increases are through. A lot of them went in the second quarter, either the beginning or mid-second quarter. The businesses tell me they're all banked and in the second half re-forecast, we'll see as we go through the year whether they put those in or not. But yes, they are through now. And it's really the Seals market. There's some price increases, perhaps, across the control markets. But it's the Seals where we're seeing a lot of pressure.

So your second question was on acquisitions. I think -- we have said before that we had a good pipeline of acquisitions. Some of them, I think, have been sellers looking to dispose of their businesses, but just not quite sure whether they want to go that far. And we spent a long time talking to them. And it's been frustrating for us, as we -- I remember sitting here last year thinking that these are coming through. And then keep being pushed back 3 months and 6 months. And certainly, Trump election pushed people back. The talk of tax cuts push people back. So we have seen quite a lot of delays. And this isn't just about pricing. Although, I -- obviously, anybody will sell at a price, but it isn't just pricing, it's just there were good markets to be had at the moment. And people are generally wanting to take another year before they do that.

I think what we're seeing more recently is there is some evidence that people are feeling that -- or some businesses are feeling that they have had that credit from the stronger trading conditions, and maybe their peak numbers. There is a little uncertainty looking out over 12 months about how strong the markets are going to be.

And with that background, they are coming forward, when we've also got some structured disposals coming forward. So that gives us confidence that they need to be sold. They're not really going to be delayed. They are going to be sold. And there were some nice businesses there, across the sectors and frankly, across the regions.

But we have got a reasonably good pipeline. And we are at different stages of looking at those acquisitions at the moment, which is why I think we are little bit more confident that some of those may come through than we were when we talked to you in November.

As I said earlier, I don't think pricing is really a driver. We're still seeing good -- remember, we are hunting in the private sector market. Family businesses. They still see good value at that 6x to 8.5x EBITDA multiple, and maybe at 6.5x, maybe at 7x. But we're not finding that it's the pricing that's stopping us getting there.

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Henry Carver, Peel Hunt LLP, Research Division - Analyst [6]

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Henry Carver from Peel Hunt. Just one in the Life Sciences businesses, that GPO restructuring that we're talking about. And that seems to be going on for [quite a while]. Have you got any steer as to how far we are through that? And I guess, once it's done, will it fundamentally change your sort of the end market as such or is it [an opportunity as well]?

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Nigel P. Lingwood, Diploma PLC - Group Finance Director & Executive Director [7]

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Yes, good question. I don't think it's going to -- I mean, we have to react and move with it. It started probably 3 years ago, you're right. And it's either being driven by the provinces themselves like Québec, we talked about, trying to just frustrate expenditure. They've got to the extent that only the minister of health could sign off expenditure over GBP 50,000 or something. They soon realized when the hospitals ground to a halt that, that just wasn't practical, so they have released it. But we are seeing a lot more professional procurement offices coming into that healthcare market.

And they are consolidating or amalgamating, either within the provinces or even across provinces. And we've had already experienced some of this in Australia where there is a high level of private sector involvement and there were more GPOs operating there.

So how long does it go on? One must hope that they are nearly coming to an end. There's a limit to how much they can keep doing this. But it is making it a more competitive, difficult environment to sell product into the hospitals. I go back 10 years and you go in and see the hospital, you see the surgeon, you see the diagnostic technician. That's who you're selling to. Now you have the huge frame contracts that you have to deliver on and meet all their conditions before they let you through the door to speak to the hospitals. So the opportunities are still there. But we just have to get more efficient at it and just more adept at working with it.

So it has changed over the last 10 years. But the opportunity is still in that medical markets, so I don't think it's going to impact us any further than it is at the moment.

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Richard Ingram, Diploma PLC - Former Director [8]

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I think to some extent that -- it does -- that situation, particularly in Canada, does help our market positioning in terms of securing our position in the value chain because it makes it even more unlikely that too many of the OEMs will want to go and bypass this. I mean, we manage a complex situation. We have good knowledge of it.

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Nigel P. Lingwood, Diploma PLC - Group Finance Director & Executive Director [9]

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Right. Any other questions? Good, okay. Well, thank you very much. Thank you for coming along today and listening to the presentation. And we look forward to seeing you again in 6 months time to tell you of more progress. So thanks, everyone.