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Edited Transcript of GUD.AX earnings conference call or presentation 26-Jul-19 1:00am GMT

Full Year 2019 GUD Holdings Ltd Earnings Presentation

Sunshine, Victoria Nov 21, 2019 (Thomson StreetEvents) -- Edited Transcript of GUD Holdings Ltd earnings conference call or presentation Friday, July 26, 2019 at 1:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Graeme Whickman

GUD Holdings Limited - CEO, MD & Director

* Martin A. Fraser

GUD Holdings Limited - CFO

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Conference Call Participants

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* James Ferrier

Wilsons Advisory and Stockbroking Limited, Research Division - Senior Industrial Analyst

* Jordan Rogers

UBS Investment Bank, Research Division - Director and Small Caps Research Analyst

* Matthew Nicholas

Crédit Suisse AG, Research Division - Director

* Ross Barrows

Citigroup Inc, Research Division - Former Head of Emerging Growth Research, Director & Emerging Growth Analyst

* Russell J. Gill

JP Morgan Chase & Co, Research Division - Head of Emerging Companies for Australia and New Zealand

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Presentation

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Operator [1]

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Welcome to the full year results of GUD Holdings for the year ended June 30, 2019. Your presenters today are Managing Director, Graeme Whickman; and Chief Financial Officer, Martin Fraser. (Operator Instructions)

I'll now hand the call over to you, Graeme. Please go ahead.

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [2]

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Well, thank you, Ashley, and welcome to our Earnings Call of the GUD Results for the 12 Months ended June '19. I'm Graeme Whickman, Managing Director. I'm here with Martin Fraser, the company's Chief Financial Officer.

As a matter of housekeeping, at the end of the call, we'll have time for questions and discussions. So if you wouldn't mind, please hold your questions until then. And a recording of this call will be, along with the presentation material, available on today's website on GUD.

Now I'll start the call by running through an overall summary of the group performance in '19 and then provide some commentary on both automotive and water businesses, and then I'll get Martin to cover some of the financial results in more detail. And then we'll finish with a brief strategy update and conclude with our outlook for the current financial year.

Okay. So let's turn to Slide 3 to the FY '19 highlights. The net profit from continuing operations up 18% to shy of $60 million. However, that's actually 13% when you adjust for a tax provision release. If you look at the underlying NPAT, it was up 10% to nearly $61 million. With the same tax provision release applied, that would be a 6% uplift. And that's on the back of revenue growth of 9%, both acquired and organic, taking our group revenue to $434 million. Our underlying EBIT was up 6% to just shy of $90 million, and our basic earnings per share grew by 18% to just shy of $0.70 per share.

Now on the latter part of the year, we did experience a confluence of economic and industry challenges, which constrained the larger automotive gains seen in previous years. Although robust growth was achieved, it was largely through our acquired businesses with a modest contribution from our continuing businesses.

Now Davey delivered single-digit revenue and EBIT growth in a market that was actually down, and they lift it 3%. Collectively, our cash conversion of 78% improved certainly from the half year result. That was around the 50% mark and was in line with our full year projection when we spoke last in January. And as I reflect on the key constituents of shareholders, employees and customers, I'm pleased to report on a number of positive outcomes in 2019, now starting with shareholders, and it's pleasing to be able to deliver a final dividend payment of $0.31 per share, fully franked, and that's up 11%, with a full year at $0.56 per share, which is a record-high cps for us and up 8% versus last year.

Moving to employees. We're heartened by our employee-level engagement, and we remain diligent on the safety of our employees with more work always to be done. There was a slight increase in our total recordable injury frequency rate, but we also note that our lost time injury rate is actually half, which is a positive measure, half of the Safe Work Australia benchmark norms. And then finally, to our last constituents, the customers, who have kindly recognized our respective businesses, superior suppliers in the numerous awards, which we've detailed through the deck.

Now apologies, we have to refile the deck shortly -- a short while ago with a corrected slide, which is Slide #4, I'm going to take you there. Taking a closer look at the auto segment results on Slide 4, the revenue increased by 12% to $330 million and the majority of that coming from our acquired businesses and 1% from our organic. Full year, we did see some customer house brand impact in lost revenue, and we saw certainly a slowing down in Q4 where we had a sharp fall versus the prior year. The underlying EBIT increased by $4.5 million or 5%, and the corresponding margin came off by 160 basis points. You don't see that actually on the slide, we round there, it was actually 28.1 down to 26.5, so about 160 basis points. And about 2/3 of that was a dilution impact from the acquisition businesses and about 1/3 from COGS inflation and other expenses. We do, however, see scope over time to regain margin through some operational efficiencies and scale and integration, which I'll talk about a little later on.

Now moving to the next slide, turning down a little bit further. We're looking at automotive here, operating performance half-over-half because the year was actually about 2 halves of sorts of quite a strong story there in terms of the second versus the first half. Now auto underlying EBIT was up to $87.4 million, as mentioned, and it's 5%. And the total split on the slide between existing and acquisition, and the acquisition is DBA, 12 months, and also 5 months' worth of AAG.

Now looking at H2, the total revenue dropped over H1 by 3%, and the underlying EBIT down by 1% organic and 3% acquisition, totaling a $1.4 million drop. Speaking although a little bit more broadly, if we looked at our more established businesses, we saw filtration businesses deliver about a 4% revenue growth, and it was BWI's revenue which was flat. Now we had strong expectations, as mentioned, at the half year for the BWI business, particularly around the Narva catalog. And the first and total response was positive, but the sales, we achieved were really quite strongly impacted by a number of our key resellers wanting to reduce their inventory significantly, in fact, deliberately taking many days supply of inventory out of their DCs. Now as discussed, at the H1 juncture, we had planned and have implemented price rises with the exception of Ryco from April through to August.

Now on Slide 6, we start to move through just a quick snapshot of each business. I won't take too much time here. As mentioned, Ryco delivered some revenue growth. And that's in heavy-duty sales up markedly, which is positive. The team kept the workshop conquest tempo at our desired rate, and they started to push really hard and lean into an incremental marketing and sales defense plan so mitigating the new entrants into the filtration space.

Wesfil again delivered revenue growth in filters but also some other products: wipers, spark plugs, cleaning products and the like, which quietly launched with good success. And they were proud to be recognized by the AUTO ONE Group in terms of an award and also the new Sydney location that is proving productive.

Now IM Group are showing some positive signs with Goss via Wesfil distributing to independent resellers. But we have to recognize that, that was a headwind, and we'll continue to try to work through that. They have been able to implement strong pricing, and they do have a profit improvement plan underway.

Now on the next slide, we talk about BWI first off. So they lost business to some house brand activity. Their performance was flat. And the story really was around not enough traction in the Narva catalog and I think largely due to the cautious sort of inventory requirements of their customers. They did gain an important distributorship, Phillips, and some great awards, particularly OE, in terms of Supplier of the Year, as you can see on the screen, for PACCAR and Kenworth.

Now if I split a couple of slides forward to acquisitions, which is Slide #8, and just talk a little more about the acquisitions. So at the half year, we spoke about AAG, let's start there, an agreement made with Bapcor, which ultimately leaves us in the long run with a dominant market share. They continue to push out new product SKUs, and we started to confront the challenges in that business. We've had to recently announce some business restructuring to our employees and some other stakeholders. However, we do see a strong future position for AAG, as I mentioned, a pretty dominant market share given the acquisition of Pro-Torque brand as well. And I think that will drive an enviable market share, but the hard work does need to necessarily be invested.

In terms of DBA, they've proven to go from strength to strength. Export to the very customers -- sorry, countries, now constitutes actually more than 1/4 of their entire business. And we were quite thankful that the AAAA gave them the Silver Award for exporter of the year. So the performance of DBA was ahead of our expectation.

Now as we sort of pivot into just a reminder of the industry we're working in. So the product portfolio for us, first in terms of ICE and all-vehicle types, we saw the same trend for us versus 2018, and now we are approaching 60% unrelated to internal combustion engines. But of course, this will ebb and flow as we acquire businesses. It shouldn't be interpreted that GUD will not look at businesses that are ICE-related, but we see positivity on both elements or segments of the market.

Now Slide 10's graph talks about the car parc, and that's when I start to pivot into the industry. And so the Australian car parc remains substantive, over 15 million vehicles in the space where GUD plays, and it has a changing composition, which leads to the next slide. And you can see the continuing shift within the car parc. SUVs overtake passenger vehicles and pickups continue their rise, both of which are really useful trends when you have businesses like DBA and BWI. We have strong product offerings that really do suit that trend and that change in the composition.

Now on Slide 12, you'll get a snapshot of the brands in the GUD stable, just a reminder. And again, sort of stand back and reflect on the previous slides, you'll realize that the car parc is of a significant size and wonderfully complex, which is great for us. We have momentum of product creation and innovation. We'll look to leverage our strong customer relationships, and I'll talk about those a little bit more later on. And we're going to keep acquiring businesses. And that combination sees those varying brands really well positioned to sustain returns for us and our shareholders in the medium to long term.

Now moving to the automotive outlook on Slide 13. It's fair to say we've seen some challenging trading conditions. In the new financial year, there are a number of variables, such as domestic inflation, careful pricing strategy considerations and investment and defending our strong position, particularly in filtration, which results in a year of consolidation and modest EBIT growth. Now importantly, we recently agreed multiyear preferred supplier agreements on select auto categories with 2 of our 3 major customers, and that really is important. That provides us a wonderful opportunity to further cement our place and value with those customers in those years ahead.

As we look to the medium and long term, we firmly believe that GUD remains well positioned to deliver growth, leveraging those preferred supplier statuses, working in new channels, pushing for increased operation -- operating efficiencies and actually really working hard on the value-add acquisitions will all combine in service of those growth aspirations.

Okay. Let's transition to Davey on Slide 14. So Davey improved their revenue, up $104 million, 2 -- sorry, $104 million, up 3%, and the underlying EBIT increased at the same rate of 3%. The revenue increase was seen across all the regions they operate in. And the revenue was about -- without actually any pricing, so meaning that increase came in unit sales just as they put aside Davey just to put pricing into the market of 3% from July 1. That's the first time they've been able to do that in a few years. Now the team launched the new Nipper chlorinator, and that sold out its entire European inventory allocation. Davey also continued to work on its strategy and made tough decisions like outsourcing its fire fighter product with some resulting one-off costs.

On Slide 15, we give you the equivalent sort of water snapshot as we've done with the automotive. And you can see that much of the water treatment started to gain traction and started to generate revenue through paid trials with some of the big New Zealand and Aussie players in the dairy farming sector. And as mentioned, the Nipper product kicked off well, and the team also launched the Tank Sense product. Interesting, we're now seeing adjacent areas for modular water treatment, and we're now pitching for business in hotel resorts who need potable water and medical institutions who need certain levels of water sterilization.

So the Davey outlook is seen on Slide 16. And the teams really are starting to find their seat as they execute the midterm strategy, and innovation is showing some green shoots. There are 4 key strategy planks for Davey, and we will take the opportunity when we have an Investor Day in October, October 1, to take you through in much more detail the Davey strategy, in fact, at the Davey location. But their 4 strategy planks are around design for manufacture; supply optimization, so supply chain optimization; how they look at the channels to market; and then commercializing innovation. And all of that is underpinned by quite a large transformation in both people and culture of Davey. So we do expect to see the early fruits of their efforts in the new financial year.

Okay. All right. Well, I'd like to now transition and hand over to Martin for just a little bit more of a deeper look at the financial information. Martin?

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Martin A. Fraser, GUD Holdings Limited - CFO [3]

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Thanks, Graeme, and good morning, ladies and gentlemen. I'm Martin Fraser, GUD's Chief Financial Officer, and it's my pleasure today to take you through the financial results.

I'll start on Page 18, which contains the key profit and loss measures for the group. During FY '19, full year revenue grew by 9%, and reported EBIT increased by 13% as the level of one-off cost was well below the prior year. This year, we reported one-off costs of $1.8 million, and these were driven by Davey with $800,000 mainly related to the outsourcing of the fire fighter unit manufacture and $1 million in onerous lease and relocation cost accruals in automotive through a committed move in FY '20 to a single distribution center in Auckland. Once excluded, underlying EBIT grew by 6%.

At the net profit level, net profit after tax from continuing operations was up 18% or 13% if the one-off tax provision write-back is excluded. As we saw in Slide 2, the underlying NPAT grew by 10% over the prior year's result or 6% if the one-off tax provision write-back is excluded. The final dividend of $0.31 per share was declared, up 11% on the prior year's final dividend, bringing the full year to $0.56, which is 8% up from the prior year and, as Graeme said, represents an 80% payout ratio.

I'll step over to Slide 19 as I've already spoken to the nonoperating items and move to Page 20. And here, we can see -- sorry, here, we can see the net working capital moved down slightly from the result reported at the half year, which is consistent with internal targets for the second half. Nonetheless, year-on-year working capital increased by $30.4 million, at which just under $8 million was acquisition-related for DBA. Of the balance, the main drivers were inventory, which went up by $14 million; and receivables, which went up by $6 million.

Now looking a bit deeper just in regards to stock increase. Approximately $2 million was associated with what I'd call transitional or final make fire fighter inventory for risk management as we move to outsourcing that item. $7 million of the increase was to support new product introductions and approximately $5 million represented general stocks above desired levels due to slower FY '19 sales than we anticipated when the stock purchase and commitments were made. The receivable increase reflects revenue growth; some of Davey's project sales in the modular water treatment area, which have slightly longer payment terms; and some general trade -- terms of trade revisions.

Turning to free cash flow. The tax payments were higher than the income tax expense as we made a final top-up tax payment in respect of the FY '19 year, which was higher than the previous year, and stepped into some installments for DBA as they came into a tax group. In the prior year, we received one-off capital gains and income tax adjustments from the -- or refunds from discontinued operations, which also speaks to the year-on-year delta.

Turning to Page 21. To the right, we show our pretax cash conversion measure. At the half year, and Graeme said this before, the measures stood just over 50%, and we expressed the desire to finish the year approaching 80%, and we finished at 78%. That said, net working capital, and especially inventory optimization initiatives, will remain a priority into this year, but we will be willing and/or continue to be willing to invest in net working capital for product launches or extended terms of trade for compelling supply agreements. And finally, the full year dividend lifted to $0.56 per share, up 8%.

Now I'd like to take us to Page 22, which talks principally to our net debt position. Our net debt increased by $40.4 million over the prior year. And $22.8 million of that related to acquisitions, most of it being DBA and with the small earn-out payment of $1.6 million triggered by IMG's FY '18 performance. Our net working capital increases drove the remainder. Notwithstanding, the gearing remains a modest 32%, and debt metrics remain strong. Our unused banking facilities are in excess of $90 million (sic) [$80 million]. And even considering funding for seasonal net working capital piece, we sustained unused banking facilities well in excess of $80 million to support logical acquisitions. Our current banking facilities expire in July 2020, and we expect to renew the facilities in the first half of FY '20 on commercially favorable terms.

I'd now like to take you to this final slide, which I will present today, which speaks to changes in accounting standards. In the current financial year, we applied AASB15, which addresses revenue recognition. This has seen customer-related expenditure, representing about 0.4% of our sales, move from marketing expenses to be deducted from revenue, so not an overly material change. We did not restate the prior year. In the coming year, we'll adopt AASB16, which addresses leases. This will require our financial statements to reflect, commencing 1st July, both lease assets and lease liabilities. The initial take-up of those assets and liabilities is expected to be $88.2 million for both items. As you can see from the total to the right, during FY '20, lease payments will be replaced with amortization of leased assets and financing costs. We estimate that in FY '20, the result will be EBITDA will increase on a like-for-like basis by $11 million; EBIT will increase by $0.9 million; interest by $3.5 million; and hence, profit before tax will reduce by $2.6 million.

I will now hand you back to Graeme who will take you through the group strategy and then the outlook. Thank you, Graeme.

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [4]

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Okay. Thanks, Martin. Now before we talk specifically around the group strategy update, I wanted to give you a bit more clarity about the group structure. As the year progressed, the structure of the group changed, some by design and some as opportunities arose. Now we took the opportunity to appoint a dedicated acquisition resource, a key management person, from April onwards. And we're fortunate that Bob Pattison has taken this role. We also took the opportunity to flatten the structure somewhat by having each of the business leaders report directly to my role. And with the resignation of the RYCO Group CEO, this will mean that we have a flatter structure and honestly, we get closer to our customers.

Now in Slide 26. Earlier in my tenure, I set out to work on some business foundations, and those were mentioned at the AGM at the half year. I took the opportunity to look at that while we were attending to the business strategy. And I suggested we needed to concentrate on 5 key areas of the business foundation, and they're on the sort of screen as you see it now.

As it stands today, we've included -- and if I click through quickly on each of those. Customer relationships, we've recently agreed to multiyear preferred supplier agreements across some really important automotive categories with 2 of our 3 most critical automotive reseller groups, and that should secure considerable revenue streams for the next 3 years. We've also deepened our relationships with OE companies like Toyota and PACCAR. And in some other businesses, we've been able to secure new customers and channels in select export markets.

From a supplier engagement point of view, we worked importantly with a number of our critical suppliers to confirmed sourcing security. I've spoken in prior presentations around the need to ensure that we don't get deprioritized with the large Chinese aftermarket tidal wave. And we've been able to do that, which is very positive and also, at the same time, started to defray some of our currency impacts. We're also cooperating with a major China-based supplier who's now building a new factory in Vietnam to ensure supply capacity and also helps us from a geo point of view in terms of sourcing.

From a people cycle planning point of view, I've talked quite repeatedly about the need to develop future leaders for the current businesses and our future acquisitions. And the early results were evident. We've been reallocating resource, such as the first leader of automotive acquisition and strategy. We reallocated and appointed our first group logistics manager. You've heard in the past around our appointment of the first Chief People Officer, and we've promoted the former innovation officer to run Ryco Filters and, at the elevation of the leaders of Ryco Filters, IM Group, AA Gaskets and DBA to report directly to my role. So the number of key management personnel has actually reduced, but the executive leadership team has been expanded. I really want to harvest the strength of that leadership team.

From a product cycle point of view, so we complemented the existing innovation focus with sort of a broader engagement on the renewal and broadening of existing products. And we've seen some new products come through, pretty exciting, such as Davey's Tank Sense, which monitors water levels remotely, and Ryco's Catch Can. Finally, on product planning, we've been fortunate to have a reflection of our innovation pipeline acknowledged by the 2 government grants on innovation, and that sits at both DBA and BWI.

And then finally on the slide, operational efficiency, and that's a pretty important element for us. In light of an ever-demanding competitive and customer landscape, the need for increased operational efficiencies are certainly clear. We need to leverage the wider GUD group of businesses and get the potential to achieve the cost savings through that leverage of greater commonality and scale. And we've reallocated and appointed a key finance and operational leader in support of the operational efficiency task force, as I like to call it, and further business transformation projects.

Right. Slide 27, please, Martin. So looking from a strategic review point of view, so the Board and management have been engaged in a portfolio and individual business unit strategy review in the second half of the year, including an overseas study tour to better understand the innovation approach applied by other companies and better understand the potential commercial application of our technologies in both water and automotive. And the review concluded that we remain comfortable with the current business portfolio, and we remain willing to make logical automotive acquisitions. Now the business units specifically continue to apply the GUD high-performance approach. But in 2019, we've introduced the Roger Martin where to play and how to win framework to guide strategic development, and we're working with the Ignition Institute to embed the associated strategy framework and tools and approach in the businesses. This is critical as we reinforce the need to sort of future proof our individual business units.

Now on an earlier slide, I spoke about my view on strengthening the 5 business foundations. And as this gains traction and as part of the review just mentioned, we are also committed to sharpening our strategic direction, which is detailed in the next slide. As you can see, the 3 pillars. So the core, which is GUD wide initiatives; the growth, which is at an individual business unit level; and then acquisition, which is around portfolio and category plans.

Now if I sort of tip through each of these quickly. From a core, pulling the progress to date, so the quality and logistic councils have been introduced to leverage scale and skills. We've put internal management resources, and they've been pivoted to address operational and leverage efficiencies in the likes of logistics and information technology. We've increased the emphasis on supplier cost downs, and we even have the first start of that sort of combined GUD approach with a distribution center in Auckland.

From a growth point of view, so the individual business units' competitive strategies are a work in process. They're centered on levers of growth. We're looking at addressing new organic growth pathways, including a broader focus on exports. And we're strengthening our resources around innovation in support of that with our Chief Innovation Officer. And then finally of those 3 core pillars, acquisition. So we are applying a slightly refined acquisition criteria and decision thresholds, making sure that returns are above the cost of capital beyond the initial integration. And as I already have mentioned, we're increasing the automotive acquisition and strategy capacity under the leadership of now a dedicated acquisition and strategy key management person.

So we believe these key pillars really do provide a great level of opportunity for further top and bottom line growth. These are not overnight solutions and require a steady and thoughtful approach across the next 12 to 36 months. We've also done this in a cost-effective manner with a lot of speed around reallocating resource and utilizing cost-efficient internal and external expertise.

So I'll just move now to the final slide. Thank you. So from an outlook point of view, well, certainly GUD remains well positioned for the medium- to long-term horizon. The automotive division maintains strong brands, products and customer service in support of a large and proliferated car parc, which GUD believes is really strongly defensible. We're also pleased with the recent multiyear preferred supplier agreements, and we'll work hard to provide strong partnership outcomes as we move forward.

Now in 2019-'20, we expect further revenue growth in both the automotive and water businesses, although economic sentiment and recent demand suggest growth will be modest. We're not, however, going to reduce our innovation or new product development or acquisition activity to compensate as we remain committed to ensure we have the right midterm foundations in place for long-term growth and shareholder value. Therefore, in this environment, we expect modest underlying EBIT growth in 2019 to '20 and continuing solid returns to the shareholders. And of course, we look forward to spending more time with the investment community at our Investor Day planned for the 1st of October 2019.

Okay. Well, that concludes the presentation results. I'll now hand you over to Ashley who will coordinate any questions you may have. Over to you, Ashley.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Matthew Nicholas, Crédit Suisse.

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Matthew Nicholas, Crédit Suisse AG, Research Division - Director [2]

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Just in terms of the competitive aspect on Ryco, in particular, can we firstly just get a bit of color? If you look at that auto business in totality, how much of that right now do you think is exposed to the competitive tension that's coming in? Is it across all of Ryco? And if it is, how much would you say Ryco accounts for overall auto revenue and EBIT?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [3]

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Well, look, we don't normally and traditionally break out the individual business units. We've given you a little more flavor today, by the way, meant to try to give you a sense of the results. Look -- and again, without naming specific competitors, we're aware that there'll be global competitors that will come and have come in the past. We've seen them often in the past, without naming that particular competitor, and we're very well aware that there's one currently in the market. Having said that though, I mean they are going to have to overcome 76 or so dedicated employees who eat, sleep and breathe filtration in this market with a SKU range that is unrivaled, strong, strong brand strength and years of experience. That doesn't mean though, of course, that we're arrogant nor are we sticking our heads in the sand. And frankly, that's why I made a point a little earlier on around our strong marketing and sales defense plan in support of making sure that we do what we have done in the past and seen all manner of different competition.

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Matthew Nicholas, Crédit Suisse AG, Research Division - Director [4]

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All right. And just in terms of, which I'm sure you've gone through this exercise, just the initial feedback out of customers because it's been a category that hasn't had a huge amount of competition by your own admission, by your own success over the years, just in terms of what the customer take-up looks like and the satisfaction on the mechanic end.

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [5]

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Look, I'll talk about 2 sets of customers: firstly, our direct customers. We're seeing limited take-up. We saw growth at our revenue level, as I just mentioned, through last year in both our filtration businesses. It shouldn't be dismissed obviously that we have reached agreements with both of our really important customers. We have many important customers obviously, but 2 of our bigger customers, and that includes filtration. And we expect, therefore, an ongoing performance in terms of sales revenue with those customers.

And then I'll talk to the second set of customers being the end users, so the customers of our customers. And we track regularly and quite specifically their views of not just the brand but also the product performance and the level of work we do there, the visitations with those workshops, as you know, many thousands, over 20,000, to ensure that we really do make sure they're aware and completely understanding of just how good the Ryco product is, so best part of that push and pull strategy we've spoken of in the past.

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Matthew Nicholas, Crédit Suisse AG, Research Division - Director [6]

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And those agreements that you alluded to on the call that you've done with 2 of your major 3 customers, presumably price is an aspect there. Is that a headwind on margins heading into FY '20 and beyond?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [7]

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Look, it's never useful to talk about commercial terms at that level of specificity. We expect a decent return from our filtration businesses, which is useful both for our customer but also useful for us.

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Matthew Nicholas, Crédit Suisse AG, Research Division - Director [8]

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Okay. And just the last one from me, just on M&A. I suppose given what's going on in the filtration business by some of the challenges you've got within the portfolio given various acquisitions over the last couple of years, has the appetite for large-scale M&A waned from any respect? Is there a sense now that you should be focusing on the existing business? Or given where the balance sheet is, are you guys still comfortable on deploying capital over the next 6 months?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [9]

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No, we're still very comfortable on the deployment of capital. We look at all manner of acquisitions, whether it be bolt-on or more significant, and have been over the last 6-or-so months. We will pursue acquisitions. I need to say this very clearly, we need to pursue acquisitions that are logical for us and that we have a stronger view of the integration and we can see potential of either margin uplift or decent margin outcomes that helps us strategically as we bolster the overall portfolio. There are a number of categories we do not operate in across our businesses in terms of automotive. I'm talking about categories of either parts or, in some cases, soft parts, but we are looking at it, and we'll continue to look at it. The biggest challenge for us, frankly, as I've said in the past, is not about funding, it's not about the number of potential opportunities and it's not about our appetite, it's just simply timing, Matt.

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Operator [10]

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Your next question comes from Russell Gill, JPMorgan.

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Russell J. Gill, JP Morgan Chase & Co, Research Division - Head of Emerging Companies for Australia and New Zealand [11]

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Just following on from the initial question on your -- I guess your growth sales line in your automotive business. The organic number was at plus 1%. I just want to get a feel for how that's growing, I guess, relative to your own customers. You did call out that BWI was impacted by some home brands switching and the like. You have also indicated this sort of poor economic sentiment at the moment, but I just want to get a feel for, I guess, market share that you're seeing, I guess, from the sales perspective across your brands relative to competition and whether the sales number of plus 1% is a market share issue or whether it's a shift in inventory around in the channel.

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [12]

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Okay. Thanks for your question, Russell. Look, you know it's very hard to be very specific around market shares. There's no quantifiable or empirical information that you can point to. So therefore, you have to triangulate through a number of things. Parking house brand activity, and I'll come back to that in a second, parking there, I don't think at the moment that we're sitting there losing any significant market share. I think the demand certainly in Q4, and that really speaks to BWI more than anything, but in Q4, we did see a sharp drop. And whilst the likes of BWI had some pretty stiff year-over-year comps, I mean we were -- both May and June last year were record months for BWI in their history. We just didn't see it pull through. We felt that, that was, in large part, because of the reseller inventory positions, but we're not sitting here looking at hypothesizing around market share degradation.

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Russell J. Gill, JP Morgan Chase & Co, Research Division - Head of Emerging Companies for Australia and New Zealand [13]

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Okay. And then if we can unpark home brand for a minute, can you talk through the dynamics and the different categories? You said BWI in the commodity area. Across the rest of your portfolio, where would you deem other commodity areas where home brand penetration could impact you a bit more?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [14]

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Look, we saw the home brand -- that wasn't just BWI, it was a bit of IMG. As you might remember, we saw Goss brand derange. But the home brands, we talked about $4-or-so million on the deck, was primarily between BWI and IMG. The commodities we're talking about are things like potentially cable ties or fuses or those sorts of things. And largely, our business is made up of higher revenue and, I would say, more defendable product lines than simply those. I don't think that there's a huge quantity if I were to look at our exposure of our product profile that is home brand-able in each case.

I would say that some of our customers are now having conversations with us around whether the home brand outcome is useful for them, whether they can actually continue to manage it in the way that we could in the past. And we have seen this, and certainly historically the team here have seen this, where one of our major customers went down a home brand path many years ago, and they probably settled at a certain point where they're comfortable. And we probably see that as the floor, so to speak. And yet, we grow with that particular customer year on year on year. So I'm not seeing a home brand crisis or something of that nature. And where we lose some products to home brands, we may well be the provider of that home brand. At the same time, the individual business unit strategies around levers of growth, we'll be looking for new products to push into our customers and also potentially in different geographies.

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Russell J. Gill, JP Morgan Chase & Co, Research Division - Head of Emerging Companies for Australia and New Zealand [15]

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And just on the revenue, the implementation of AASB15 has basically, I guess, forced you to separately spread out rebates. If you analyze those rebates year-on-year, it does look like the rebate level has gone up from 8% of growth to 10% in the automotive division. How much of it -- I guess there's obviously an acquisition that comes in and can move those things around. How much of that rebate increase relative to your gross revenue is acquisition as opposed to actually what's going on in the marketplace?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [16]

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Yes, I would say, without talking specifically in terms of the configuration, yes, there is a little bit of acquisition there. But a good portion of that is customer rebates directly to our major customers.

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Russell J. Gill, JP Morgan Chase & Co, Research Division - Head of Emerging Companies for Australia and New Zealand [17]

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So are you seeing an increased level of -- effectively, year-on-year, there has been an increasing level of rebates. Do you expect that to increase further in FY '20 as a proportion of gross revenue?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [18]

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Well, again, it's a little bit commercially sensitive. Having said that though, we saw growth with those same customers. So the growth -- and I won't talk individual businesses, but the growth that we achieve is often tied to the rebate we pay. And so there is a relationship around risk and reward. The multiyear agreements we have agreed, in some cases, there will be elements of those commercial terms that will be advantageous to both parties, but we're doing it again with an expectation of certain growth outcomes as well.

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Russell J. Gill, JP Morgan Chase & Co, Research Division - Head of Emerging Companies for Australia and New Zealand [19]

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Okay. Great. And 2 final questions. Just on your auto margins, it seems to have sort of hobbled around this 26.5% first half and then into the second half. Prior to your time, the previous management sort of guided the market over the medium term to a high 20s, almost 30% margin in the automotive division. There have been acquisitions. And now there hasn't been an acquisition for almost 12 months now. How should we be thinking about, I guess, the medium-term trajectory for margins in this business? I'm happy for you to leave that to October if that's a better time. I just want to get a feel for whether the high 20s to 30% number remains or whether they're -- it's a different focus for the business going forward.

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [20]

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I'd love to carry that conversation over to October when we have a bit more time and actually we can be a bit more finite and also a little more sophisticated in our response. I mean just on a broad level, yes, the margin year-over-year is down. As I said a little earlier on, 2/3 of that is through dilution at the end of the day. It's not to say that the businesses are having to expand significantly more on a per product basis. We will expect though the margin to, I guess, sort of go up and down in given years given the product profile and the composition of our sales and then obviously the mix within that. So there are a number of factors affecting that, Russell, but we can talk more when we are face to face. Martin?

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Martin A. Fraser, GUD Holdings Limited - CFO [21]

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I'll just add to that. Graeme was talking about 2/3 of dilution. Just to be clear, that's really dilution because of the new businesses, which trade in much lower margin, 1/3 of it in our existing businesses. And that's largely a mix between Brown & Watson, Wesfil and Ryco and how they were moving. So if you strip it back to margins as individual businesses reported, they're all quite robust. But as we saw, Wesfil and Ryco outsold BWI.

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Russell J. Gill, JP Morgan Chase & Co, Research Division - Head of Emerging Companies for Australia and New Zealand [22]

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And just very final question, just on your cash flow conversion. Appreciate the big swings around abouts and you obviously were a bit disappointed in the take-up of the catalog in the second half. You're targeting 80% cash flow conversion in FY '20, which is the same as FY '19. Prior years, you've been closer to, I mean, even over 90%. Is 80% the new norm for you guys? I want to get a feel for what the ongoing capital intensity in your business model actually is from a working capital perspective. Is 80% the new number going forward that we should be thinking about your business model? Or is it just a timing issue which extends into FY '20?

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Martin A. Fraser, GUD Holdings Limited - CFO [23]

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Yes, sure. And I'd like to think it's the latter that we will return in time towards that 90%. But just don't want to box myself into that for this year, so we don't end up making dumb decisions which has impacts on revenue given that we could have more products that we want to bring into the market. We did a pretty clear shout out there saying 5 million stock is just an overshoot; we'll be working on that. But there's other products we want to bring to market and we -- I just want to be a little bit cautious, not creating expectation. We don't think we'll have actually going to compromise revenue and EBIT and long -- midterm growth so just to convert -- caution for this year.

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Operator [24]

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Your next question comes from Ross Barrows, Citigroup.

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Ross Barrows, Citigroup Inc, Research Division - Former Head of Emerging Growth Research, Director & Emerging Growth Analyst [25]

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Just 3 questions from me. Just picking up on the house brand comment earlier, you mentioned that materials is around a $4 million impact over the year. Was that an even impact throughout the year? Or was it more skewed to the second half or even into the fourth quarter?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [26]

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It was more the second half although the likes of Goss was more longer term in terms of the full year, but it was more back-end as we went through.

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Ross Barrows, Citigroup Inc, Research Division - Former Head of Emerging Growth Research, Director & Emerging Growth Analyst [27]

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Yes, and the other question around M&A. In the material, it does mention a revised acquisition strategy and criteria. Could you just elaborate a little bit on some of the changes that you may have made to the strategy?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [28]

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Yes, sure. So back in December and some of that January it was, we took the Board through our lessons learned on the last few acquisitions, at the last 5 acquisitions. Some of those more historic. So we had more trend information, but we basically took them through that and ourselves to ensure that we are a learning organization. And we found that perhaps we could augment our criteria a little bit more with a view around how do we look at acquisitions from a future proofing point of view, what is the margin uplift more definitively through integration and finally the capacity optimization of those businesses, not financial, I'm talking more operational. Those were the 3 things that flowed through. It was not a criteria change in terms of automotive to something else or some sort of confining or a restricting set of criteria. It was just more a refinement.

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Martin A. Fraser, GUD Holdings Limited - CFO [29]

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Yes, so just to add that, so really, as we step through and make those changes after acquisition that we're perhaps also a little bit more premeditated with talking about those at the same time we announced the acquisition.

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Ross Barrows, Citigroup Inc, Research Division - Former Head of Emerging Growth Research, Director & Emerging Growth Analyst [30]

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Great. Actually, just one other quick one on Ryco. You mentioned that sales were up 4%, but heavy-duty was up 23%. Could you just remind us how big the heavy-duty segment is within Ryco or asked a different way, what sales would have been without the heavy-duty component?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [31]

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Again, that's very commercially sensitive because we have aspirations in that area. I'm sort of loath to divulge that kind of information not because I want to be mysterious, it's just that there's a competitive opportunity there. And I don't really want to communicate where it sits in our portfolio as a percentage. I'm sorry to be evasive.

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Operator [32]

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Your next question comes from Jordan Rogers, UBS.

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Jordan Rogers, UBS Investment Bank, Research Division - Director and Small Caps Research Analyst [33]

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Just the first question is around that, I think, $4.2 million FX gain in the notes. Could you just talk through that? Is that going to be a headwind heading all into FY '20? Or have you -- is that -- did that align with when your price increases have come through?

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Martin A. Fraser, GUD Holdings Limited - CFO [34]

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Yes, well, really, that was the recognition that the gain on the hedges that we bought back when that was 76% and then working through. And most of that was stepped down from 76% to now, for this year, around 71.5%, just to be very clear. A lot of that step-down was starting around about May. And some of the -- the first price increases were -- got away in April, which is DBA, and the remainder was during -- from May through to August 1. So that sort of gives you an idea where we're stepping down. And that $4.5 million would work through in terms of the hedge accounting in terms of our COGS. So I think the relevant issue is just the step-down between what our average FX was last year versus what it's going to be this year, Jordan.

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Jordan Rogers, UBS Investment Bank, Research Division - Director and Small Caps Research Analyst [35]

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Yes, yes. No, that's understood. And then just another clarification around the guidance. You talked to EBIT growth. Are you -- is that excluding, though, sort of $1 million EBIT gain you've got on AASB16? Or is that sort of a like-for-like?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [36]

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A like-for-like.

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Martin A. Fraser, GUD Holdings Limited - CFO [37]

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Yes, so excluding the gain. So we're talking -- so you can look at this year's and say, "Are we going to step ahead of this year before any accounting changes?" That's the nature of that statement.

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Jordan Rogers, UBS Investment Bank, Research Division - Director and Small Caps Research Analyst [38]

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Okay. And so...

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Martin A. Fraser, GUD Holdings Limited - CFO [39]

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We then have to overlay obviously the AASB16 impact on top of that.

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Jordan Rogers, UBS Investment Bank, Research Division - Director and Small Caps Research Analyst [40]

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Yes, yes. So you've got, I think, about a $2.5 million you're saying there a headwind at the PBT line.

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Martin A. Fraser, GUD Holdings Limited - CFO [41]

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Profit before tax, yes. And that's because of a sort of actuarial approach on the amortization, on the financing cost more particularly. Amortization is straight line, but the financing reflects the balance sheet load.

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Jordan Rogers, UBS Investment Bank, Research Division - Director and Small Caps Research Analyst [42]

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Yes, yes, that's understood. I'm just checking that it's the PBT line, sort of making a comment on PBT for this year versus next including the AASB16.

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Martin A. Fraser, GUD Holdings Limited - CFO [43]

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Correct.

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Jordan Rogers, UBS Investment Bank, Research Division - Director and Small Caps Research Analyst [44]

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Okay. Just another question around your comments around the week of full ordering due to your major customers pulling some data out of their supply chain. Do you think -- is there a reason this is a sort of recurring feature given the pretty big plans some of your major customers have on warehouse rationalization over the next 5 years?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [45]

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So that is a pretty hard answer to give because it's on behalf of our customers. And clearly, we wouldn't do that. I would -- what I would venture a point of view is that I don't think we saw the same inventory contraction in the same period last year. In fact, in some cases, yes, we saw the reversal as customers were working hard to hit certain loyalty levels and trigger certain things in their commercial agreement. That's not to say and again, as a management team, we're not simply sitting here thinking that it's going to rain pennies from heaven and expect that the entry positions from our customers simply returns. The view of plan for the worst and hope for the best applies here. That's why we're looking at our inventory very carefully. That's why we're looking at a more broader level at operational efficiencies to make sure that any potential headwinds that come towards us, we're not sort of sitting here on our hands and wishing them to go away.

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Jordan Rogers, UBS Investment Bank, Research Division - Director and Small Caps Research Analyst [46]

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Yes, okay. And then just around, sorry another quick one on the numbers. The -- where do you -- where are you expecting the tax rate to -- you mentioned it might step up for '20, but is it normalized around the sort of 28% mark?

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Martin A. Fraser, GUD Holdings Limited - CFO [47]

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Yes, depending on what the government ultimately does on R&D incentives. But yes, around that level. I think you can take this year as perhaps at the expense level as a bit of a guide.

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Jordan Rogers, UBS Investment Bank, Research Division - Director and Small Caps Research Analyst [48]

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Okay. Yes, sure. And then just last one from me. You talked a fair bit around the changes to your acquisition team. Can you talk just in the last -- since your last acquisition a little over 12 months ago, has there been a material change in vendor pricing expectations?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [49]

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No, No, not on smaller bolt-ons that we've been speaking to. Really, the only thing that has perhaps slowed us down has been the expectations with timing. With a dedicated resource now since earlier on in April with Bob, we expect to accelerate in terms of really working through the opportunities. That allows us to be more efficient with our time, but it still requires a vendor on the other side to one day be ready to sell, the next day not and then the next day after that still be ready to sell. So there's a complexion there that we always face. But the vendor expectations, as we've seen them, no, they haven't.

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Martin A. Fraser, GUD Holdings Limited - CFO [50]

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I'd add one thing there. We get offered a lot of assets that we don't go ahead with. So we get various points to triangulate market price expectations. I mean obviously, lower interest rates and a lot of hunger, all indications are that private equity will pay more than they used to or that they would've paid this time last year. But generally speaking, they're not assets that are compelling for us.

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Operator [51]

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(Operator Instructions) Your next question comes from James Ferrier, Wilsons.

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James Ferrier, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Industrial Analyst [52]

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Just the first question around the inventory and the destocking from your customers. I think Martin, you mentioned the figure of $5 million of inventory. Was that primarily in BWI? Or did you see some destocking activity in the filtration part of the business as well?

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Martin A. Fraser, GUD Holdings Limited - CFO [53]

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I'll just look up my notes, give me 2 seconds to look at my notes. No, it was across a few of the automotive businesses. I wouldn't want to -- I think it would be misleading to call out one above the other. But not so much -- we're still really more Brown & Watson, Ryco and some of the other ones that sold to the big majors because Wesfil sells the half to independents, and they tend to buy more in a just-in-time basis because none of them have DCs. So it didn't impact that part of Wesfil. But certainly, to the major resellers that have DCs, it was pretty much a common theme.

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James Ferrier, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Industrial Analyst [54]

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Okay. Yes, and so if you gross that $5 million up to an equivalent sales number, call it something like $8 million, for comparable purposes as the next size, you could maybe just add that back in and look at what your second half automotive sales result might have been if that customer destocking activity had not occurred.

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Martin A. Fraser, GUD Holdings Limited - CFO [55]

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Well, James, you do it for a living more than me. Looks, it's a hypothesis, but I don't like to sell hypothesis.

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James Ferrier, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Industrial Analyst [56]

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Yes, understood. The price increases that you have put through in recent months, your decision not to proceed with a price increase for the Ryco brand, what was behind that change?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [57]

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Look, we need to be responsive to the market, responsive in terms of our pricing strategy, who's operating in the market. And I talked about a strong defense plan for any potential new entrants in the market and part of that would be our pricing strategy. So reflecting on that, we want to make sure that we remain compelling in terms of the value proposition to the end user.

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James Ferrier, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Industrial Analyst [58]

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Yes, okay. Martin, I think you mentioned in answer to an earlier question, a currency rate of 71.5%. Was that your average rate for FY '19?

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Martin A. Fraser, GUD Holdings Limited - CFO [59]

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No, that's the average rate we're going into for FY '20, and we've got that hedged out to sort of March, April, sort of rates that have got 75% of what we sell, 75%, 80%. And we always tend to hedge that 75% or 80%, so there's nothing different there, but really just saying last year for what we hedged was a hedging of 76%, and that really stepped down around about that 71.5% level from about April on. But there's a bit of a delay obviously between hedging and then working its way through COGS.

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James Ferrier, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Industrial Analyst [60]

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Yes, understood. Understood. So in your outlook commentary where you talked about a situation where you might not be able to fully cost recover in FY '20, you look at the currency at 69.5 now, what quantum of price increase at this point in time do you think is a realistic expectation for you to proceed with -- at some point in FY '20?

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Martin A. Fraser, GUD Holdings Limited - CFO [61]

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So we've completely gone out generally with price increases at the 3% to 4% level. There are a few outliers. Graeme spoke to Ryco. Our IMG business around the reman and repair services have gone up 8%, and there's a few businesses where there may be a chance for a second round during this year. But that's about where we stand at the moment, James, unless you've got anything to add on that, Graeme?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [62]

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No, you said it completely. So that's fine.

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James Ferrier, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Industrial Analyst [63]

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Yes, and just you mentioned other source of inflation beyond the Aussie dollar. Where else are you seeing cost inflation within the business?

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Martin A. Fraser, GUD Holdings Limited - CFO [64]

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Well, it's really around our lease premises because most leases have a CPI adjustment sort of baked into them.

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [65]

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Plus your people.

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Martin A. Fraser, GUD Holdings Limited - CFO [66]

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And your people.

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James Ferrier, Wilsons Advisory and Stockbroking Limited, Research Division - Senior Industrial Analyst [67]

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Okay. Yes, great. On the water business, the EBIT margin in the second half of 10% versus 8% in the first half. When we look at FY '18 the first half, second half margins, pretty similar. Was there anything in particular that drove such a stronger margin result in the second half?

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [68]

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Well, look, I think we start -- mainly obviously we had some one-offs and the like, but we're starting to see some green shoots in Davey. We're not yelling from the rooftops here though. We've been able to get a better tempo domestically even though, in Australia, there were some climatic issues. But they've been able to drive that through in their more traditional business. They've had some relatively useful success in the Middle East and also in Europe. I talked about selling out their new Nipper chlorinator, and they've been able to put away a small number of some of our newer innovation products in terms of modular water treatment, which has a different margin composition than perhaps some of the other products. So it's a mixture of both things run through.

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Martin A. Fraser, GUD Holdings Limited - CFO [69]

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Yes, we still do quite a bit of self-assembly there, James. So as you lift the volume, proportionally, the EBIT grows quicker than you would do if you were just a wholesaler, so we're seeing a little bit of that. And as we continue to build on the business, we're hopeful that we'll see more of that benefit flow through.

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Operator [70]

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There are no further questions at this time. I'll now hand back to Mr. Whickman for closing remarks.

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Graeme Whickman, GUD Holdings Limited - CEO, MD & Director [71]

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Thank you, Ashley. I was just about to say I'm being told that there are no further questions, and I was going to close by thanking everybody for their time and the nature of their questions. Look forward to sitting with you over the coming days and more importantly in October, having the opportunity with a little bit more time, the luxury of time, to walk through with some more detail around a number of our businesses and have you visit with us in those businesses to sort of illuminate you to what the future lies because we do see a positive future. So with that, appreciate your time, and I'll speak to you very soon.