Ferguson Enterprises Inc (FERG) 2012 Q2 法說會逐字稿

We may as well get started. Eyes down for a full house, Gareth. Good morning, everybody. I'm here with John Martin and Gareth Davis, our Chairman and I see Mr. Andrew Duff, our Senior Independent Director has also come in for the show today. We'll take you through our half-year results.

Highlights. I think we've made decent progress in the last six months. Although the US has been better, clearly Europe is getting tougher. The top line has grown reasonably and in virtually all core geographies we've gained or held market share.

We've held gross margins over the period. It remains, though, a pretty fierce pricing environment out there. We've executed our cost reduction plans in the low growth markets and John will take you through the details. Our trading profit is up 13% and EPS up 30%.

Customer service has improved and even in these tough times we have improved our engagement with our employees. We now have targeted plans for all 26 of our business units that reflect investment where there is growth and cost reduction where there is decline. We're beginning to get some leverage in terms of Group synergies, but we still have much to go for here. And the balance sheet is strengthening, hence our rebased dividend. Again, John will take you through our thinking here.

We see some early signs in North America of stability, certainly better than it was six months ago. But Europe is still at best flat, or declining and the next 12 months we think will be tough. We're considering and preparing further actions in Europe to address markets where we see decline. Pricing and gross margin management is a constant challenge, so we still see some pretty difficult markets out there. Let me then hand you over to John to take you through the numbers.

Thank you very much, Ian. Good morning, everybody. You can see from the financial highlights on the screen, I'll just pick out a couple of them up front. But overall, given the economic headwinds that we had through last autumn, it's great to be standing here with like-for-like growth at 5%, really driven by that performance in the US.

As Ian said, the pricing environment across pretty much all of our regions has been very demanding. But on an underlying basis we have maintained gross margin at last year's level. Last year we flagged some additional costs, most notably in share schemes and pension contributions but we've been very focused on improving efficiency across the Group. I think that's apparent from the flow through. You can see incremental trading profit on incremental revenue of 16.5% in the underlying business.

Reported trading profit was GBP310m. That's 13% ahead of last year. And by getting the financing and tax charges into the right place, that gives us EPS growth of 30%. And of course, we continued to generate cash and brought net debt down to GBP529m.

To get to the underlying performance of the ongoing business, we stripped out GBP8m of profits from businesses being disposed. And we've added back GBP16m worth of non-recurring items that have been charged to trading profit. And that brings the underlying profitability to GBP318m. And the reconciliation between those numbers is there for you in the back of the pack.

So the ongoing business grew by 7%. Trading profit grew by 16% and that brought the return on sales for the ongoing business to 5%. The first half was boosted by an extra day and that was worth about GBP6m at the trading profit line. And there's also GBP2m of FX, principally in Central Europe.

Just in the second half, the number of sales days in the second half is the same as last year. I know we've got an extra day for Leap Year but it gets used up somewhere else, I'm afraid.

Quarterly performance for a minute. Overall, the growth rate in the second quarter was in line with the first quarter at 5%. The US growth rate was against tougher comparatives but almost all of our businesses there grew well. Canada has come back nicely, actually, after the slow summer last year. And in the UK we are constantly looking at the performance of the ongoing business. Last year's contract loss is history. After that we grew by 2% in the second quarter.

Growth in the Nordics was flattered by the mix of sales. That includes some larger-volume lower-margin sales and market conditions in the Nordics remained and remain pretty tough. In France, whilst the like for likes are okay, market conditions have tightened towards the end of the period and we expect that trend now to continue into the second half of the year. And in Central Europe, our team is continually focusing on the quality of sales and margins, rather than on market share gains.

In the USA, the good growth is pretty broadly spread, both geographically and across our business units. Blended branches, our waterworks, industrial, fire and fabrication all making healthy gains in market share. In fact, the only real slow spot was HVAC and that was up against pretty tough comparatives last year as a result of incentives provided by the US government.

It's worth remembering as well in the US, this growth is overwhelmingly coming from the RMI markets. Our exposure to new residential, new home residential in the US is still only 14% of the US business.

The underlying gross margin in the US was slightly lower than last year. We had falling commodity prices in the first quarter and that dragged on our margins. Copper prices, though, have rebounded in the second quarter.

Operating expenses were 7% higher. We achieved good leverage on the branch and DC network, but staff costs were higher overall and we invested GBP9m in additional share-based payments and resumption of the 401k payments that we suspended the year before. We also had increased sales commissions.

We took a one-off charge of GBP11m in the period. That was to settle a rebate which had been claimed in error from a supplier in earlier periods. Adjusting for this, the underlying profit flow-through was very strong. We completed three acquisitions and opened a number of new branches, principally in water works and industrial. Net branch openings were 15. We also churned and continue to churn some poor performers.

We made steady progress in Canada. Revenue was 3% ahead like for like. Modest growth coming from blended branches, though market share there dipped slightly. Strong growth in industrial, where we continue to gain share. Gross margin was slightly lower but labor costs were very tightly controlled and headcount was 91 better than last year. Operating cost growth there restricted to 3% and trading profit ahead by 9%.

Like-for-like revenue in the UK was 3% lower. But the plumb and parts team have done a really great job replacing the sales that we lost last year with that large contract lost. And adjusting for that, revenue was 2% higher. By the fourth quarter we expected to be generating real like-for-like gains in the UK.

The heating market shrank but demand throughout the rest of the product categories is better and we incurred price inflation of about 3%. Pipe and climate and drain sensor both grew very well. They increased their profits and they gained market share.

Considerable focus, both on pricing, procurement and a better sales mix all helped the UK to improve overall gross margins. Operating expenses were 4% higher and we invested GBP3m in restructuring. And you'll see headcount at the end of the period was 179m million -- sorry, 179 heads better than last year.

Staff costs were slightly better, despite investment in some new branches in plumb and parts and integrated services. We're also making a fairly sizeable investment in our e-commerce capability in the UK, including importing the build.com business model from the US.

In the Nordics, like-for-like growth was 5%. But market conditions across the region were tough and in Finland and in Sweden now, we're trading against some pretty tough comparatives. But our strong market positions across the region were maintained. Some of that growth has come from the contracted new build business at lower margins. And so gross margins across the region overall were slightly lower.

Operating expenses were 7% higher. 2% of that came from selective investments including three new branch acquisitions. We also increased staff costs and both fleet and credit costs were higher. We have a number of efficiency initiatives underway and we're going to be pretty cautious on the cost base in the region until market conditions improve. So overall, trading profit was GBP1m down at GBP47m.

In France, building materials grew by 4%. Wood products were broadly flat. Gross margins were lower. We've reduced headcount numbers and staff costs but both fleet and credit costs were higher than last year. And underlying operating expenses grew by 1%. Underlying trading profit was GBP1m lower.

Restructuring costs were GBP2m and given the deterioration in market conditions, we are evaluating today ways to reduce our cost base further in France. Just one last point as a reminder, the business in France is highly seasonal. We generally make a lot more profit in the second half of the year.

In Central Europe we continue to focus on quality, rather than sales volume to ensure that we provide our services to customers who value the value that we add. So overall, like-for-like revenue growth was 1% but in Switzerland, Austria and Holland, we expanded our gross margins. We also made some selective investments and operating expenses were 4% higher. Trading profit was up GBP3m, at GBP20m and, compared to where we were three or four years ago, I think that's a decent result. Historically, as you know, we struggled in this region.

We bought Group costs down again, to GBP15m. The cost of servicing the old construction loans business, those are going. Central costs now are running at 1% of the overall OpEx base of the Group. And remember, we don't recharge central costs to our regions.

Let's take a minute to look at the operating costs of the ongoing business. We've invested GBP10m of operating expenses in new branches, both acquisitions and new openings. Across the Group we spent GBP16m more on share schemes and pension contributions, some of which have been suspended in the downturn. The variable costs associated with that top-line growth, with the additional sales, including distribution and sales commission costs, came to GBP30m.

And the other cost rises were driven by staff costs. You'll see, we've got the headcount numbers in the back of the pack, that we've been very careful on headcount. And actually, headcount is 335 better than in July. That even includes the impact of acquisitions. But after two years of pretty stagnant wages around the Group, we had wage inflation over the period, which averaged about 2.5%.

These and other cost increases, including freight costs, were GBP40m higher than last year. Depreciation was GBP8m better than last year and other efficiency savings amounted to GBP21m.

One of the productivity measures that we use in the Group is we look at how well we convert gross profit into trading profits. And this advanced to 18.3% in the period, despite those catch up of costs that we talked about, labor productivity delivered an additional 60 basis points. And the leverage on other costs an additional 80 basis points. This is the best result for five years. But there is still substantial scope for improvement. Prior to the downturn, we got 22% out of that number.

Let's cover the non-trading items in the income statement. We've got an exceptional charge of GBP13m. Two items there. We've got -- we had the profits on disposal of stock building supply net of a write down of assets held for disposal.

In the autumn we talked about restructuring charges and you'll see we've charged GBP5m in the UK and France. That's been charged for trading profit because it's not sufficiently material to be taken out as an exceptional item. Restructuring costs for the full year now might exceed that original guidance. That will depend on the scope and timing of individual projects.

We brought finance and tax charges -- sorry, we bought finance charges down to GBP15m because we got the benefit of those new facilities combined with lower debt levels. On the underlying tax rate now, just south of 26%, that reflects the full period impact now of the relocation and going forward we should be able to maintain the tax rate in that type of range. So, trading profit growth of 13%, finance and tax charges are now in the right place, has delivered EPS growth of 30%.

The cash flow chart reconciles EBITDA on the left with the reduction in net debt there on the right. The proceeds of asset disposals net of M&A investment came to GBP160m, the single biggest contributor to that being the disposal of build center. We used GBP60m of that to invest in the UK pension scheme as we said last year.

Cash tax and interest amounted to GBP36m and we invested GBP64m in capital investments. We also invested another GBP81m in working capital. And that investment really represents three things. One, it's investment in the additional volume. Two, we've made some selective investments on behalf of specific customers. And three, there are some seasonal effects in there.

Going forward, we continue to expect incremental investment in working capital of 12% or 13% of incremental sales. After paying the final dividend of GBP85m, net debt on an all-inclusive basis was GBP176m better than in July.

Moving on to investment for a moment. We invested GBP41m in six small acquisitions. They had total revenue of GBP100m, trading profit of GBP2m. These acquisitions are being into our business properly and promptly. The M&A pipeline now is a little bit more interesting but as we've said very consistently, we're going to stay very disciplined on M&A activity.

The majority of the GBP64m CapEx investment was invested in technology and in existing facilities. But we also opened 39 new branches at a cost of GBP6m. That's a little bit slower than anyone expected six months ago, because of our focus on existing operations in the current climate. We've also closed a number of branches in the normal course of the business and that's something that you should expect as part of a disciplined and healthy approach to improving our operation.

I'm pleased to say, net debt is getting much simpler now. Factored receivables will be gone shortly. There's no material working capital adjustment and no separate construction loan debt. And adjusted net debt will come down further when we complete the sale of Brossette shortly.

Despite the additional GBP60m pension funding, net pension liabilities have come down just GBP9m. And that's a combination both of the discount rate used to discount liabilities and also lower investment returns over the period than expected.

We are making some progress in getting our return on capital to the very attractive levels that are available to really good operators in our industry. The return on gross capital employed was 11.6% in the period and excluding goodwill, that's just over 27%.

Finally, the Board has considered very carefully the dividend policy. We will pursue a progressive dividend policy with the priority being to sustain dividend payments through the cycle. Last year we started paying dividends again after the downturn, with a dividend of 15p per share. That's now been rebased to 20p per share, an increase of 33%.

We continue to expect the interim dividend to be about a third of the total payout for the full year. The future growth rate will reflect the potential long-term earnings growth capacity of the business. That's the end of the financial section. I'll hand you back to Ian.

Thanks, John. In terms of our strategy, I just wanted to remind you about this and then we want to take an example of the US blended branch business that we'll go through. Firstly though, just eight key points.

We're going to remain very focused on the service and distribution businesses in both plumbing and heating, as well as building materials. Fundamentally, as John has made the point already, there's a very clear need for a cost effective distribution service to our customers and for our vendors. And our markets can deliver for a strong player, good returns through the cycle.

Secondly, because of our low absolute market shares we have a huge opportunity to grow within existing geographies and the business units. We have less than 20% market share in some of our biggest businesses. But in some of our local areas where we make very good returns, our share is well in excess of 25%.

Benefits of scale from sourcing, lower costs, as well as investing in a deeper range of inventory, allow the market leader in a country to generate the best returns for the industry. And if we look at other comparator companies, they also make their best returns where they have leading positions. Obviously Travis in the UK, Saint-Gobain in France and Holcim in Sweden.

Because of the benefits of scale from strong national positions, gaining share will deliver great value, provided we're not discounting away our service and distribution proposition. This means that we will focus first on gaining share on existing customers and then gaining new customers across all of our businesses.

We have many strong businesses that are beginning to perform better by gaining share organically and profitability. 86% of our businesses are either the number one or the number two position in their markets. We've now developed targeted business plans for all our business units that tackle the growth opportunities. But clearly, where we have weaker markets our focus is on margin management, rather than on share gain and growth.

Yet we believe our targeted approach by business unit and within business unit will continue to rebuild our profitability, so we can get back to former peak margins in the next few years, assuming reasonable market conditions. We have a very clear approach to acquisitions, to our strong businesses to consolidate the markets.

We have strict financial criteria and we will integrate the businesses rapidly to deliver a decent payback. We've already built some attractive related businesses that share costs, customers and suppliers with our core businesses and we will grow these to leadership positions over time.

Examples are the industrial waterworks business in the States, where we shares suppliers, the Silvan DIY business in Denmark, that sources product jointly with Stark in Denmark, and the wood solutions business in France that sources product for Reseau Pro in France and the rest of the Nordics countries.

We're now beginning to get some decent leverage across the Group in terms of sourcing best practice sharing and the business model development. And we'll focus more attention here as our business units begin to perform better.

And to deliver consistent dividend growth, given the cyclical nature of our business, means we need to maintain a conservative balance sheet. And having worked very hard to get our balance sheet sorted, we can now increase our dividends and the growth rate at a sustainable rate.

We've used this chart before, to demonstrate the huge opportunity we have to grow our core businesses. Despite being the leader in the States, we are two times larger than the nearest next player, we still only have an absolute market share of 17% in our largest single business unit. Across the Group, where we're strong locally, we can have share well excess of 25%.

And similarly in Canada, UK, Denmark, France and Switzerland, we have lots of share gain opportunity. Only in France, in Reseau Pro are we not the market leader but we do have some much stronger regional market share positions in France in the north and west of the country. And it is a good gross margin market. Yet we believe we can still make acceptable returns, even as the number two player.

I described before how we managed the strategic and operational process in parallel. The best way to explain how this works in practice is to go through a specific example of our largest business unit, blended branches.

John's already covered briefly the other geographies. Although today we'll only focus on one business unit in the States, I want to stress we're working very hard to ensure we do execute consistently across all our other business units. For example, all units have now defined the core range that they need to have in stock and to a 99% availability. And we're measuring progress towards that objective. We'll review later Group and cross business unit synergies where we're now beginning to make some reasonable progress.

We explained last time how we think about our strategy within a business unit and what we expect the outcomes to be. I think we've made it very clear across the Group, we will drive towards best customer service, supported by the best branch staff in the industry. Make sure we do gain the benefits of scale by having preferred relationships with our core vendors. And make sure our operating model is the most efficient in the industry.

This will allow us to gain share of existing customers and also gain new ones. We therefore expect our businesses, over time and in reasonable market conditions, to deliver market share gains, expand our gross margin incrementally, improve our productivity. So we get back to our peak margins and deliver double-digit flow-through on incremental sales. I've chosen our US core business because of its importance. Again, we do invest significant time, though, in making sure we execute consistently across the Group.

In terms of the US market, we all look at the same variables, so I won't bore you about these -- the details here. Suffice to say, consumer confidence is picking up and many of the other variables are beginning to move in the right direction from a low point. I don't think we're out of the woods yet but it certainly feels more robust than it did six short months ago.

The blended branch business is about 60% of our US sales, followed by waterworks, where we're joint leader and our industrial business, which is a very fragmented business. And we have some strong niche positions. In plumbing and heating we are twice the size of what we believe Home Depot sell to the tradesman and four times larger than the nearest distributor, Hajoca.

The margins are good and we have the largest branch network across the US. We serve nearly 90,000 customers and many of these are small, privately-owned companies. We have a fragmented supply base, although five suppliers do make up nearly 20% of our sales. We have 275,000 active SKUs and the business is well spread, with 57% being our RMI, only 14% focused on new residential.

Our market shares vary massively, dependant on what has happened historically in the business. I'm not going to go through every state, don't worry. But in our strong markets, where we have -- make very good returns, like California, Virginia and Washington DC we have very high market share. Well in excess of 20%.

But in contrast, in some of the markets, largest markets, our share is well below 10%, in the Northeast and around Chicago. Yet we see huge potential on a state-by-state basis to both infill, where we are strong and also open new branches where we are weak.

We're also actively working the pipeline of bolt-on acquisitions across the US and it's beginning to look a little better. In the last six months we've added 15 branches and similar geographic strengths and weaknesses exist in all our other geographies and we have similar plans to consolidate our positions.

The blended branch performance has been improving over the past few years. There's still plenty to do, though. We've gained good share, outperforming the market by about 6%. Historically, we'd only performed in line with the market.

Our gross margin has improved. Our labor cost ratios have improved but as John explained, we have some cost catch up in the last six months and we do expect to do better in the next six months. Our return on capital has improved as we have managed our working capital better and these are results that we would expect from our strong businesses across the Group.

Now, just to give you a sense of some specifics, we have good visibility down into branch performance. Here are just two examples of Chicago and New Orleans and this is the monthly dashboard that Frank and Kevin and the guys use. We do have similar dashboards in our other businesses across the Group.

Firstly, in the red, we have our consumer service split into our deliveries outwards to customer. How many self-service events have occurred, our fill rate, what percentage of the business required manual pricing intervention, and the net promoter score of the branch, the customer survey. We also order rank each branch so that we can then benchmark with similar branches to drive better results.

Secondly, in green, we have the financial performance where we look at the profit and loss along several dimensions including productivity measures. And then the light blue, thirdly, capital discipline within the branch, including cash days, reduction in excess inventory. This is the six-pack measure and also DC utilization to make sure we're getting value from our core supplier and DC investments.

Again, each month we order rank and benchmark to make sure we're moving the performance bar upwards. We've said many times our business does not yield to grand gestures. Instead, many small incremental steps are required to deliver great performance.

And in terms of market share performance, green is good, red is bad. You can see from the map that in many areas we are gaining market share. However, it's not everywhere and not in a few important metro areas. In the far Northeast and also in the Southeast we can do better. So going green is very much part of Frank's plan for the next six to 12 months.

The market share growth has been driven mainly by improved customer service and product availability. I've said in the past, we're not -- we were not good at measuring and monitoring our service offering. Now we're measuring our performance consistently and all the components of service from range, to pricing, to speed of service and relationship with our employees.

We measure service using customer surveys across all business units within the Group. And I've shown you this data before, in terms of looking at our net promoter score and what is driving it. So I won't dive in too much detail today.

We're making month-on-month progress, but we still are not yet consistently best in class in all locations. And this improvement has been driven by our focus on availability of the top 3,000 SKUs. But we've now started refunding customers if we cannot live up to our promise. And we continue to drive this initiative in all our markets.

In terms of what's driving gross margin. The key initiatives have been better category management, using fewer core suppliers and gradually increasing our own brand penetration. It's still not yet 8% but small changes given the profitability have a big margin impact.

Our showroom business has also grown well, driven by sales initiatives in the 300 locations we have. And again, this is a higher margin business than the core. And finally, we've emphasized the pick up business in branch by better merchandising and better focus on higher margin products, to gain share in this profitable small customer segment.

In terms of driving productivity, we continue to push the DC network harder. We have eight DCs with three pipe yards across the States. We've constantly improved by better fleet management, better replenishment processes. Constantly challenging existing operations by lean process reengineering and making sure the branches are complying with DC programs.

The results are improving in terms of on time in full, compliance with programs, cost per line picked and shipped and inventory rotation. And we know this structure is one of our key advantages, versus small local competitors.

We now measure productivity down into all business units and in all branches across the Group. We find certain key ratios are helpful to enable us to benchmark not just within our business units but also across our business units. Our ratios in blended branches have improved, as we've utilized our branch and DC network better.

But labor cost, as a percent of gross profit, has got marginally worse by 30 basis points. This was driven by the catch up costs that John explained in terms of 401k and share-based schemes. But we do expect this to come down in the second half and further over time.

In terms of future growth, we currently have several significant opportunities. We know we have plenty of options within the existing branch network by a combination of new branches, increasing sales density in existing branches and acquiring other small competitors. We are investing substantial funds to improve our e-commerce offering and make sure that we do become a leading multi-channel distributor and also access directly the consumer market.

But we are also now tackling some large customer segments that, although more difficult to penetrate and serve, do offer good growth and healthy margins. Historically, we have not dedicated resources to these three segments in hospitality, facility maintenance and the government.

So, looking at acquisitions that can make -- that can be very accretive in our strong business units, provided, as John's already said, we are disciplined. This is just an example of one we concluded in the middle of last year. So far it has been very successful. We may not repeat this performance in all instances, but we'll try.

The year one return on investment will be well in advance of what we planned. And critically, we've completed the integration within three months. The acquired business has come onto our infrastructure. All duplicated costs have been removed. Service has improved. New customers have also been targeted with a better inventory range that is available from combining with the Ferguson inventory range.

Turning now to e-commerce. We've installed -- invested significantly to improve our e-commerce business. Roughly $10m over the past two years. And we now benchmark ourselves against the best providers of e-commerce solutions, Amazon and Grainger. We need an excellent B2C, B2B offering that gives our trade customers access to their accounts and ability to price and buy online. With all delivery options available to them. We are the clear leader in this channel.

We have also developed a B2C business, build.com, which is growing fast and is now over $0.25b in sales. We're the number two player in this market, behind the Home Depot retail business. Net e-commerce is now about 10% of our business and is clearly growing.

Over the past 18 months, we've dedicated resources to tackle the three large customer segments I explained earlier, hospitality, facility maintenance and government. These segments require far more activity up front to understand the needs of the customer who are often looking for a comprehensive solution covering several geographies or even nationally. And also making sure that we are qualified to be on the bid list.

So it's a complex and relatively costly sales process. However, the margins are healthy. Some of our customers are outsourcing this activity for the first time, using third party contractors, but insisting on being able to see the margins that are being marked up on products and services.

We're well set up to tackle these types of customers and have a dedicated team that is beginning to make some headway. All three segments are very large, with many fragmented players. But also a few competitors like Home Depot, FM and also Grainger have made good returns over time. So by dedicated the sales resources and utilizing our network, we see good, profitable growth in these segments.

In summary, then, I hope you can see that the blended branches example how we are executing our strategy and the opportunities we still have in the States in this business. Performance is improving. We're very focused at organic growth at a detailed level.

The plumbing and heating market in the US is large and very attractive and less volatile because of its reliance more on the RMI customers. But we still have plenty of growth to go for and at a healthy margin. So we're pushing forward in blended branches and investing all we can sensibly. At the same time, working hard to ensure we execute as well, in other markets across the Group.

And on this theme, although we're making decent progress in many businesses, we know we are not yet executing consistently across the whole Group. So two years ago we established a process to make sure we're sharing and adopting best practice. This is beginning to work well now.

This is the front page of the portal we use. On the left-hand side here, sorry, you can't see it too clearly, but these are all of the current areas, 11 areas that we are digging into, ranging from branch staff training, gross margin management, vendor management, sales force productivity. So there are specific targeted areas that we're working on.

We run video conferences with all our top 150 managers each month so that they can see other business -- what other business units have achieved. And when we see great work in the monthly performance reviews we add it to the portal and make sure all the top team are aware. Our experience suggests that good managers will adopt good ideas pretty rapidly if it will help deliver better bonuses.

As our business units have begun to perform better, we have been able to focus a bit more on delivering synergies across the Group. We're going to continue on this path to make sure that there really are hard financial benefits from being part of the Wolseley Group. We're now delivering in excess of GBP20m from cross-business-unit sourcing activities, mainly across Europe. And we've only just started to get the US and the European teams to work together, hence we do see some more potential for hard sourcing benefits.

We've already benefited from a single approach to our IT platforms, infrastructure, data centers and telephony across the Group over the past couple of years so we see limited future potential here. Clearly our move to Zug has been very beneficial to our Group tax position and our strong balance sheet allowed us to access low-cost financing for the whole Group.

Best practice sharing, as I mentioned, is beginning to work. The great work the UK team completed on gross margin management has now been adopted across many markets and is another reason why we have managed to hold on to our gross margins. Also the work on customer service measuring and product availability has been adopted following the US lead. We certainly have much more potential here to drive performance.

We're getting better and moving talent across the Group. For example, the CFO in Canada was from Plumb in the UK. And he's made a significant impact on the business, although obviously difficult to quantify. But we know moving talented people around rapidly accelerates best practice adoption.

Finally, we're beginning to find ways to converge our business model so that over time, by evolution, we will find common processes and practices and supporting IT platforms that give us an advantage over smaller local competitors. For example, we know that managing our pricing nationally within clear tramlines locally yields better margins. Reducing local sourcing activity improves cost, reduces risk and delivers better margin and service. Complying with DC-supported programs also yields better results. So being clear what processes are run in branch versus what is run nationally are critical to generate a business model that is lower cost than local competitors.

The e-commerce model that supports build.com in the US is currently being imported into the UK, avoiding cost duplication and saving three-year learning period. So we know that evolving to best business models will over time yield great results. We need to get to the right balance though between staying totally connected at the local level with our customers but deliver the benefits of scale available to us.

Overall we've benefited again then by executing within a clear strategic and operational framework. The US businesses look encouraging. However, our European markets are going to be pretty challenging, we think. We have made solid progress in most areas, but absolutely acknowledge we still have a long way to go.

We know we still have great potential to improve and grow our existing businesses and that is our main focus. So we feel well placed for the long term as our markets come back, but prepared to react if we see some short-term slowdown.

Thank you. We will now happily take any questions.

Howard Seymour from Numis. A couple, if I may. Can I just start on strategic -- Ian, you mentioned winning more work with existing clients. Just a point of clarification on that really. Is that the three segments that you mentioned there specifically or is that a similar organic initiative that you've got with your existing clients?

And secondly, related to that, as you go into those markets, do you see the majority of the growth coming from organic growth of what you've got or does it require acquisitions?

Yes. Very much our thrust across the whole business, the whole Group is gaining wallet share of existing customers. When we dig into the customer research we only find about 50% of our customers use us on more than 50% of their needs, so there's a huge opportunity for us to just gain wallet share from customers who may buy 10% or 20% of product from us but they're using clearly a competitor of ours for their major needs. And in terms of the growth, all of this will be coming organically.

So when I talked about facility maintenance, hospital and government which are segments that we're beginning to penetrate, absolutely we can see that growing organically with the dedicated resources. Again, I think over time could we see some small add-on acquisitions in those areas? Yes, that would make sense as part of our strategy to gradually consolidate the market by taking add-on acquisitions when they come up. I think we've probably bored you to death how disciplined we're going to be on it though. And deadly serious, we mean that because we absolutely want to get the returns on the money that we're investing. Does that make sense?

Okay. The second one was just a little bit simpler, I think, and just really on Canada, because Canada last year had a higher first-half skew than traditionally. What would you see -- because you mentioned the French so I think if you can give a direction on that, I might as well ask on Canada as well? Would you see it as a more normal 50/50 split this year in the Canadian market?

Wel,l I think quite possibly, Howard. We clearly don't mention the weather, but they've had a decent spring so far and I hope they're getting some pipes in the ground. I think overall my observation in Canada is the most important thing is the business now keeps momentum. It has got some momentum back now over the last six months and we need to keep that momentum on and get back to taking market share in blended branches. And if we do that, I could imagine the second half being slightly better.

Okay.

Thanks, Howard.

Thank you. It's Charlie Campbell from Liberum. Two questions from me, please. I just wondered if you could give us a bit more detail about how the second half has started, just by different geographies.

And the second question, the GBP11m item in Ferguson, just wondering if you can give us -- how much confidence you can give us that that won't repeat and just give us a bit more guidance on or a bit more color on what period that relates to? Is that just last year or a period of years, just to help us understand that a bit more?

Sure, if I take the first one, John, you can have a go at the second one. In terms of the second half, I think, look, overall the trends that we've seen since the end of January, just overall trend about the same. US slightly stronger. Europe slightly weaker. Okay? And I think if we look at the US continues to look more optimistic, you see all the stats that we do, new housing starts up to at least 700,000. But all the whole range of data, consumer confidence picking up, delinquency rates dropping off, unemployment coming down, employment going up. Now again, we're at the early stages of this but certainly it does look better than it was six months ago.

And our growth is pretty broad-spread across our geographies. So we're not having radically different geographical expansion, in fact. Even on the West Coast now we're seeing some growth, which is the first time we've seen that in a long time. And in fact the West is coming back now quite well, and if anything it's the East Coast side which had not really had much of a recession which is proportionally a bit lower.

And again, it's pretty well spread across the business units in the States. HVAC is lower, but that's because there were some tax benefits that were used last year that aren't coming in this year. So I think US looks pretty sensible.

Across Europe it's just pretty stodgy all the way across the piece in terms of we've seen a slowdown in consumer confidence in virtually all the markets. The housing starts have begun to come off just a little bit. And if we look forward to the metrics that we see, yes, it just looks a little bit weaker across Europe.

And sorry, just as a follow-on to that, on the US, you said it's slightly better. Is that slightly better than the first half or the second quarter, because there's slightly different numbers?

Second quarter, yes. And in terms of the GBP11m, John?

Yes. The first thing is this issue went back a number of years. And the second thing to say is we picked it up in an internal process methodology review. We got -- it was properly investigated. We put an external investigator on the issue because clearly it's important. It's big. It's material. We dealt with it very promptly. And I think that the individual supplier concerned as a consequence of us having taken it to them said we did something wrong. I think that they saw that as very positive. They remain a very large supplier of ours, so that's good news.

And we've taken the appropriate action. There were a number of people in our organization who knew about it and had walked past it. They're no longer with us.

And finally in terms of the recurrence, we have looked for similar possibilities elsewhere in the business. Interesting learning point, this was an acquisition some time ago that had not been properly integrated. I know it sounds strange; we haven't done any acquisitions for several years. We're still integrating some of them. So that's now been done. So we think not. We think that -- we think that we are at the bottom of that.

Thanks, Charlie. Yes?

Harry Goad from Credit Suisse. Two questions, please. Firstly, John, you were talking about the metrics, the conversion of gross profit to trading profit and you talked about that previous peak number of 22%. In terms of how we get there, how much is just simply reliant upon volume and how much could be from margin initiatives?

And the second question would be could you give us a feel for what the spare capacity is in the business, both in Europe and the US?

Yes. I think on the conversion, I think one observation I would make is if -- is looking at the business now compared with two years ago when I came in, I see more and more opportunity for us to get better and better at running our existing operations in a better way. And therefore we absolutely shouldn't be reliant on volume. We need to get at it and make our operations better. And in that sense, no, it shouldn't rely on volume; we should get on with it. Frankly that's what we're paid to do.

So we're not waiting for volume. It will clearly -- volume helps. You can see that from the US growth now. But if you look at the work in the UK, sure, in the UK at the moment the results aren't coming through because of the impact of that lost contract last year. But just getting down to the detail of managing a business very closely, looking at how to make the operation better, actually really good progress. So I think that's very important in converting that profitability.

So I would say, I know it's written about as self-help measures, that's management. That's what it is. That's what we're meant to be doing. And I think there is plenty of opportunity for that.

I think the spare capacity question, sorry, do you want to take the spare capacity or for me to carry on?

Yes, carry on.

I think the spare capacity question, interestingly, again, just emerging, I'm not sure that historically our expansion was either M&A of new branches or opening new branches. I think there is a lot more scope for putting more volume through our existing capacity, whether it's DCs or branches. We have lots more scope to put more volume through that element which is fixed. Will it need more labor to shift more volume? Yes, absolutely. But does it need lots more real estate? I'm not so sure. I think we need to get better at using our existing infrastructure. So there's plenty of opportunity to put more volume through that infrastructure, both capacity and DCs.

And where we need to expand it, very often that should be looking at existing sites. Do we just need to relocate the existing site because I wonder whether -- it's very easy to take an existing site, say it's profitable, comes to end of lease, roll it over. We shouldn't be doing that. We should be constantly looking at is this a great site? Is it the best site? If not, can we relocate half a mile down the road, get a cheaper site, bigger site, whatever it is, but looking at churning our portfolio and getting the best infrastructure.

I think if you look, we're now still around about, in some of the markets, between 5% and 10% smaller than we were at the peak, but we did take out around about 10% of the branch network. So I think John's point is absolutely right. We don't see any need for incremental DCs or anything like that. We have plenty of capacity. They're only running at -- some of them are running now five shifts. Some are just beginning to move up from that. So there's plenty of DC capacity. And I think a lot more to go at in terms of the existing branch networks. So how do we actually get more value out of our property assets I think is where we're going.

Yes?

Hi. Gregor Kuglitsch from UBS. Couple of questions. Just one really, a bit of housekeeping on the cost inflation. Obviously your 401k costs going up in the first. So maybe you could just give us a bit of a guidance what you see for the second half in terms of cost inflation, whether there's any movements in semi one-offs or whatever it is. That's the first one.

The second one is really on the organic initiatives on page 46. I think if you add those up, trying to do the math, you're talking GBP80m, GBP90m of trading profit incrementally. I don't know if that's correct. And if so, over what time period do you think that's doable? Is it two, three, four years?

And then finally on the cash flow, obviously you've already done a pretty substantial dividend increase. Obviously you're probably going to undershoot your leverage target quite significantly, certainly 12 to 18 months out. What's the sort of thinking there? Is it a position you would like to be in? Would you consider buybacks or continue to grow dividend? Just give us your thoughts on that.

Do you want to do the cost one? I'll do the second one, then you can have a go at the third one.

I always get the cost and you get the rest. We should turn it around.

No, no.

I think cost inflation, look, it's worthwhile sharing with you our mindset. And our mindset is we absolutely have to get leverage, by which I mean if our topline grows at 5%, we want to grow cost at less than 5%. We've said we are, certainly over the short term, we want to see double-digit flow-through of that incremental revenue. And if you do the math on that, you need to hold cost base growth at 1%, 2% shy of the top-line growth. So that's important.

In terms of the one-offs, the only really material items are the ones that we've mentioned, the GBP11m in the US and the GBP5m in France and the UK. There's nothing -- sure, there are other one-offs, but they're in the wash. And for the second half, clearly now 401k is back. Share-based payments, those costs are going to increase again over time until they get to a peak in about a year. But it's far more linear now. The big step up has happened.

In terms of the synergies, I've got to be careful here in terms of some of these we're already delivering. So when I talk about the more than GBP20m on the cross-border synergies, that is already in the numbers. We're delivering that right now. But I think it's still a very fair question. We can absolutely see significant opportunity over the long haul. We're talking three to five years here to absolutely get the best practice sharing and the transferring of the business models across the whole of our Group up to a really good shape.

So on a year-by-year basis what's it going to be worth? GBP10m, GBP20m? Yes. Absolutely. We'd like to get more out of it, and we might be able to do that, but that's the sort of thinking at the moment. But clearly build over time to get to the total number you're talking about. But that's five years out, so that's a fair way out.

And I think in terms of the -- just the share buybacks or whatever, I think we've been very clear. We will fund organic growth, absolutely fundamentally. Secondly, we'll absolutely fund dividends. Thirdly, appropriately add on acquisitions to our core businesses in existing geographies. We absolutely want to consolidate those markets, but we see no reason at the moment to go outside into new markets. And therefore over time, if we get to a position whereby we do have a lot of cash on our balance sheet, we'll return it to shareholders in the appropriate mechanism at the time.

Thank you.

Hi. It's Paul Roger from Exane. Couple of questions. Firstly maybe linked to the balance sheet question. You've obviously talked a lot about the opportunity to gain market share, and yet your CapEx maybe isn't going up quite as much as you estimated. What's behind that? Are you just being conservative? And what do you think for the full year?

And the second thing is on the US and the gross margin. Now you talk about that being impacted by copper price deflation in the first half. Can you talk through the mechanism of how that works and help quantify the impact in the first half, please?

Yes. Okay. Well, I think CapEx, I think in a sense if you look at what the businesses do, we have a budget discussion about CapEx and it's all agreed, and then they go into the year and there's so much management resource it gets switched in those countries, in particular in those businesses where they're facing more operational challenges, more market headwinds, whatever, and their focus stays on managing the core business. I think that's entirely appropriate. So yes, it has been lower than I think it will be actually if we get the markets, particularly in Europe, becoming a little bit better.

I think the second thing is although it's still at historically low levels, GBP64m in the first half is quite a lot higher than we've had for the last couple of years and I do see that rebuilding a little. I suspect now the outlook for the current year is going to be more in that GBP130m, GBP140m range than it was the previous GBP160m. But will it rebuild over time? Yes. And the best view of '13/'14 is probably to that similar GBP160m, GBP170m level.

There are one or two areas in the business where historically we have underinvested. They're not -- it's not a hugely underinvested business, but there are some areas where we need to step up and do some basic infrastructure investment, particularly in the UK, for example. So there will be a bit more investment in some of those areas.

The copper price deflation really happened in the first quarter or the first four months of the period. And the way in which that works is slightly unusual because what happens is a number of customers just become far more aware of input prices of the commodity element of what they're buying and they just become very -- or they just became very price-sensitive. And so when we looked at the margin impact of that, certainly over those few months, there was about GBP4m worth of impact in the first four months in the US. And of course we hear about it when it's bad news. It's probably been good news for the last two months and they haven't told us about it. So let's assume that half of that's gone already. That's probably hopefully enough to give you a sense of the scale of it.

And somewhere in the back there, Roger Connett is around who is the Pipe and Plant FD in the UK. Roger, I'll dump on you here now. Roger's the guy who comes and gives us similar excuses in the UK.

You can round on him later. Thanks.

Sorry, just one quick follow-up. I think you said, yes, like-for-like growth of 5% in the second quarter. How much of that was price positive, if you can give me that.

Well, we've said across the piece inflation was a bit higher in the US, slightly lower in the UK, but in Europe there was a lot less. So it's probably 2.5%, 3% is our guess.

Yes?

Clyde Lewis at Citigroup. Three if I may. One very brief one probably on gross margins in Q3, you very kindly gave us an indication of where turnover trends have gone. Have the patterns in gross margins altered overall? No? Okay. Thank you very much.

Okay, moving on. In terms of acquisitions, I think John mentioned a more interesting pipeline. Is that predominantly or solely in the US? And again, where's the pricing expectations and your thoughts again, acquisition versus organic investment? Where does the balance lie at the moment on that front?

And the second one I had was coming back on margin. Ian, you've again tantalizingly told us you're going to get back to those previous peak margins a few years out, again that vague few years out. So I'm pushing again on that margin, John, talking again very much about confidence in cost and synergies and more belief about self help and your ability to get further forward. Is it not time to raise the bar a little bit and tell us a bit more about where you think you can get above that 6.5% peak?

Just on the -- fair question. The gross margin at the moment is fine. No significant shifts in there.

Look, in terms of acquisitions, yes, I think the pipeline at the moment does look, as John described, better in the US than across the rest of Europe. But we did do a bolt-on in Denmark, one in Norway, one in Sweden as well. Fine. We'd like more of those and the pipeline is looking a little bit better as well in Europe, but the sort of numbers we're talking about, Clyde, are very proportionate to what we've done in the first half.

I think in terms of then margin expectation over the long term, look, absolutely. We've been boringly consistent on this. We absolutely fundamentally do believe we can get back to peak margins. We're getting there. It's another 50 basis points up this time around. It's a long journey. It's a frustrating journey in that respect. But there's nothing that we see in the businesses at the moment, and in fact quite the opposite in terms of challenging can we get back to peak. I think again, as we've said, our ambitions internally are obviously to get past those. But I want to make sure we get back to peak and deliver that before we start talking up a further gain.

But there's a lot still that we can do. I think John's already alluded to the fact that we are getting, I think, far more serious now on the whole productivity area, benchmarking both internally, across business units, within business units, benchmarking across branches. We're getting some good traction there. And also benchmarking against comparator companies. There's some very good comparator companies out there whose ratios are better than ours at the moment, so we know we still have a long way to go on that one.

And time for probably one or two more and then we -- yes?

Just to focus a bit on the cost side a minute. You alluded to the fact that your restructuring costs may be higher than you were previously guiding. I wonder if you can just expand on that.

And in relation to -- there's been a lot of discussion about the positive pull-through conversion on the rising sales line. If you face a situation in Europe individually where you may get the odd country with a negative top line, can you just describe to us again the process of what you're prepared to do in terms of taking costs out and in a sense the consequence that that may happen?

Do you want to get that one?

Yes. On the restructuring costs, I think clearly in Europe we've got some businesses that -- there are some of the businesses in any case that were slightly lower margin, somewhat lower margin where we've got unfinished business, to put it bluntly. And we're still looking at how to convert those businesses to an appropriate return on sales. So the combination of that and market in one sense is difficult and in the other sense it gives us an opportunity to get on with the job. So we should do that, and we know we've got a couple of businesses that fall into that category. So whilst we haven't got the absolute scale of those today, we are absolutely working on that. In other areas it will be more incremental.

And coming to your second point on what happens if we get negative top line, we worked through for you and for shareholders last autumn what would happen if we, for example, saw a 10% contraction in our top line overall, and we talked through that example. It was a proper worked example. We've got about 8% or 9%, typically 8% or 9% of variable cost, immediately variable sales commissions and freight costs. We would accelerate looking at any of our infrastructure that we just not contributing much incrementally.

There are always a number of branches. We've said we're going to churn branches anyway on an ongoing basis, typically 1% or 2% of the estate. And you might step that up in a downturn scenario and look more carefully, because fundamentally you don't want to shut anything that's profitable and got a good probability of being profitable in the near future. But if something's been marginally profitable for several years and is consuming cash then you've got to look at it fairly hard.

And I think then the final thing is we need to focus on just how to do our business better. And if I gave you an example now, one of the businesses in the Nordics has just converted all of its customers to electronic billing. It got from 0% to over 90% in three or four months. Now sat here to you guys who are doing your shopping online every day, you must think that's strange. But actually this is a fairly conservative space and we have plenty of opportunity to do those things. And of I told you that the printing cost for invoices alone in the UK are about GBP1.8m, it's a tiny little opportunity, but quite frankly for GBP1.8m, it's worth getting out of bed. And that's what we should do.

Now that sounds easy, but of course there's a system conversion and there's all sorts of other reasons why we need to do it. But there are 101 projects like that that we need to get on with. And frankly in those businesses where we're not generating the appropriate return today, that gives us more of an opportunity and more of a requirement to get on with it and do it.

I think what we're doing and getting better at now is being very targeted, very specific. Taking the States, our industrial business is growing 15%, 20%. Great. We're putting more resources in there. But actually Georgia and Alaska are declining at the moment for all sorts of different reasons. So that's the sort of targeting we're doing. In Denmark, Copenhagen is booming, but around Aarhus is tough.

So again, we're looking at very targeted approaches. So I think what we want to communicate is expect us to keep doing that. Where we see growth we'll invest. Where we see decline we'll take costs out in a very targeted way. Does that make sense?

Yes. Absolutely. Would it be fair to say that the most unfinished business in terms of cost structure, etc., is still France?

Yes. Yes.

Thank you.

Morning. Andy Brown, Panmure. A quick question. Asbestos, I've seen the note in the statement. Is it fair to assume it's become a bit of a non-issue or is there stuff going on in the background we need to be aware of?

No, non-issue would be too glib. We went through it the last time around. No health and safety issues. We wrote out to our 20,000 customers. We explained the situation to them. We had a lot of interest. We put up a website with all the data on it. We had 500, 600 customers using the website and things like that. But at the moment there is no follow-up litigation or anything like that.

Unfortunately one of our biggest customers, Duke Energy or Duke Power, which are a nuclear power company in the States, they actually replicated exactly what we did. So they repeated our testing to make sure that we were, in inverted commas, in the right place. Totally confirmed where we were. So it was great to see Duke Power and one of our other biggest M&E contractors come out and support us. So at the moment we're not seeing anything that's coming through in terms of further litigation.

Last two. There we go. Yes? Tom?

Morning. Tom Sykes from Deutsche Bank. Just a quick one on the own label US sales that you gave. Are own label sales applicable across all customer segments or do you grow more in own label say in residential RMI or, I don't know, industrial or -- and does it pick up in new build, affect the percentage that you can get of Group revenues from own label at all in terms of the mix?

And then just in terms of the -- either at the Group, and it's a bit broad based, the Group or maybe the US. How much is actually picked up from the branch and how much do you actually deliver to customers at the moment and what is the trend in that split, please?

Yes. In terms of -- look, in terms of own label, no. It obviously varies massively business unit by business unit in terms of the sort of split and spread of it. We're running just below 8% in the States. That is predominantly more in the plumbing and heating business. So that's a good area for us. And clearly in our showroom business as well we'd expect that to pick up.

And in terms of new build, I'm thinking of the mix of the business there, that's probably marginally, but marginally beneficial for own label in terms of the product mix. There's more opportunities for us. Again, clearly that's going to be more through the showrooms. Does that give you a sense?

Yes. Yes.

Yes, and I think on the pick-up versus branch, actually this varies very considerably across the business and across business units. So there are some business units, industrial in the US, for example, where it's overwhelmingly -- where the product is overwhelmingly delivered. Blended branches we've got a lot more pick-up. If you go into the heavy side in Europe, there's a lot more delivered, typically 60%, 70% might be delivered. But even that varies very considerably by customer practice, by branch.

I would say a couple of things on delivery. One is it's absolutely fundamental to have that facility available for customers. And number two, we need to make sure that we charge properly for that. And I don't think we've always done that. And that's not a negative thing. It's just that we should differentiate between the delivered price and the pick-up price. Put bluntly, that's because we've got a different cost to deliver.

And I think the final thing is I suspect that there will be a trend towards -- a slight trend towards more delivered in the mainstream business.

Right. Sorry, just in terms of the blended branches, say, in the US, is the majority pick-up there at the moment?

Of small plumbing, rough plumbing type gear behind the wall, I would say yes.

Okay. Okay. Great. Thank you.

Morning. It's Paul Checketts from Barclays Capital. Ian, you've mentioned generally along the way some commentary on market share, but could you tell us what you think the numbers look like in terms of market share gains versus underlying volume for some of the markets, please?

Sorry, Paul, could you say it again?

Yes. I'd like to know the market share gains versus underlying volume gains for the regions, if possible.

Okay. Yes. Do you want to --?

Well, I guess, Paul, is your question what's volume, what's inflation, what's market share?

Exactly.

Well, let's just stick to the US for a minute because we might be a long time answering that one. We might need to pick it up -- we might need to pick it up separately. If you look at the US like-for-like growth over the period of 9%, we think market share is 5% or 6% of that. Inflation is most of the rest, and we think the market is relatively, relatively flat. Now that's an overarching comment because there ought to be a few percent -- there ought to be 2% or 3% market growth actually in the UK -- sorry, in the US. But we've got HVAC as the lower end of that. But that's our overall view. 3% or 4% inflation, 5% or 6% market share gains and volumes have been relatively flat in this period across our mix.

Okay. And lastly, I think consensus for earnings is about 161p. You delivered 78p in the first half. That implies second half you make no progress. That doesn't sit comfortably with the momentum in the business at the minute. What would say about that?

We're not going to make no progress. That's a dreadful way of thinking about the busiest time of the year. Well, firstly on the consensus EPS, it is what it is. And clearly we haven't come out today with a profit warning. Frankly we do expect to get some growth. We've said since the end of the half we have -- we've had some growth; slightly lower overall, but only slightly. And we would expect to get appropriate flow-through of that. And I've said that we should be targeting, if we can, to get to double-digit flow-through of that in the second half.

Thank you.

It's a pleasure.

Good. I think that's it for the day. Thank you very much.