G4S plc Interim Management Statement Conference Call
Nov 06, 2012 AM GMT
GFS.L - G4S PLC
G4S plc Interim Management Statement Conference Call
Nov 06, 2012 / 08:30AM GMT
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Corporate Participants
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* Helen Parris
G4S plc - Director of IR
* Nick Buckles
G4S plc - CEO
* Trevor Dighton
G4S plc - CFO
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Conference Call Participants
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* Jaime Brandwood
UBS - Analyst
* Daniel Patterson
SEB Enskilda - Analyst
* Paul Checketts
Barclays Capital - Analyst
* Andy Grobler
Credit Suisse - Analyst
* David Hancock
Morgan Stanley - Analyst
* Michael Lofdahl
Carnegie - Analyst
* Julian Cater
Canaccord Genuity - Analyst
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Presentation
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Operator [1]
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Welcome to the G4S interim management statement. For the duration of the call, you will be on listen only, and at the end of the call you will have the opportunity to ask questions. (Operator Instructions). I now hand you over to Helen Parris to begin. Please go ahead.
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Helen Parris, G4S plc - Director of IR [2]
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Thank you. Good morning, everyone, and welcome to our interim management statement conference call.
In a moment, Nick Buckles, our CEO, will take you through the key points of the statement for the year to date. Trevor Dighton, our CFO, will then make some brief comments on our financial position, and then we'll open up the call for some Q&A. As this is just an update on current trading, we don't intend to get into a great amount of detail on specific countries or companies today.
I'd now like to hand you over to Nick, who'll give you a brief summary of today's statement.
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Nick Buckles, G4S plc - CEO [3]
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Good morning, everybody.
As you all know, the last six months have been very challenging for the Group, but I'm pleased to be able to report that despite the challenges of the Olympic Games this summer we have remained focused on our business and our customers and are pleased to provide you with an update on our current trading.
As you can see from our statement this morning, excluding the London 2012 contract, we have seen revenues grow 6.3% at constant exchange rates, 4.1% at actual exchange rates, with the strength of sterling continuing to have quite a significant negative impact. To highlight the extent of this impact, the full-year 2011 PBITA would have been around GBP12m to GBP15m lower at current exchange rates.
We have seen a step up in organic growth in our developed markets business and continue to see strong growth in our developing markets. Overall organic growth was good at 5.5%, excluding the 2012 contract, with 4% in developed and developing markets continuing to grow strongly at 9%.
In Secure Solutions, the strongest performing businesses in developed markets in the first nine months continued to be the US and Canadian commercial businesses and the UK government business, where we're now experiencing year-to-date double-digit growth with the comparatives getting easier and with obviously all the new contracts ramping on.
In Europe, the best performing countries were Austria, Finland and Norway, where organic growth ranged between 7% and 14%. But Eastern Europe continues to be challenging, with further revenue declines in markets such as Romania, down 7%, Hungary down 16% and Czech Republic down 11%.
Growth in developing market Secure Solutions was lower than at the half-year due to low growth in the Middle East region. This is entirely due to Iraq and Afghanistan. The outlook for the Middle East is more positive, with improving trends particularly in the UAE, where we've had a number of recent contract wins in the ports, utilities and government sectors. So we do expect the Middle East double-digit growth to return in 2013.
Outside of the Middle East, the other developing markets regions achieved close to double-digit or higher growth, with especially strong performances in LatAm, in markets such as Argentina, Brazil, Ecuador and Peru, all of which grew around 20%.
In Cash Solutions, we continued to deliver good organic growth of around 10% in developing markets. The businesses in the Middle East and Asia have all grown particularly well. In developed markets Cash, organic growth was affected by the loss of the HSBC contract in the UK halfway through last year, but organic growth improved to around 3% in the third quarter after being minus 6% in the first half. And we expect further improvements to growth and margins in 2013, as new contracts at RBS and Lloyds are still being rolled out, although we haven't seen the margin improvement in the second half that we did expect from these new contracts as there have been startup costs involved in those.
Overall margins for the nine months were down three-tenths, excluding the London 2012 contract, due mainly to contract startup phasing in the UK government business and the previously mentioned problems we've had with the US government, particularly, business.
So that concludes our overall remarks on trading. I'd now like to hand you over to Trevor to talk about our financial position.
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Trevor Dighton, G4S plc - CFO [4]
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Thanks, Nick. As at the full year and the half-year, our financial position remains strong and we've got significant current headroom from committed funds. As mentioned in the statement today, our estimate of the loss on the London 2012 contract remains in the region of GBP50m. We also still expect to have an exceptional charge of around another GBP10m in the second half of 2012 for the restructuring and related headcount reductions undertaken this year.
We've spent GBP103m on acquisitions in the year to date, with the most significant being the acquisition of Vanguarda, a leading security provider in Brazil. This significantly increases our position in this important developing market, and we're very pleased to announce a major system contract with Telebras shortly after concluding the acquisition. We expect to spend around GBP120m in total on acquisitions for the full year.
With our continued focus on debtor management, cash flow also remains strong, and we're on track to hit our cash conversion target of 85% of PBITA for the full year.
Okay. I'll pass you back to Nick for some final remarks before opening the call for Q&A.
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Nick Buckles, G4S plc - CEO [5]
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Okay. Thanks, Trevor. So the business has continued to achieve good underlying organic growth, and it's a testament to the strength of the Group and its relationship with customers that we achieved a good performance despite the issues around the Olympic Games.
Our underlying expectation is to maintain Group margins at around the 7% mark in the future. However, in the short term, in the current economic environment, there is some gross margin pressure particularly in Continental Europe. Our overhead restructuring plans were put in place earlier this year to offset this pressure and get the margin back towards 7% in 2013. We still believe we'll get close to that, but conditions in Continental Europe and US government market are likely to be an ongoing challenge.
That concludes our formal remarks, so we'll now be happy to take your questions. So over to you for Q&A
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Questions and Answers
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Operator [1]
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Thank you. (Operator Instructions). And we have a question coming from the line of Jaime Brandwood from UBS. Please go ahead.
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Jaime Brandwood, UBS - Analyst [2]
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Morning, Nick. Morning, Trevor.
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Nick Buckles, G4S plc - CEO [3]
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Morning.
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Jaime Brandwood, UBS - Analyst [4]
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Just to start with, can I ask about the cash flow which you say has remained strong? As I understood, at the last Select Committee hearing there was this issue surrounding cash payments from the Olympics contract, that you'd only received GBP90m out of the total expected revenues of, I guess, 230-something-million. Is it still the case that you're waiting for those cash payments from LOCOG, or have they now come through?
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Trevor Dighton, G4S plc - CFO [5]
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We're still discussing the total finalization of the Olympic contract, and that we're treating as a separate item. When I talk about cash flow generation, I'm talking about the main business. Yes, the discussions with LOCOG are still continuing and we'll sort them out before the end of the year. But we're still finalizing the actual billing, so there's no point in saying what invoice is still outstanding. There's still a total discussion on the final outcome.
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Jaime Brandwood, UBS - Analyst [6]
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But you are expecting that to be finalized before the yearend?
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Trevor Dighton, G4S plc - CFO [7]
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Yes, we are. Yes.
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Jaime Brandwood, UBS - Analyst [8]
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Okay. And just on the organic growth, as you commented at the start, you saw a bit of acceleration in developed markets and I guess a tiny bit of deceleration, if we try and back out the Q3, in emerging markets. Just to understand, in the developed markets, is the main source of the acceleration the acceleration in UK government and the reduced rate of decline in US government, or is there anything else that's moving the dial in terms of that developed market organic growth?
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Nick Buckles, G4S plc - CEO [9]
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I think, just to give you an idea where the trends are going, UK Secure Solutions definitely picked up well. And then there are -- and that's driven almost entirely by UK government, where I mentioned double-digit growth year to date now. So, there's five or six contracts we've taken on are obviously improving that, and the comparative gets easier as court services dropped out in end of August last year.
Commercial in the UK is pretty flat, as before. European Secure trending down slightly. Developing markets on Secure and Cash, pretty much the same, apart from the Afghanistan, Iraq issues. Double-digit expected still there. UK Cash trending up, as expected. Europe cash trending down slightly, because of all the -- we had quite -- still had a benefit in the first half from the Belgian situation. And they're pretty much the trends. So the one single figure which is driving increasing growth is the UK government, really, if you take the pluses and minuses.
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Jaime Brandwood, UBS - Analyst [10]
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Yes. But presumably North America Secure Solutions has improved a bit in Q3, just by virtue of reduced rate of year-on-year decline in US government.
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Nick Buckles, G4S plc - CEO [11]
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Not really, because the commercial isn't going to be 13% in the second half.
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Jaime Brandwood, UBS - Analyst [12]
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Right. Okay. That's perfect. And then just on the developed markets, is the reason for the slight slowdown in Q3 entirely to do with the shutdown or termination of the Kabul Embassy contract?
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Nick Buckles, G4S plc - CEO [13]
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It's to do with the Iraq and Afghanistan all together, yes.
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Jaime Brandwood, UBS - Analyst [14]
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Okay. All right. Perfect. And then just lastly, in terms of the commentary around UK government, what's the situation at the moment on bids, prison bids, etc.? What's your feeling about converting any bids before the yearend?
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Nick Buckles, G4S plc - CEO [15]
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Well, I think it's pretty well expected in the market that we expect the prison bids to be announced sometime this week.
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Jaime Brandwood, UBS - Analyst [16]
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This week? Okay.
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Nick Buckles, G4S plc - CEO [17]
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And we're still hopeful that our track record, particularly over the last 12 months where we did some pretty difficult startups, actually, and did them very well, will hold us in good stead. We haven't got any insight to that at all, but we're pretty much in the same position as we were. The bid's been in, it's a good bid, and we hope to have a positive outcome. That's the only real major bid that we'd expect to hear about, I think, even this year, in terms of government.
Bedfordshire, Cambridgeshire and Hertfordshire we're still working through. Clearly that's going to be impacted by the elections. But if we get through that, we're hopeful some -- for a positive decision towards the end of the year, but there's a couple of hurdles to overcome there.
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Jaime Brandwood, UBS - Analyst [18]
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And just on the prisons, you've got seven bids out of the nine that have been tendered, is that right?
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Nick Buckles, G4S plc - CEO [19]
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Yes.
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Jaime Brandwood, UBS - Analyst [20]
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Thanks very much.
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Operator [21]
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Thank you. Our next question is coming from the line of Daniel Patterson from SEB. Please go ahead.
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Daniel Patterson, SEB Enskilda - Analyst [22]
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Yes. Good morning, gentlemen. Just one question. I know this is a recurring speculation in the market, but yesterday we saw Mr. Stanley Gold sending a letter to the board of Brink's about the -- he wants them basically to sell the company. What's your view on this? Would you be interested at all in looking at Brink's? And what's your thoughts around this?
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Nick Buckles, G4S plc - CEO [23]
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Yes. I always answer this question in the same way. We would always be interested in transactions which we believe would enhance our strategy and enhance shareholder value, but it's not something that's on our radar at the moment. We're still going to talk to shareholders over a period of time about major acquisitions. Clearly, after ISS, we got a steer clear that -- a clear steer that that wasn't going to be our strategy in the short term.
Brink's is an attractive business but, as I've just said, I think the whole issue around major transactions would be one that we need some time to talk to our shareholders about. And it's pretty fresh as well. It only came through yesterday, didn't it, so.
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Daniel Patterson, SEB Enskilda - Analyst [24]
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Yes. Okay. I think that's clear. Just one follow-up on the RBS and Lloyds contracts. When do you expect them to be fully ramped, so to speak?
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Nick Buckles, G4S plc - CEO [25]
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They pretty much are now, so we should see a little bit of improvement in the final quarter. But -- and next year's budget will see some progression, but probably not quite as great as we hoped. It hasn't really returned to previous levels in terms of profitability.
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Daniel Patterson, SEB Enskilda - Analyst [26]
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Okay. Thank you.
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Operator [27]
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Thank you. (Operator Instructions). We have a question from the line of Paul Checketts from Barclays Capital. Please go ahead.
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Paul Checketts, Barclays Capital - Analyst [28]
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Morning. If I can just ask a question on the downgrade of the -- of your investment grade, are there -- I don't think there are, but can you just confirm there are no implications for the interest level you'll be paying?
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Nick Buckles, G4S plc - CEO [29]
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Just before I pass you over to Trevor, I think what I would say is we're very pleased to see that S&P confirmed they expect us to continue to grow strongly. We're in a strong position in terms of organic growth and cash flow generation, and we were described as strong. It sounds like the downgrade is more around the project management around the Olympics, but overall I think the report was very positive about us. But I'll pass you over to Trevor in terms of the detail of it.
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Trevor Dighton, G4S plc - CFO [30]
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Yes. My take is it's a bit of a reflection on credit rating agencies continuing their trend of more stringent measurements, I think, because the report itself was quite strong. Absolutely no impact at all on our borrowings. Our current borrowings are not impacted not at all. If we go out to the market for new borrowings, it might impact by 20 basis points, but money is so cheap at the moment that it wouldn't make an awful lot of difference to it if we put another bond out shortly, which we might possibly do. So, yes, no impact at all.
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Paul Checketts, Barclays Capital - Analyst [31]
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Okay. And if we just move to the US government space, is there anything completed on Diego Garcia?
And in the same vein of questioning, I think you lost Oak Ridge contract. Is the weakness there generally rather than losing contracts? Is it more about the government reducing volumes on ongoing contracts?
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Nick Buckles, G4S plc - CEO [32]
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US government business, as I mentioned at the half-year, has suffered from a number of factors. The main impact on profitability in the first half was the decline in the mine clearing business, and that's also had an impact on the UK risk management business as well. So that was a big profit impact from prior year. The domestic or the high-level security business was really -- has really suffered from rebids in terms of pricing, but also reductions to services in existing contracts due to, I guess, reduced threat levels and budget cuts. So that's been the underlying issue.
Oak Ridge, which we've had for a number of years, finishes this month. And that was really down to an operational issue which emerged during July/August time, which we've now solved and sorted out with the primary contractor. But we are going to step out of that, and that's about $80m a year. But then we are going to start the processes we removed from Diego Garcia, and that's going to start in March and that's about $45m to $50m a year. And although that's not US domestic business, clearly that's where we're going to show it because it's run by the US government piece.
So the ongoing trend there is that we expect the organic growth to pick up in the second half. First half will still be strongly negative. The margin is down at 1.5%, 2% anyway. We don't see that improving significantly. But hopefully, with a new government elected, there's a number of bids that we have in the pipeline and hopefully there'll be some decisions made there which will give us some new starts in the first half which we haven't budgeted for.
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Paul Checketts, Barclays Capital - Analyst [33]
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And if I can just follow up on your comments on margin, Nick, for next year, it sounds like 7% is probably going to be a bit of a stretch. What are your thoughts on is it going to be flat, are we going to see 10, 20 basis points improvement? How do you think it's going to pan through?
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Nick Buckles, G4S plc - CEO [34]
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This time of year is always a difficult time of year to make predictions. You know we don't typically make very firm predictions anyway. But I think it's fair to say the Continental Europe business is much tougher than we expected. In fact, probably each quarter it's got tougher as we've gone through the year. The US government piece is there, and it will recover slightly but not significantly. So our overall view is that the margin will be slightly better than this year but it won't be back towards 7%, slightly better. And that's than this year's number, if you strip out the Olympics, basically.
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Paul Checketts, Barclays Capital - Analyst [35]
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Okay. Thanks very much.
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Operator [36]
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Thank you. Our next question is coming from the line of Andy Grobler from Credit Suisse. Please go ahead.
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Andy Grobler, Credit Suisse - Analyst [37]
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Hi. Good morning. Paul actually asked most of my questions on margins. I just wanted to ask about Europe. You've mentioned that that has got incrementally tougher and that Eastern Europe is particularly challenging. What about -- within your Western European operations, in the Benelux and Scandinavia, are there any areas in particular that have got -- have become more challenging? And where are those challenges? Is it in terms of price or cost or volume?
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Nick Buckles, G4S plc - CEO [38]
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It's really the continuing issue in places like Benelux, Scandinavia, where you've got pretty consolidated markets or very consolidated markets. There's not a lot of new business. There's no government outsourcing. There's very -- nearly all the in-house guarding's been outsourced. And so any work moving around just moves around on lower prices, basically.
So if you're replacing 10% to 15% of your business every year, then it's going to be at significantly lower margins, and that impact comes through over time because the pricing's dropped in the market, basically. And so that's why we've alluded to gross margin (technical difficulty) trimmed 1% or 2% off the overhead in Europe, but then the gross margins have probably come down, not quite as much but similarly, and that's the challenge we've got, basically.
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Andy Grobler, Credit Suisse - Analyst [39]
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And do you think that that change is a structural one? Are those pricing points going to be the norm for the next few years?
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Nick Buckles, G4S plc - CEO [40]
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I think it depends what happens in the general macroeconomic environment. These countries, as you've seen in the past, have gone extremely well when there's good growth in the markets, because the business grows and margins are improved with price increasing outstripping wage awards. But in an ongoing recession which has lasted three or four years there now, customers are just used to getting lower prices, basically. That will change once the economies start picking up.
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Andy Grobler, Credit Suisse - Analyst [41]
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Okay. Thanks very much.
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Operator [42]
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Thank you. Our next question is coming from the line of David Hancock from Morgan Stanley. Please go ahead.
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David Hancock, Morgan Stanley - Analyst [43]
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Morning. Yes. Two from me, please. One, on acquisitions, does the tougher environment in Europe make the acquisition environment better rather than worse?
And the second question's on the timing of the phasing of cost savings. How do you expect those to progress as we go through the rest of this year and into next year, please?
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Nick Buckles, G4S plc - CEO [44]
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Yes. Acquisitions, as we've said previously, we're really focusing on developing markets. Typically, we'd expect half to two-thirds of our spend to go into developing markets. Europe would be more around capability building. You saw us recently buy a fire and safety business in Belgium. So there wasn't really a lot of acquisition thought or thinking going into Europe, and indeed most of the companies that could be available are usually smaller manned security businesses. And we -- although in the short term you can build incremental earnings through those types of acquisitions, they've never really been on our radar. So it doesn't really impact our acquisition strategy.
In terms of the cost reductions, we said at the half-year we'd expect in a full year to deliver GBP30m plus. So, in theory, there should be another GBP15m coming through next year, in terms of cost reductions. But clearly the point I alluded to in Europe has meant some of that has been eaten up in terms of margin. But certainly don't see any other margin changes other than the Europe situation, which I've already described.
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David Hancock, Morgan Stanley - Analyst [45]
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Great. Thank you.
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Operator [46]
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Thank you. Our next question is coming from the line of Michael Lofdahl from Carnegie. Please go ahead.
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Michael Lofdahl, Carnegie - Analyst [47]
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Yes. Hi. I have two questions. First, if we turn the question around regarding acquisitions, are there any markets in Europe that you're thinking of leaving, as you have done in the past in some countries?
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Nick Buckles, G4S plc - CEO [48]
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Our divestment strategy which we pushed up at the Capital Markets Day hasn't changed. There's four or five criteria. If we believe the businesses we own are not going to meet our long-term margin targets, that would be a decision point to decide whether we should have a closer look at whether we should own that business. If there's another parent willing to pay an attractive premium for those businesses, then clearly that would make it even better. If we don't think we can extract value from the business in terms of best practice sharing that would be another.
So we run the rule across the businesses probably every half-year. And there's no businesses at the moment we have that are creating a real concern in terms of profitability or strategic fit. But as we go through that exercise, there will be some that come onto the agenda, I'm sure.
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Michael Lofdahl, Carnegie - Analyst [49]
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Okay. Thanks. And second question, I know what you've said before, but the healthcare reform in the US, given, of course, the election today in the US, I don't know what happens with that. But if we assume that the ObamaCare comes in place in 2014, what's your -- how do you prepare for that, or what can you do to prepare for that?
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Nick Buckles, G4S plc - CEO [50]
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Well, our US government business is predominantly cost plus and there's pass-through costs in there anyway, so we don't have an issue in that. In our US commercial business, it really depends on the contract and what current schemes that our employees are in. And our view is that on the -- if we have significant costs on some contracts, not all of them, from introducing the new schemes, then we'll pass them on to customers.
That's one thing. I have to say our US business is going particularly well this year, as I mentioned earlier. Organic growth's dropping a little bit, but it's still strongly double-digit. Margin slightly improving and they do have extremely good relationships with their customers. And on a customer-by-customer basis, which is the difference, clearly, between US, UK markets and Continental Europe, you could make those negotiations site by site, depending on your cost increases.
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Michael Lofdahl, Carnegie - Analyst [51]
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And you think the customers are going to accept you passing on that cost?
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Nick Buckles, G4S plc - CEO [52]
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It depends on the customer and the relationship and the degree of competition in those -- in the different parts of the market. But in principle, we've passed on, in my experience, in the last five or six years, any cost increase that we've had in the US, basically.
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Michael Lofdahl, Carnegie - Analyst [53]
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Okay. Thank you.
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Operator [54]
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Thank you. (Operator Instructions). And we have a question from the line of Julian Cater from Canaccord Genuity. Please go ahead.
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Julian Cater, Canaccord Genuity - Analyst [55]
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Good morning. I'd just like to ask a couple of questions on your comments on the Lloyds, RBS cash contracts. You said that the startup hadn't gone quite as well as you'd expected, you'd incurred more costs. And then I think you later said you don't expect those contracts to achieve previous levels of profitability. Can you expand on those two comments, please?
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Nick Buckles, G4S plc - CEO [56]
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Yes. Wasn't quite what I said, was nearly what I said. So we lost about -- I think about GBP15m revenue towards the back end of last year. And then we had the hiatus between then and June time, to take cost out or leave cost in in order to start the contracts that we'd won, which would more than replace those contracts. And basically -- so that was one of the reasons that we've seen the margins dropped in the first half.
And then, in theory, we were going to put the business back onto the same sort of level in terms of gross margins and revenue very quickly, by just replacing the business that we'd lost. But clearly things changed in the operation during those periods of time and they didn't just go onto the network as expected. Operationally, they've gone smooth. There's no issues around the take on. It's just the fact that the gross margin that you'd expect to generate quickly on those contracts hasn't come through quite as quickly. But it will do.
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Julian Cater, Canaccord Genuity - Analyst [57]
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Okay. So you will get back up to the previous levels of gross margin on those contracts that you've seen historically?
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Nick Buckles, G4S plc - CEO [58]
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It's not exactly that scientific on a network type business. I think what I also said is I don't think the margin next year will return to the 2011 level for UK Cash, which I guess would be a sort of comparative. But it will be back up to a decent level.
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Julian Cater, Canaccord Genuity - Analyst [59]
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Yes. Okay. Thank you.
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Operator [60]
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(Operator Instructions). We have no further questions coming through from the telephone line.
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Nick Buckles, G4S plc - CEO [61]
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Well, thanks, everybody, for joining the call today, and I look forward to seeing you all soon. So thank you very much.
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