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Edited Transcript of NTG.L earnings conference call or presentation 4-Dec-18 9:30am GMT

Half Year 2019 Northgate PLC Earnings Presentation

London Oct 28, 2019 (Thomson StreetEvents) -- Edited Transcript of Northgate PLC earnings conference call or presentation Tuesday, December 4, 2018 at 9:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Kevin Bradshaw

Northgate PLC - CEO

* Philip Vincent

Northgate PLC - CFO

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Conference Call Participants

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* Andrew Nussey

Peel Hunt - Analyst

* Julian Cater

Numis Securities - Analyst

* Jane Sparrow

Barclays Capital - Analyst

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Presentation

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Kevin Bradshaw, Northgate PLC - CEO [1]

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Good morning, everyone, and welcome to our FY19 interim results presentation. Today I'll be leading off with some of the highlights before handing over to Philip who will take you through the financial review. I will then cover a brief business review before we take questions.

I would also like to take the opportunity at this stage to welcome Philip who you are seeing in a results context for the first time. I am delighted that he's doing the business and is already bringing strong leadership to bear for the finance function across the Group.

Let's start with the highlights. So, today we are 14 months into the strategic plan I set out at our Capital Markets Day and have seen substantial levels of change and transformation since then. We've put behind us a period for Northgate where the fleet was sold down to create disposal profits in order to support a declining rental business, and are now implementing a new strategy where we look forward to delivering a strong and growing rental business with an attractive margins and returns.

While we are not there yet, I've never been more encouraged as we complete the foundations upon which we're building that future. In the last six months the business has delivered growth in vehicles on hire that's exceeded our expectations with the UK achieving 12.7% versus prior year and Spain 13.2%.

These are extremely encouraging results and reflect the effectiveness of our strategy, the strength of our customer propositions, and also the structural shift that we continue to benefit from as customers move from owning assets to renting them instead.

Our UK&I rental margin has now come through its trough in the second half of last year, improving to 17.1%. While we benefited from a change in depreciation rate, we also saw significant one-off costs within this number associated with the integration of vehicles acquired from TOM, as well as further restructuring charges. That integration is now complete and is delivering good accretive margins with operating profits ahead of our acquisition case.

With strong revenue growth now in both key markets we've turned our full attention to margin improvement initiatives in each territory. These reflect a combination of actions to deliver a higher margin mix of business, further selective increases in pricing and a significant reduction in costs, especially in the UK, as we implement the new asset management system from Infor.

Our fleet optimization strategy launched in the second half of last year has delivered absolutely as planned. We've extended fleet holding periods, reducing the volume of sales and purchases of vehicles in the first half. And while disposal profits, as planned, reduce through this aging process, we've seen a significant improvement in cash with free cash flow strongly improved versus prior year despite substantially growing the fleet.

Elsewhere we continue to invest selectively in capabilities and infrastructure to ensure that future growth can be delivered. And, as part of this, have opened a new flagship site in Madrid, adding substantial capacity in the region. Let me now hand you over to Philip who will take you through the financials.

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Philip Vincent, Northgate PLC - CFO [2]

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Thank you, Kevin, and good morning, everyone. As you know, this is my first set of results as Northgate's CFO having been in the role some 4.5 months now and I'm very pleased to be here today. I was previously at SAB Miller as the Regional Finance Director for Asia Pacific. Prior to that I was the Group Finance Director for finance and control in the head office.

I really believe that Northgate is well-placed to benefit from the opportunity in the LCV sector as a result of the structural shift in consumers wishing to move from the ownership of assets to rental. And I was attracted to Northgate to be part of this journey and I'm excited to be part of the management team that is going to be delivering this.

I think I met most of you already, but if I haven't then please feel free to come speak to me after the presentation.

So, let's turn to the numbers. I'm going to start off with the P&L. When the story is of high rental revenue and EBITDA and, as expected, lower operating profits due mainly to lower profit from vehicle disposals. Rental revenue grew by 10.7% to GBP259 million with revenue from disposals down slightly as expected. I will look at the moving parts within the revenue lines in more detail in a moment.

Underlying EBITDA was 4.9% ahead at GBP133.5 million. However, underlying operating profit fell by 6.2% to GBP36.7 million, and this movement was very much as expected and, as you know, reflected the strategic decisions taken last year to optimize the fleet.

Rental profit increased 6.8% benefiting from the depreciation rate change, and profits from disposals fell by a third. The operating profit number benefited by GBP7.7 million from the change in depreciation rate from the start of the year. And I will look at the breakdown within the operating profit in a little bit more detail in a moment.

Underlying PBT was down by 13.6% reflecting the increase in our interest charge which was due to higher net debt and also an increase in the cost of debt triggered by the higher net debt at the end of the year.

Underlying EPS was 18.5p, down by 10.6%, and we've increased our interim dividend to 6.2p per share, reflecting our confidence in the direction of travel [of our] business as we execute the strategy.

If we move to the revenue bridge where you can see that all of our revenue growth came from the rental business. We saw double-digit rental revenue growth in both Spain and the UK and Ireland driven by strong VOH growth in both segments. The [pattern in] disposals was different between the two segments with UK and Ireland up 10% while Spain fell by around a quarter. And this was due to the UK benefiting from higher residuals and also higher disposal volumes as we sold just over half of the ex TOM vehicles we had acquired right at the end of last year.

Turning to the operating profit bridge, at a Group level we can see the rental profit is more than offset by the fall in profit from disposals. Again however, we can see a mix in each of the two segments. Rental profit in the UK and Ireland was down by just over a quarter with our strong revenue growth more than offset by lower margins year-on-year.

Kevin will take you through the UK rental margins in more detail in a moment including the initiatives to improve margin, but product mix and some one-off costs all contributed to the year-on-year decline in UK and Ireland rental profit.

In Spain, however, we saw rental profits increase by 38.5% due to the depreciation rate change at the start of the year. Group disposal profits were significantly lower as expected, but comprised a 12.9% increase in UK and Ireland more than offset by a two-thirds drop in Spain.

The UK and Ireland disposal profit was higher than we originally expected in respect of both PPU and volumes. Residual values were high and we benefited from the sale of ex TOM vehicles that we had acquired at a discount to their market value. These factors offset the reduction in de-fleets that we saw as a result of the fleet optimization policy.

The reduction in disposals profit in Spain was in line with the de-fleet policy with PPU down by more than a half and disposal volumes a third lower. There was a small increase in corporate costs, mainly headcount, but most of the increase we see here was actually due to several one-offs flattering last year's number.

So, let's turn to cash flow. Cash generated from operations improved by GBP33.9 million to GDP141.7 million driven by higher VOH and the management of working capital. Interest and tax has reduced to GBP10.4 million with higher interest offset by the timing of payments on account.

Financing includes the costs in extending the bank facilities by one year, which was completed at the start of this year. As a result free cash flow before CapEx at GBP127.7 million was GBP34.3 million higher than last year.

We purchased 4,800 vehicles less than last year, which has driven the reduction in new vehicle purchases of GBP38.7 million and vehicle disposal proceeds have decreased GBP6.8 million as the volume of disposals decreased year-on-year. Total CapEx therefore reduced by GBP29.3 million to GBP149.5 million, resulting in free cash outflow of GBP21.8 million which is GBP63.6 million better than the prior year off the back of GBP34 million better cash flow from operations, demonstrating the benefits of [aging the] fleet.

And you will note I've own shown total CapEx spend and I've not split it between growth and net replacement. I intend to do so going forward, but I'm currently reviewing the methodology of this split.

Now although CapEx was lower than last year, our investment in expanding the fleet to grow VOH pushed net debt up by GBP40.5 million to just under GBP480 million at the half-year. And we also paid the 2018 final dividend in the first half of just over GBP15 million.

As we announced in our Q1 trading update, we extended our bank facilities by GBP50 million, so we still have plenty of headroom to grow the business. Our total facilities now are just over GBP630 million of which we had drawn GBP494 million at the end of the first half, leaving us with GBP137 million of headroom.

I mentioned the higher interest cost earlier. This was due to the 0.25% margin increase in the UK facility from 2.38% to 2.66% as a result of net debt at the end of last year moving above the 1.75 times net debt to EBITDA threshold. Our overall cost of debt is now 2.49% and compares to 2.27% in 2018.

And we have sufficient headroom for growth and, as you can see from this slide, we are not constrained by our covenants. The key net to EBITDA covenant threshold is 2.7 times and we ended the first half at 1.87 times, only slightly above the 1.75 at the start of the period.

And we said at the end of last year that we intend to manage leverage at a 1.5 to 2.5 times range only going towards the higher end of that range in periods of major growth and that very much remains a policy. So, thank you. I'm now going to hand back over to Kevin.

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Kevin Bradshaw, Northgate PLC - CEO [3]

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Thanks, Philip. Let's start with a review of our vehicles on hire performance in the UK and Ireland. So, the chart on the left is I think a pretty good demonstration of the self-help agenda and strategy in action that we set out just over a year ago.

Building on the turnaround in Q4 2018, we saw first-quarter growth in vehicles on hire reach 12% supported, of course, by the TOM acquisition and the second quarter reached 13.4%. This is significantly ahead of our estimates of market growth and demonstrates a start to the recovery of market share lost over prior years.

Minimum-term provided the key engine for growth and now stands at 19% of the UK closing fleet. There's clear evidence that minimum-term growth is being fueled both by displacement of competition and also by the conversion of owned vehicles as customers recognize the economic benefits of switching to a minimum-term contract instead.

In our flex business, despite the application of a 4.8% price increase across much of the fleet over the course of the first half, volumes remain flat indicating customers' clear acceptance of the price rise.

Let's turn now to UK and Ireland rental margins, where the story is very much in line with what was set out at the prelims. The context of course is that we're turning the UK business around and putting it into growth, which inevitably means that margins are held back in the short-term and is why we guided to no margin increase in FY19.

Overall margins for the first half have come in very slightly below our expectations, but with VOH growth coming in above what we expected. We think that this is an acceptable trade-off and one that's neutral with regard to our expected UK&I rental profit for the full year.

In terms of the components, first we saw a benefit in margin of 1.5 percentage points from the change in depreciation rates applied at the beginning of the year. Vehicle holding costs have dragged margin by 1% mainly as a function of increased purchase prices from the OEMs. Pricing and business mix account for a further 1.4%, and in the UK this is mainly a function of mix as minimum-term has grown substantially as a part of our portfolio. Other operating costs increase driving 1.8% of impact.

As we said at the prelims, being able to return to strong VOH growth and at the same time deliver for our customers means that we need to invest to put a lot of things right. Some of that is capital, for example, in the new asset management system, but a lot of it is operating expense in terms of sales, marketing, workshop people and processes, effectively doing things the customers want and need but we just stopped doing. If we don't do this and don't incur the costs, clearly our momentum risks being short-lived.

Finally, one-off costs have dragged margin by 0.8% and there are two components here. First, the integration costs, primarily labor and utilization, of rapidly processing 3,400 vehicles acquired from TOM. Second, restructuring costs taken above the line as we've restructured certain operations in the UK business.

And now to a sequential view of the UK and Ireland margin trajectory. On the left-hand chart you can see rental margins dipping to a trough of 6% in the second half of last year. From that point we delivered a step-up in the first half to 7.1 and expect this margin expansion to continue.

We have announced this morning updated guidance for full-year rental margins of 7.5% to 8% and by implication this means a margin in the second half of 8% to 8.5%, substantially ahead of prior-year comparison. There are three reasons for our confidence here.

First, we've been focused on implementing selective price increases through the first half in addition to driving better recoveries in areas of under charging such as excess mileage or mechanical preparation that falls outside of our contractual commitments. As we move into the second half we are now seeing total average hire rates across the UK and Ireland ahead of prior-year levels, despite there being a far higher mix of minimum-term contracts in the business. This is the first time in over three years that we've seen this positive average rate variance and we expect it to continue right through the balance of the year.

Second, we expect to see improvements in utilization and lower direct costs starting to feed through in the second half as a result of increased minimum-term business.

And third, we expect to see significantly lower one-off costs as the integration of TOM vehicles has now been completed.

Turning to the fleet, the UK and Ireland saw a modest overall increase of 600 vehicles in the size of the operational fleet across the first half as the de-fleet and sale of vehicles acquired from TOM, along with natural de-fleets, mostly offset the underlying purchases in the period. We've reconciled these de-fleets along with third-party sales and stock movement in the table on the right to show total vehicle sales reported of 10,800.

Excluding TOM, sales from de-fleets reduced significantly to 7,000 units, just 13% of the opening fleet in the period versus 20% in the first half of FY18. And this of course is entirely consistent with the fleet optimization strategy and aging policy that we've put into practice. Excluding the TOM acquisition, the fleet grew by 2,200 vehicles while VOH was able to be increase by 3,600 vehicles at improved utilization. So, overall a very good result.

Turning to Spain, we've seen continued double-digit VOH growth supported by having the widest portfolio of rental propositions available to customers coupled with market-leading levels of service. The modest reduction in growth that you see in Q2 reflects some increased selectivity on Northgate's part as we identify low margin customers and segments and manage them out of our portfolio.

Growth has been driven by minimum-term contracts which now comprise 28% of vehicles on hire and are often sold as part of a bundled proposition. We've now got good traction with large customers and are more proactively targeting SMEs and sole traders as sources of future growth.

Turning to margins in Spain, we've seen, as guided, a significant increase in overall rental margins driven by the change in depreciation rate. Vehicle holding costs reflecting OEM price increases have been well-managed, producing just half a point drag on margins in the first half with utilization being broadly flat.

Price and business mix have created a drag of 2.2 percentage points, and this was a function of there being more minimum-term in the product mix and stronger competitive pricing in certain segments across Spain, particularly within our large accounts. Other costs were well-managed with the benefit of operational leverage coming from growth mostly offsetting investment in the network, including the new flagship rental depot opened in Madrid.

I said at the outset that we are focusing hard on margin improvement initiatives and in Spain these include a more concerted focus on SME growth where we enjoy both higher margins and less competitive presence. In addition, we are improving our margin mix by identifying business segments with high costs to serve and weaker margins and are withdrawing from them. We also expect to feel tailwinds from continued VOH growth over the fixed cost base in the business.

Turning to fleet, we saw a net growth of 3,100 vehicles in the period in Spain. As we saw in the UK, implementation of the fleet optimization strategy has led to a significant reduction in both de-fleets and vehicle sales as holding periods have extended. So, de-fleets represented just 9% of the opening fleet versus 16% in the first half of FY18.

So, before we turn to the outlook and with the Commons vote on Brexit just one week away, as well as the ongoing regulatory pressure on diesel vehicles, I wanted to briefly reassure you on these key areas of potential risk.

First, we reviewed in detail the impact of a no deal Brexit on Northgate. Our main risk relates to the supply of UK vehicles that are largely imported by OEMs from the EU and either a disruption to the supply chain or a significant increase in costs due to tariffs or foreign exchange management. We feel very well-placed to mitigate this risk.

In the short-term we would reduce our fleet proposals to ensure that we could continue to meet growing customer demand, while in the long-term we believe that OEMs will manage supply lines effectively. In the short-term it is possible that we would see some margin compression, but that long-term cost increases can and would be effectively passed on to customers.

We also see potential upside from greater demand in rental services in the face of increased costs for new vehicles, along with significant potential upside on the residual values for secondhand vehicle stock.

With regard to diesel vehicles, those with Euro 4 emissions are likely to be the next target for regulatory focus. Now virtually all Northgate vehicles are currently Euro 5 or Euro 6 compliant and all of our diesel purchases moving forwards are Euro 6. Again, we see potential upside from increased regulation of Euro 4 vehicles, particularly with a minimum term rental of more compliant alternatives acting as a very attractive customer proposition.

We continue to stay close to the OEMs with regard to electric vehicles and our objective is to stay ahead of the curve as this vehicle class penetrates the market.

So, let me finish with our outlook. In the UK and Ireland we've delivered stronger VOH growth than expected in the first half and we expect this to continue and are raising our VOH guidance to double-digit for the full year. As a result, we now expect rental margin to be within a range of 7.5% to 8% versus the broadly flat guidance compared to 8.3% delivered last year. Importantly, we see the net impact on UK&I rental profit to be neutral as a function of these two changes.

In Spain we've seen strong performance in the first half. In response to increasing competition we're fully focused on margin enhancing initiatives and see no reason to change our full-year guidance.

For the Group, the stronger-than-expected VOH performance in the UK will lead to around GBP10 million to GBP20 million higher CapEx than previous guidance. And we remain confident about the positive trajectory of the business going forwards. And we are on track to meet our full-year expectations. So, at that point, perhaps we can hand it over for questions.

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Questions and Answers

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Andrew Nussey, Peel Hunt - Analyst [1]

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Good morning. Andrew Nussey from Peel Hunt. A couple questions, if I may. First of all, looking at UK VOH, obviously the growth has come from the flex segment -- sorry, from the [fixed] segment. Could you give us a feel for what customer cohort has been a key driver within that, whether it is larger accounts or the SME, particularly given I think you've invested quite heavily in the SME marketing?

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Kevin Bradshaw, Northgate PLC - CEO [2]

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I think in the UK we've seen growth for minimum-term come right across the board both in the major accounts right through to regionals and SMEs. Moving forwards our intention, Andrew, is to focus much more on the SME market for the same reasons as we highlighted in Spain. We see stronger margins there and less competitive presence. So, that will be the shape and focus of our efforts as we move into the second half and next year.

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Andrew Nussey, Peel Hunt - Analyst [3]

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I guess sort of following that up, in Spain just the confidence that you can mitigate that pricing pressure by driving the SME segment. I imagine it probably needs a bit more sales and marketing activity to get that moving forward?

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Kevin Bradshaw, Northgate PLC - CEO [4]

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Yes, that's right. We firmly believe that we are best placed to serve and acquire customers within the SME market across Spain as a function of our strong regional network and the relationships and capabilities that we've got on the ground. So, that is -- that's absolutely our intention.

We're further looking in more depth at that market and segmenting it to a greater level. So for example, identifying sole traders as well as the SME market and the micro end of that SME market so that we can target more effectively that customer group.

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Andrew Nussey, Peel Hunt - Analyst [5]

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And just last one, just in terms of the timing of i4 rollout, is that still on track, on schedule?

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Kevin Bradshaw, Northgate PLC - CEO [6]

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Absolutely. So, we maintain our guidance of Infor being implemented through the course of FY20. I think things are progressing well. There's a significant level of invested time and focus on the implementation of Infor and the broader accelerate program that's being run. But yes, the time frames remain intact. Julian?

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Julian Cater, Numis Securities - Analyst [7]

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Good morning. Two questions for me, please. First, on the UK, the VOH growth, you look like you've had conspicuous success in cross-selling to existing customers. I wonder whether you could talk about the traction you are getting, your initiatives to win new customers.

And then my second question is also on the UK market. You've obviously seen an element of Darwinism in terms of TOM falling over. And I wonder whether you could make any other remarks about what you are seeing in terms of the competitive landscape within the UK, please.

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Kevin Bradshaw, Northgate PLC - CEO [8]

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Yes, sure. So, for the UK market I think it's fair to say that the growth is genuinely coming from both further penetration of our existing accounts with minimum-term and cross-selling, as you say, but also in terms of attracting new accounts.

We are seeing some very good momentum build within our telesales operations that's focused on the SME side of the market, as we have started to develop and launch (inaudible) marketing campaign over the course of the last few months and the momentum behind that will continue into next year.

We also see, I think, good opportunities to grow and continue to grow new accounts in the regional size groups of our marketplace. So, the growth, as I say, is coming across both of those fronts.

On TOM we remain focused on looking out into the UK at potential opportunities. We've seen one or two smaller opportunities than TOM come across the radar in the last few weeks and months and we'll continue to look at those and evaluate them to see if they make sense for the business. But as I said on previous occasions, aside from that we maintain and keep live a potential list of acquisitions for the UK in order to bolt-on and build scale as rapidly as we can.

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Jane Sparrow, Barclays Capital - Analyst [9]

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Jane Sparrow from Barclays. Just on UK pricing where you've talked about I think saying continued price actions. Obviously you put through a fairly sizable increase in the first half. Are those continued actions a bit more focused on specific customers or are you intending to put through another sizable increase in the second half?

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Kevin Bradshaw, Northgate PLC - CEO [10]

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So, I think the pricing actions fall into two groups. On one side we have been selectively increasing prices and reducing discounts across various elements of the product mix, in particular in minimum-term. As that business grows then we frankly get to appreciate more the competitive strength of the offer from Northgate relative to competitors in the UK, so we've been testing our ability to achieve price premium in minimum-term.

On the other side we've made some significant gains in terms of increasing the discipline around recoveries. And I talked briefly about areas of damage, but also areas of mechanical preparation that fall outside of the scope of our proposition and committed contractual obligations to a customer.

We are just improving the rigor of our processes there so that when damage falls outside of that or mech prep falls outside of that we're more effectively capturing and billing those aspects. And that's also contributed significantly to the rate improvement over the course of the last six months.

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Jane Sparrow, Barclays Capital - Analyst [11]

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And then just on OEM price inflation, do you have a feel for how much -- I know you said you are mainly Euro 5 and Euro 6. How much of the market is still Euro 4? And therefore if some of your smaller competitors are having to buy perhaps more expensive vehicles now, whether the market generally might be able to push through those price increases?

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Kevin Bradshaw, Northgate PLC - CEO [12]

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So, the -- in terms of the vehicle park in the UK, as in Spain, and as you would expect, there is a terrific tale of legacy standards out there. And we continue to believe that making available on a strong economic basis a minimum-term alternative that is Euro 5 or 6 compliant represents a really good alternative for customers who are faced with the prospect of increased regulatory controls, costs and, in some cases, an inability to operate in some locations because of the standards of the vehicle they are running.

So, we see headwind from that. And further, we are in the UK offering a we buy, you rent facility, which has seen very good success over the first half of the year where we will purchase a vehicle from a customer, trade it out through Van Monster into the secondhand market in order to provide an opportunity to switch them into minimum-term contracts instead. And that's getting and continues to get really good traction in the market and helps alleviate that issue for customers.

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Unidentified Analyst [13]

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Just turning back to what was slide 17 and the de-fleeting and the proportion which went through Van Monster was largely unchanged on largely similar volumes year-on-year. Was there any disruption caused by TOM in terms of what you could get through Van Monster? I'm thinking [consciously] that you obviously deliberately expanded quite a lot of the selling space for Van Monster through the course of last year.

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Kevin Bradshaw, Northgate PLC - CEO [14]

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So, we clearly with the TOM vehicles acquired them at a very good discount to cap. So, one of the compelling things about this deal I think was that we always knew that if there were vehicles within the acquired pools that we would take on that didn't naturally sit within the core fleet for Northgate that we would be able to dispose of them profitably out into the market.

In fact, a good proportion of those vehicles went out both through the retail channels and also through the trade channels. And we evaluated them in much the same way as we would have evaluated de-fleet stock off the core rental business. So, we saw I think a mix of channels for the de-fleet there.

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Unidentified Analyst [15]

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Going forward should we expect the proportion going through Van Monster continuing to tick up?

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Kevin Bradshaw, Northgate PLC - CEO [16]

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Absolutely. Yes, and that remains a key focus for us. So, as we triage those de-fleeted vehicles with ever-increasing precision our intention is to continuously shift up the proportion that go out through the retail channel at 42%. We still see some good headroom and some good opportunity to continue to increase that.

Okay, are there any more questions? No, I think we've run dry. Okay, well look, everyone, thank you very much for your time. And I think on the line we'll draw things to a close. Many thanks.