discoverIE Group plc

LSE:DSCV

Earnings Call Analysis

Earnings Call Transcript 2022-Q2

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Good morning, everybody. Welcome to the discoverIE interim results for the 6 months ended 30th of September. I'm Nick Jefferies, and with me is Simon Gibbins. We're going to run through the slide pack of results. I'll start with an introduction, and then hand over to Simon, and then back to an operational review at the end.So we're pleased to report that in this period, we had very strong organic performance. Record organic growth in orders, sales and order book, along with the underlying earnings per share. So orders were up 64% organically compared to the last year. That's 34% ahead of 2 years ago the pre-COVID period. Sales, likewise, up 15% and up 8% organically versus 2 years ago. And the order book up a very strong 71%. So that, along with tight cost control, has meant that underlying earnings per share are up 37% on last year and 18% on 2 years ago.I think the key point to really make though is that since we started to accelerate the D&M strategy 4 years ago and 2/3 of our acquisition value has been made over the last 4 years, our organic growth since that -- over that period is 9% CAGR, and underlying earnings per share is 17% CAGR, bringing in the benefit of the acquisitions.Along with -- that, along with our organic performance, we've concluded the exit from our Custom Supply channel with the sale of Acal BFi announced earlier this month and the sale of Vertec South Africa announced last month. That means that the group is now wholly focused on Design & Manufacturing, which is obviously the higher margin part of the business.So our underlying operating margin for the continuing business when stripping out the discontinued Custom Supply division is now into double digits for the first time at 10.3%. And we, therefore, raised targets, as you'll see later, to increasing our margin targets to reflect the disposal.The other thing to point out is that following the sale of Acal BFi and the proceeds from that, our gearing will be at less than 1 at 0.9 on a pro forma basis. So that obviously gives us quite a bit of horsepower for further acquisitions in the D&M space.Over the period, we've made 3 acquisitions for GBP 85 million. So we announced Beacon and Antenova in September, supported by a GBP 55 million equity raise; and just prior to that, CPI. All 3 of those acquisitions are performing very strongly, and we're pleased with the integration so far.You may remember that back at the full year results, we talked about the need or the expectation of seeing a strong recovery in project design activity. Well, we're pleased to say that, that has happened. We've seen a very strong recovery in design wins as well as new project activity.ESG is taking up a lot of our thinking time at the moment in our actions. I'll talk more about that a bit later. But just to say at this stage that we have a lot going on in relation to reducing our carbon emissions. And I'll report on some of those details later on. We've also made a new appointment which was announced last month with Rosalind Kainya joining on January 1, with a specific responsibility for developing our ESG strategy and focus.H2 has started well. We'll talk a bit more about that, but we're running ahead. And as you'll have seen, we've upped our numbers this year on the back of the strong performance so far.Just a couple of words on Acal BFi. So Acal BFi completes the exit from Custom Supply to GBP 50 million enterprise value, which represents roughly 7 -- an EBIT multiple of 7x the pre-COVID average earnings. We're expecting completion by the end of this financial year, so sometime in February or March, probably. Consultation of the French Works Council is underway, and we believe that we've got agreement with that or are imminently going to get agreement for that. Regulatory approvals are required in Italy and Germany. We have already achieved that in Italy, and we're waiting to hear from Germany. If the approval time line falls over into the new calendar year, then we'll also need to gain U.K. approval. But we'll see where we get to. That all dependent upon Germany.Cross-selling continues as it would have done -- or as it was doing before the sale. The only difference being that it has to run at arm's length. And so in many respects, there won't be any great change to that. It's worth pointing out that we've added in about GBP 1 million of extra central costs to support the investment in IT at the ongoing group center. It's IT investment for the D&M division, and that will -- some of that will start coming in the second half of this year, but it will annualize out at about GBP 1 million.And just finally to say, the divisional reporting structure is under review. Obviously, now we're a wholly D&M business, so we will be -- we are looking at how we will develop that reporting, and we'll report on that in due course.We've included on these 2 charts here the revenue and underlying operating profits and margins for Custom Supply, which really just paints a picture as to why we felt it was appropriate to dispose of the business. It's lower growth with lower margins and higher cyclicality. So increasingly, it was really an outlier from the sort of the dominant part of the group, which was D&M.So as a result of the disposal, then we've revised upwardly our strategic targets. So you can see in the 4 charts there that our D&M target was always to have greater than 75% revenue from the D&M division. Well, that's now 100%, so that target will drop away from here on. But secondly, the operating margin, our target was 12.5%. We've increased that to 13.5%, which really is just a reflection of the removal of that part of the business.Internationalizing the sales. You'll see later on that actually, the D&M business is a very sort of well-balanced international revenue profile, and that's important. I'll talk more about why that's important. But therefore, we've upped our target to sales beyond Europe to 45%. And sales into target markets, our target remains unchanged at 85%. Again, I'll talk a little bit about that later. But we think that these targets will -- if we deliver all of these targets over the next 3 years, then we'll be -- 3 and a bit years, then we'll be in a very good shape.Okay. With that, I'll hand over to Simon to talk a bit -- talk through the finances.

[Simon M. Gibbins, Group Finance Director & Executive Director]

Thanks, Nick, and good morning, everybody. Yes, first up, the -- went too far. First up, the financial highlights. There's a good set of financial highlights here. Just a key point to start with, this is the continuing business results, current and historic as required by IFRS 5, post the discontinuation of Custom Supply.Second key point is we have shared, as you can see on that summary, the results for the pre-COVID period 2 years ago. I think that's really important to see -- to show the resilience of our business through COVID and also has a strong growth coming out of that.So a really good period of progress. You can see strong growth in sales, profits. EPS, you can see is up 37% against last year, 18% against the pre-COVID period. Our margin, as Nick said, is now over 10% for the first time. We've delivered -- continued to deliver strong cash generation, and that cash generation has reduced gearing below 1 for the first time in 8 years and gives us plenty of firepower for acquisitions.In terms of ROCE, ROCE is broadly on track with our target. Our target is 15%. We're a shade lower than that, but we have made 6 dilutive acquisitions. Well, they're dilutive that would start to be accretive from a profits point of view, but dilutive -- more dilutive on the ROCE, but that will pull back. So all of these, I think, really ably sort of demonstrate the business we are. It's custom product. It's capital-light, organic growth in target markets, accretive acquisitions.This chart shows, as you can see, revenue for the last 9 years. I think this really sums up -- it is -- that is the D&M business, and it really sort of sums up what we've delivered in the last 10 or so years. So you're building a business up basically from scratch across that period.Nick talked about the really strong order growth that's driving -- organic order growth. That's driving through into organic sales growth, 15% against last year, 8% against the pre-COVID period. And you can see good contributions from acquisitions. So that's very much the model we are, organic growth augmented by accretive acquisitions. So 20% growth versus 2 years ago at constant exchange rate. And if you look at the performance over the last 5 years, we're growing at around 20% compound annual growth. So very strong, consistent performance.So that's driven strong growth in operating profits. As you can see, we're up sort of over GBP 4 million to GBP 18 million, and again, that is up 20% -- 27% versus first half 2 years ago. And again, you've got that consistent performance, 28% compound growth since H1 '18. I've put 2 operating margin lines there. The lower one is the historic margin. That's including Acal BFi. The upper one is the ongoing margin. And so you're seeing strong growth on an underlying basis. So we've delivered 0.8 percentage improvement in margin this period, and it's up 3% overall, given the additional benefit that comes from the disposal.And look at the growth. Nick's talked a very key metric for us is delivering growth in operating margin, and you can see we've delivered that across our -- well, for a while, but there's a full year span there. And even under the -- with the ongoing margin, you've got over a 2 percentage points increase in the last 4 years, which sort of demonstrates the organic improvements we're making.This chart takes you from a pre-COVID periods, that's 2 years ago. The GBP 14.2 million of operating profit through to the profits this year of GBP 18 million, I think that ably reflects the underlying performance of the business outside COVID. The first 3 bars that you can see there on the left, that is the organic performance, operating performance. So if you take it from the left, organic revenue is up 8%. That's GBP 4.2 million of additional gross profit.Gross margin. Our gross margin is actually -- not surprisingly after the disposal of Acal BFi, it's actually at a record level. It's nearly 39%. And actually, when I started over 10 years ago, the margin was down around 25%. So again, that sort of really demonstrates the change we've made moving up the value curve, higher-margin products.Importantly, we managed to maintain -- there are a lot of supply pressures out there. Through this period, we've managed to maintain the organic margin pretty much on track. It's 2 bps lower. So it is a small impact on the profits. In terms of operating -- and actually, just in terms of that, but I think, again, that really shows what our business is. We're priced by design. It's made to design, not surprised. So we're managing to maintain those margins.In terms of operating OpEx, we've invested carefully coming out of the COVID situation. OpEx is up by only 5% over the last 2 years. And if you take those 3 bars in combination, that's the organic operating performance of the group. That's a 16% drop for -- I think that's pretty good.I put a bar there which is head office. We've been upscaling. We're a growing business. We've been upscaling our central capabilities. So we brought in additional resource in terms of M&A to help growth but also to help governance. We've sort of augmented our team in internal audit and risk, and we've also recruited into ESG.And in terms of the second half, Nick talked about the IT which will start coming in. But additionally, we're expanding our group executive committee with -- in order to give us bandwidth to support the growth within that division.LTIPs, there's a line there. The impact -- the NIC costs that we have on the exercise of options, that's been impacted very much from the share price growth. We've had -- share price is up 150% in the last 18 months. That impacts the NIC cost as does the NIC hike that is taking place next year as well as moving into EPS vesting metrics.Acquisitions. We've done 6 acquisitions in the last 2 years, and they're adding -- they're all contributing well to the model but adding GBP 5.3 million to the profit line. And again, I think that really demonstrates what the model is about. It's organic growth with drop-through, augmented by acquisitions.The division, as Nick said, we're down to 1 division for the time being. So not too much extra information on this chart. We obviously talked about sales of the side. I think the key takeaway is if you look at the EBIT growth, but it's delivering 38% EBIT growth, 34% against a pre-COVID period. I think it really demonstrates the resilience of that D&M business. But also look at the margin. The margin is up 1.4 percentage points. About half -- 0.5% of that is through the organic growth, and the rest is from the high-margin acquisitions we're bringing into the group. So more on the operations from Nick coming up.PBT and EPS. This gives you a track from the GBP 18 million operating profit down to EPS of 13p versus the 2 years. I think you can see the finance cost, tax are broadly in line. PBT up 38%. The key changes that you can see are the number of shares. We did a share issue this September, 6% placing. Shares up slightly this period. But versus 2 years ago, we also did a placing back in October around the time of the Sens-Tech acquisition, so 13% there. So EPS up 37% this year, down to still a decent level at 18% growth. And if you look at the chart, on the bottom right, we're actually growing 18% versus pre-COVID period, and we're growing at a 21% CAGR over that period since H1 '18.I'd just draw your attention to the bottom line. That's the reported EPS. So that includes the adjustments. That includes acquisition costs and amortization of acquired intangibles. It is lower than 2 years ago, as you can see. But that is the model. We've done 6 acquisitions this year -- in the last 2-year period. That's GBP 165 million as we increase the growth potential of the group.Cash flow. We're a very cash -- we talked about this before. We're a very cash-generative, capital-light model. And I think this table at the top sort of ably demonstrates that. You've got a walk there from EBITDA of GBP 49 million through to operating cash flow of GBP 40 million, free cash flow of GBP 28 million, all important metrics for us.Working capital, you've seen a lot of growth. This is over the last 12-month period, as we typically put up with the interims. GBP 4.4 million investment in working capital. There's been a lot of sales growth. We need to do the investments to support there. And in terms of working capital metric, you've actually reduced the D&M working capital from about 18% of sales down to sub 17%. So we're really pleased as we continue to focus on efficiencies.CapEx. CapEx is about GBP 5 million, though it's still -- it's a 12-month period, so it is still impacted by the restrictions we put in place. We moved to sort of maintenance model during COVID. We're moving through to expansion, so you'd expect that -- I expect that number to be up near over sort of GBP 7.5 million for the full year when we get better and as we invest in additional capacity as well as rolling out some of our ESG initiatives.So operating cash flow of GBP 40 million. That's up 19% against 2 years ago. It is actually GBP 16 million down on last year in terms of value. But actually, there's a GBP 22 million swing -- that working capital swing that came about due to COVID. Sales down, working capital in, sales up, working capital back in. If you take the working capital out, we're 18% up in terms of the last year as well.Free cash flow. Similar sort of growth metrics in terms of free cash flow. You can see how we're sort of developing that very important metric for us. The conversion is great. It's around about 95% for both operating cash and free cash flow. And you can see at the bottom our consistency of delivering well above that 85% target in terms of conversion. In fact, that -- this strong cash flow has helped reduce our gearing down to 1.3. Net debt at the period end of GBP 76 million. And when we get the Acal BFi proceeds, gearing will be sub 1 target, up to 2x in terms of where we feel comfortable at gearing, so that gives us plenty of capacity alongside the facilities that we have.Dividend. Probably interim dividend, I think, again, 6%, probably no surprise there. It's a progressive dividend policy, and actually, sort of seen us double that dividend in the last 10 years. And actually, in terms of the cash cost, that's up 400%. It's around about a GBP 10 million number. Cover works -- equates to 2.3. Over time, we'll continue to grow the dividend. But we like to see it go above 3 to give us that combination of progressive dividend and self-funding of acquisitions.Targets. We've continued to make progress on all of our targets. And as you can see on this summary, Nick talked you through the upgrades we made in the KSI, so that's the top part of the chart. In terms of the KPIs, further down, again, good progress, very good progress. As you can see, strong growth in sales; growth -- strong growth in EPS; excellent cash conversion, operating cash and free cash; ROCE, in line with -- broadly in line with our 15% target. And in terms of carbon emissions, we're making very good progress on that, and Nick will update you.So with that, I'll hand over to Nick to update on the strategy and operations. Nick?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Okay. So well, I'll skip over this slide. This is just a summary of the sort of the scale of the group. Now we've got 30 manufacturing sites all over the world now, which is increasingly important as we -- as the world regionalizes and as our customers continue to operate internationally.This is the key slide, really. Target markets are driving the organic growth. You can see on the right-hand side that the -- so this is growth over 2 years ago. So 8% total organic growth is achieved through 13% organic growth in the target markets, offsetting a 6% decline in the other markets. And then on the left, you can see the target market revenues now account for 77% of the ongoing group sales.So we're really pleased with that. It's further verification that these are the right markets to be selling our products into. Our products are essential in the customers' applications when they use them. So once they're designed in, the customers need them and getting them designed into markets and customers that are going to grow drives -- is what drives our growth. And that strategy is working really well. So -- and we expect all of our design activity focus now is really on increasing the activity in these areas.And then this -- again, the format of this chart will be -- this slide will be familiar. The key point is really the left-hand bar chart there. You can see the organic growth going back, so this year on -- well, this is period-on-period and year-on-year organic growth going back to Q4 '17, FY '17. And you can see the strength of the organic growth over that period. And really, what it's showing is several things.Firstly, the strong organic growth of around about 10% through the up cycle in the -- towards the left of that chart. You can then see it's starting to slow a bit in H1 and H2 '20, really as the cycle started to peak and overstocking started to come in globally. And we were a little bit frustrated by the 5% growth in H2 '20. That was a bit lower than we were aiming for. But nevertheless, it was better than -- significantly better than the market at that stage. And then '21, obviously, was COVID. And then in the right-hand bar, you can see just the bounce back. And so the resumption of strong growth is what we were expecting to achieve, and we're very pleased to report that.The central bar chart shows the growth by region. You can see there that Asia has grown 29%. That's year-on-year. So that's principally China but also India. You can see that Nordic, there's only 2%, but part of that is because some of the major customers have moved their production to Asia, following their end customers' demand. So that's the explanation for Nordic. Rest of Europe, that's widespread actually, Central, Southern European and a bit of Eastern European demand, so just sort of strength and pickup everywhere. Germany is back on track with 13% growth as is the U.K.The -- if there's any disappointment, it's the North American growth, only 5%. And the reason for that really is there's still some of the major rail projects have taken a long while to come back post-COVID. Although the orders have picked up in the States, you can see there the lag as a result of the time it took for those projects to get back to norm.And then on the right-hand side pie chart, you can see the revenue split by region. And that's the kind of split we really want to be seeing, a broad-based international revenue stream.And then order book. So this is really quite remarkable order book growth. It's just shy of GBP 200 million. It's up 71% on a year ago, 54% on 2 years ago and up 44% organically from the year-end. So just a remarkable growth. Really 2 reasons really for that. Firstly, obviously, our growth customers are ordering more. They need more. And in fact, we have felt the effects of the supply chain restraints limiting that growth in the short term. But also, customers order books have lengthened. They've got more confidence, and they're also fearful of supply. So the average order book length has increased from a shade under 4 months at the height of the pandemic concerns last year to now just over 6 months. So the result is that order book growth that you can see driven by 2 factors.Design wins. So we said last -- at the last results session back in June that we were expecting to see a strong pickup during this period in design activity, and that's what we've seen. The design wins year-on-year are up 56% and up 10% on 2 years ago. I mean, really, what we saw at the height of the pandemic, as sort of fear set in, customers paused or withheld some of their project activity to just deal with the here and now. So we saw quite a drop-off in activity. But what this is showing is the strength of that recovery.Also, our project activity pipeline has increased strongly. It's at a record high. We have a pipeline actually of over GBP 800 million of ongoing projects. So very, very strong indeed.And obviously, as I always say, the design activity is the driver of the organic growth of this business. So there, it's a very, very important focus for us. All of our businesses are focused on this. And you can see in this slide, we talk about 80% of the wins are in the target markets. Actually, that's down a little from previous periods. It's typically about 90%, 95% of our wins in target markets, but there is an element of all ships floating on a rising tide at the moment. So -- but still, 80% in target markets is very good.ESG. Well, there's loads going on in ESG. The main activity is on the sustainability in environmental areas, where we are installing and taking actions to source renewable energy. We've installed renewable energy sources in 2 of our sites now of Poland and Sri Lanka. Sri Lanka, there are actually 3 phases to it. We've completed the first phase. But those 2 sites make a very material or will make a very material reduction to our carbon emissions. So we're very keen to see that come through.On the social side, we've stepped up our diversity activities quite significantly, both on a gender and ethnicity basis. We've done a lot at the group level, but we're also now starting to trickle that down into the operating companies and the operating company management.And on governance, there's a lot going on and more than I can fit on this slide. But we've established a whole series of supplier -- or external supplier audit programs, anti-bribery and corruption revised policies. We're just about to embark upon our first external Board evaluation program, et cetera. And in fact, if you look at the press release, you can see much more of the details that we're talking about on that. And in order to achieve a lot of these actions, we've added some resource centrally to help us do that.I won't go through the strategy in any great detail. There's no change to the strategy. It's a consistent strategy that we've had now for 10 years, more than 10 years as we're focused on sustainable growth markets, which are aligned with the UN sustainability agenda. And we focus on designing our products into markets that serve renewable energy; transportation, which is principally electrification; medical; and industrial and connectivity, which is really about industrial and connection with wires and fiber connectivity.So going to the outlook. The second half has started well. We've got continued growth in organic growth, in orders and sales, which means our record order book continues to grow. We've got a very strong design win funnel and opportunity funnel. So despite the supply chain and FX headwinds that we saw in the first half and that we are pretty sure that certainly these supply chain headwinds are going to continue in the second half, but despite that, we are confident that we're going to continue growing very respectively.We've got a good pipeline of acquisitions underway in the pipeline. Our gearing, as I mentioned or Simon mentioned earlier, is 0.9. So we've got quite significant funding headroom to self-fund those acquisitions. And so the result of all this is that we've -- our trading is ahead of where we had -- the Board had expected it to be, which is why you will have seen a circa 4% upgrade to the consensus numbers this morning. So we're expecting the second half to be a strong half.And with that, that concludes the presentation. We'll now hand over to a Q&A session. So if you have questions, please flag it, and we'll come to you one by one.

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

So our first question is from, let's just see, Mark Davies Jones of Stifel.

[Mark Davies Jones, Associate]

I've got a few things, if I may. Firstly, quite a lot of moving parts in your sort of central costs. You're obviously putting some more investment in there. You've got the higher IT spend. Where do you think that will end up for the year? And do you think that continues to grow kind of in line with revenue, as you put more investments into the central operations of the business? Or was leverage on that central cost part of how you get up from 10.3% to 13.5% of margin?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Yes. Well, we're always aiming to grow with operating leverage as we've done through this period. So OpEx will grow. But our OpEx for the year on 2 years now are up 4% versus 2 years ago, which is, given the extent of the top line growth, is a very decent element of drop-through. So we will continue to grow in that way, just gradually phasing in the resources both at the center and in the businesses. But yes, we will -- as we said, we put in GBP 1 million for annualized costs as a result of the disposal to -- which is all part of that, really, just building up the central capabilities.

[Simon M. Gibbins, Group Finance Director & Executive Director]

Yes. We've got to get the shape of the group right. There's a focus on growth, and we need to get the right people, the right tone there to do that. And there's a -- and on the governance side as well. But we'll certainly get leverage on that as we grow, undoubtedly.

[Mark Davies Jones, Associate]

Okay. Second one was just -- obviously, the order growth has been spectacular. How comfortable are you that there isn't any kind of restocking, double ordering, customers taking out insurance policies within that?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Yes. So the principle of our model is that because the products are customized and when the customer orders, they have to take them. So we've seen in previous cycles that there is very little sort of speculative ordering because they know they're going to have to take it once they've ordered it. So it's a kind of build-to-order type business, which is very different to standard products, where in times like this, you see a lot of double ordering as people just trying to sort of scamper around and find products wherever they can.So in theory, the order book is pretty firm. I think if there is -- I mean, undoubtedly, there -- companies around the world are building stocks undoubtedly as a result of these strong demand patterns. It's yet to be seen how much of that is going to continue. But I think from our perspective, if there is any softening, then we'll allow a bit of flexibility in rescheduling. But pretty much, now what your order is what you get.I think the key point to make there is our order book represents just about 6.5 months of annualized demand. So we're -- despite the strong order book, we're still reliant on continuing ongoing new orders to keep -- to build the short-term order book sufficiently to satisfy sufficient sales. So if there is any sort of slowdown that comes along, then the first thing we'll see is that new order rate starting to adjust, and -- but there's certainly no sign of that yet.

[Mark Davies Jones, Associate]

Great. If I can ask one more, and I don't want to be churlish on a fantastic results. But the exit price for Custom Supply looked relatively modest at the time of announcement, but it looks a little bit more modest to me because the numbers there in the first half are actually pretty strong. So that performed pretty well in the first half, and there's quite a chunk of cash within that business, I think GBP 26 million or something. So can you just run through the rationale for -- I can see the strategic rationale for exit, but around the price?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Well, I think it's -- you've got to compare apples with apples. So the discoverIE Group margins, the sales are less cyclical. They're higher growth, and they're higher margin than the Custom Supply business. So the multiples of the group are very different to the multiples that you would expect for the Custom Supply business, which is lower growth, higher cyclicality and lower margins operating across multiple European territories.And historically, businesses like Custom Supply have sold, historically, in the region of 6-ish time EBIT multiple. So a 7 EBIT multiple on a pre-COVID basis is actually pretty good for that kind of level of business. Obviously, with the growth this year, it's a bit lower than 7. It's more like sort of upper 5s, but it's a more cyclical business. And so therefore, that's kind of what one would expect.So yes, so it's -- comparing it to the discoverIE Group, it's a lower multiple. But if you compare it like-for-like with other businesses with those characteristics, it's about in the right part. So we're not unduly fazed by that.

[Simon M. Gibbins, Group Finance Director & Executive Director]

So I'll just pick up on the other point in that, Mark. In terms of the cash, yes, it was GBP 26 million on the balance sheet of that business. But it's a debt-free, cash-free deal. So if it's GBP 26 million when we sell it, then we'll get paid -- we'll get an extra GBP 26 million payment for that cash, pound for pound.

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Okay. Thank you. I think, Henry Carver, next.

[Henry Carver, Analyst]

Yes. Does that -- I should be unmuted now, is that right?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

I think, yes, we can hear you.

[Henry Carver, Analyst]

Good, good. Just one actually for me, and again, related to Custom Supply. I was just wondering if you could remind us how much of D&M revenues was through Acal BFi. And is it sort of concentrated in any particular sector? And obviously, there's comfort around going forward, the relationship will continue to be strong. But yes, just any more detail around that would be great.

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Yes. The sales to Acal BFi were around GBP 8 million on the D&M. In the last -- that would have been the pre-COVID year. And yes, I mean, as you said, the relationship continues. I mean, the way we incentivize the teams doesn't change, but the way we measure it does because we have to move to an arm's-length basis. So that means we adjust the calculation of the incentive starting point, so the cost price versus manufacturing -- cost price for the -- so Acal BFi has to buy the product from us. And obviously, there are 2 margin points, where the original incentivization was an end-to-end from manufacturing cost to sales. So it was -- the transfer pricing was invisible to the sales engineers, and obviously, we can't do that now. So therefore, we have to adjust the incentive schemes to reflect that.

[Henry Carver, Analyst]

Great. And the GBP 8 million, was that across all sorts of end sectors? Or was it particularly concentrated anywhere?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Yes, no, it was -- it had a couple of -- there are a couple of particularly large customers, but there are sales into all of the target markets and non-target markets, actually because Acal BFi has a slightly larger proportion of non-target market sales because by nature of the -- by virtue of its business model. Because it works with third-party suppliers, they've always expected sales to be achieved in non-target markets as well as target markets. So it's a little bit more spread out for that reason.Okay. Onto the next one, James Beard.

[James Beard, Analyst]

Yes. I've got 2 questions, please. Firstly, could you talk through how you've arrived at the 100 basis point increase in the operating margin medium-term targets, particularly given that the disposal of Custom Supply is just under 200 basis points margin accretive on a pro forma basis to the group? That's the first question.And then second question, just in terms of M&A, obviously, very strong balance sheet right now, given the impending Acal BFi disposal. Any particular product categories or end markets that are particular short-term M&A targets that you can mention?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Yes, sure. So on the margin target, so the margin target is for the year ending March '25. And so we've upped that target, and it reflects the -- essentially the proportion of margin and revenue that Acal BFi would have represented in 3 years' time -- or 3 and a bit years' time. So it's not -- your point is quite right that today, it's nearly 2 points of -- representing nearly 2 points. But in 3 years' time, it would represent about a point of difference. And so that's why we've adjusted the targets by 1 point because of the faster growth, both organically and acquisitively in the D&M division.On the second point was M&A targets. So we've got a very -- we have a sort of matrix of products, technologies and geographies that we're looking in for our M&A. And that's quite widespread actually. And so we basically set out some of our matrix, and then we go looking, and we see what comes in or what comes up. And that's actually quite broad-based. So -- but all of the businesses that we're looking to acquire have to be able just sell into these target markets. That's the key. They may have -- what typically happens is that the -- on acquisition, the proportion -- they'll have a proportion of sales, but it might not necessarily be that high in target market sales. But we would expect that with our organic focus over the sort of following 3 to 5 years, that proportion would increase significantly. And certainly, if you look back at past acquisitions that we've made, that's exactly what happens.So yes, it's a fairly broad-based answer to your question, actually, Mark -- James, so apologies for that, but that's the way it works.

[James Beard, Analyst]

Great. And if you may indulge me of one more question, just thinking about it. Input cost inflation is clearly on all the people's agendas at the moment. Are there any areas of cost pressure that you're seeing? And how comfortable are you that you can mitigate those through pricing?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Yes. We're seeing cost pressures everywhere. I mean, there's no one exempt from it. So raw materials and components that we buy in, I've all seen it wherein some cases, we're on our third round of price increases. We're seeing it obviously in the well-publicized freight, freight rate increases. And that rate of growth is slowing, but nevertheless, the rates are still going up and still very, very high. We have freight charge -- freight surcharges with our customers to cover the cost of that. And you've seen in the gross margin in Simon's part of the presentation, you saw the organic margin, gross margin, our model passes on raw material changes, and that's what we expect to pass through. And we get slight ebbs and flows from time to time, but they're very small in aggregate. And we -- because we pass them through, that's the model, and that will continue to be the case.Next question from Christian Hinderaker from Liberum.

[Christian Hinderaker, Research Analyst]

Nick, Simon, hope you can hear me. I've got 2 questions, if I may. Firstly, Simon, you talked about the working capital improvements in the continuing business. Just interested, given the disposal, to understand a bit more about the inventory dynamics as you move away from Acal and also as you expand your footprint.And then the second question, maybe if I may, just pick up on the cost pressures. Any pressures in terms of the labor dynamic? You talked about raw mats and components, but any thoughts on labor? Would be interested.

[Simon M. Gibbins, Group Finance Director & Executive Director]

Yes. Just in terms of working capital, yes, the data I talked about, the improvements in working capital, that related to the D&M division. We talked last year that Custom Supply, as a distribution business, had better, lower or higher stock turns. And typically around about 10x in Custom Supply versus about 4x in Design & Manufacturing. That's the nature of those 2 businesses. But our focus going forward is to drive improvements within D&M working capital, and so far, so good. We've delivered improvements.If you look at -- there's a slide in the back of working capital, you can see the improvements we've made year-on-year for the last 5 or 6 years. Typically, when we acquire companies, we seek and achieve improvements in their working capital. We've got a central team that are pretty hard at that.

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Yes. And in terms of labor, yes, I mean, your right, Christian, that is another pressure. The more immediate pressure on labor is recruiting additional people, and that's pretty much everywhere. Availability of people is a challenge. They're just -- they're a hot commodity, so you've got to move very quickly, and finding them is difficult. And when you find them, they typically cost you a bit more. So we have that sort of challenge. I think that, that will start to settle down a bit next year. But yes, certainly, that is -- we're feeling that pressure through into labor rates and overall salary levels, and we will continue to see that.But again, these costs have to be passed through. And our model is all about designing products that provide a price to the value they provide to the customer. And we do that to a very high degree. And we have to pass -- as part of that sort of model, we have to pass on these changes as they come through. And as our model shows over many years that we're able to do that. And as long as we don't abuse that by trying to overcook it in any way and pass on more than our fair share of those kind of costs, then we can maintain very stable and steady margins. And that's what you're seeing in these numbers.Okay. Tom Fraine at Shore.

[Tom Fraine, Research Analyst]

Hope you're both well. Just talking in terms of the forecast. Obviously, you've got a very strong record of under promising and over delivering. I just wanted to get a bit of an idea of what assumptions you're making for H2. Obviously, the design wins are very strong, and you said that these are a key driver for the organic growth performance. Did the -- does the operating profit that you're guiding to for the full year include similar growth rates to H1? Or do you expect these to accelerate given the very strong design wins and obviously, the benefits of the acquisitions?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Yes, that's a good question. So to answer your question, growth rates will be broadly similar in the second half, we expect. The big gating factor is they could be higher than the first half growth rates, but it will depend upon component availability, of raw material availability. And that is -- we're kind of in the peak constraint period, we think at the moment. In the run up to Christmas and the general demand for everything is particularly strong. We think that might ease a little bit in the calendar first quarter, our fourth quarter, and perhaps it will sort of continue to get better through next year. But that will be the gating factor.And in the first half, we saw organic growth of 15% year-on-year. Where if not for the supply restraints, we could have added another 3 to 4 percentage points of organic growth. If you flow -- if you assume the same for the second half, if you say it was around about 15% organic growth, it wouldn't be unreasonable to think that there's another 4% to 5% there if the supply restraints come off or improved. But let's see. We're not planning for any great dramatic improvement in availability in the second half, which is why some of the growth rates will be broadly similar to the first half.

[Tom Fraine, Research Analyst]

Okay. Brilliant. So just to be clear, we're expecting -- well, the design wins obviously, presumably, put you in a best position though. But you think that some of that might be offset by the achievement points, benefits -- sorry.

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Well, that's right, yes, yes. Yes, exactly. And the design wins will drive -- it takes 6 months for the design wins to really start coming through into meaningful revenue. So from approximately speaking from our fiscal Q4 as the January to March quarter, we'll start to see some of those design wins coming through into new production. But it's pretty small at that stage. It's only really been fiscal Q1. So that's the mark, the April to June quarter next year that the design wins really start to get going. And as a rule of thumb, the design wins produce about 50% of their expected annual value within the first 12 months of the -- or after 12 months of registering a design win. So it really takes a good sort of 3 to 6 months to get going.

[Tom Fraine, Research Analyst]

Great. And finally, on the target margin increasing to 13.5%. What do you expect that you need to do in order to achieve this target? Do you think further M&A of higher-margin businesses will be necessary? Or do you think you can achieve that kind of margin without further M&A?

[Nicholas J. Jefferies, Group Chief Executive & Executive Director]

Yes. The -- so M&A is an important part of what we do. I mean, the focus on organic growth with the operating leverage, [indiscernible]. That will [indiscernible] in operating margin. So it will account for 1 point or 1.5 points of the increase from 10% to 13.5%, and then the balance will come from acquisitions.And if you look back at the acquisitions we've made over the last year, 2 years or last 6 months, all of the recent acquisitions, the operating margins of those business on aggregate are around about sort of 22% to 25%. So that's the kind of business we're trying to buy now, sort of early mid-20s operating margin. So if we do more of those, that will -- that's where we'll move the dial.Okay. Thank you. I think that concludes all the questions, unless anyone has any more. But if not, no, I think that's it. So in that case, thanks, everyone, for your attention and for joining the call, and look forward to speaking to some of you through the rest of the week. Have a great rest of your day. Bye-bye.

[Simon M. Gibbins, Group Finance Director & Executive Director]

Thanks very much.