Thank you for standing by, and welcome to the Adairs Limited conference call. All participants are in a listen-only mode. There will be a presentation followed by a question and answer session. If you wish to ask a question, you will need to press the star key followed by the number one on your telephone keypad. I would now like to hand the conference over to Mr. Mark Ronan, Managing Director and CEO. Please go ahead.
Good morning, all. We're glad that you could make the time to join us as we announce details of Adairs' acquisition of Mocka, a vertically integrated pure-play digital home and living product designer and retailer operating across New Zealand and Australia. The acquisition of an online pure-play business with strong sales growth, good margins, and high levels of profitability and cash generation is a great strategic fit with Adairs. The transaction will see Adairs acquire 100% of Mocka for a notional enterprise value of NZD 80 million, with NZD 43.4 million payable in cash, NZD 5.7 million payable in Adairs shares, and variable deferred payments based on earnings for the FY21, FY22, and potentially FY23 years. The transaction will be funded by an increase in our debt facility to NZD 90 million, with the upfront payment due in the middle of December.
The acquisition is expected to increase Adairs' online revenue mix to approximately 29% of sales and deliver EPS accretion of circa 10% based on the pro forma FY20 results. Mocka is a highly complementary strategic fit for Adairs in the fact that both businesses share a common DNA and philosophy. This is highlighted through a customer proposition that is design-led with a focus on providing value for money, the offering of exclusive product which provides control of the vertical supply chain and market pricing, and a focus on delivering a superior customer experience. Mocka is a pure-play online retailer in a large and growing category with a focus on furniture at a lower value price point than the Adairs business.
This provides a good fit with Adairs, as Adairs is a soft furnishing business with an element of furniture, and Mocka is a furniture business with an element of soft furnishings. Like Adairs, Mocka focuses on ensuring it looks to deliver a profitable business model with the Mocka management team building a highly profitable and cash-generative business with low CapEx requirements. As highlighted on page three of the slide presentation, through the good execution of their underlying strategies, the Mocka business has a strong track record of delivering revenue and EBIT growth. Importantly, Mocka has significant growth potential through continued execution of their underlying strategies and increasing their brand awareness. It is important to note that the acquisition will see Adairs partner with the existing management team of Mocka, with the Mocka business to be run independently of Adairs.
The Blake family, together with the experienced management team they have established over the past three years, will continue to run the business and execute and deliver on their proven strategies. Mocka's existing strategies have seen the business focus on delivering great product and compelling everyday value for money across its well-designed, functional, and stylish home products. The growth has come from, and will continue to come from, ensuring the product offering is differentiated in the market. As a design-led product business, the in-house team allows Mocka to develop products for their customers that deliver value at sustainable margins. Their versatile approach to design allows products to coexist across ranges and categories with a distinctive Mocka handwriting. This allows customers to buy with confidence, knowing the pieces were designed to come together in a contemporary family home.
As a vertically integrated business, Mocka owns the customer experience, allowing them to ensure the product is developed and designed with a focus on building a profitable business with attractive margins and that strong cash generation. The growth for Mocka will continue to come from three key pillars, which Adairs understands well and is well-placed to assist with. These being category range expansion, where there is further scope to both offer additional options within existing categories, as well as look to expand into new categories. The customer experience, where there is always opportunity to invest in the web platform and associated technology to enhance the customer experience. Brand awareness, where there is great scope to enhance the brand awareness, shopping frequency, and market penetration, in particular within Australia. Through our experience at Adairs, we have the opportunity to add significant value to the Mocka business.
This will be done by leveraging our digital and social media assets and expertise, together with our understanding of the Australian home consumer, to increase brand awareness of Mocka and assist in building a more efficient customer acquisition model within Australia. Further, our understanding of the Mocka growth strategies will enable us to help accelerate and de-risk their range expansion strategy whilst helping the Mocka team build systems and capability to continue to deliver profitable growth. For our shareholders, this acquisition creates a larger, more diversified business with increased exposure to the fast-growing online channel. We look forward to working with the Mocka team to help Mocka achieve all that it can become and collectively continue to grow Adairs as the leading homewares retailer across Australia and New Zealand. I'll now hand over to Ash Gardner, who will walk through the deal structure, funding, and financial implications of the acquisition.
Thanks, Mark. Good morning. As Mark mentioned, the transaction involves us acquiring 100% of the Mocka shares, with 65% of that paid up front, which equates to circa NZD 43.5 million in cash and NZD 5.5 million in Adairs shares. The balance of 35% notionally will be paid through FY 2021 and FY 2022, and as Mark mentioned, potentially FY 2023 based on the earnings of the business. We've chosen this deferred consideration model for a number of reasons, but principally it is to ensure that we retain alignment with the vendor managers that will continue within the business and both businesses remain focused on growing and realizing the full potential of the Mocka business. The deferred consideration amounts are subject to a minimum amount of NZD 20 million over that period.
However, we anticipate, based on our expectation of the earnings performance of the business over the years, that Adairs will ultimately end up paying in the vicinity of AUD 85 million-AUD 90 million. From a funding perspective, we've funded this through a combination of cash in the form of new debt facilities. Those debt facilities have been put in place and are now secured until March 2023, which is an extension of the current facility that we had, and that facility will increase to AUD 90 million. From a balance sheet perspective, we don't see the increased level of leverage creating any additional issues for the business. We expect to maintain our current dividend policies and our covenants and so on remain largely unchanged and comfortable and capable of being serviced by the business, the combined business. From a revenue and earnings perspective, Mocka is an accretive acquisition.
We expect to see revenue grow to circa AUD 410 million in FY20 on a pro forma basis, and likewise, earnings growing to circa AUD 53 million, taking the midpoint of our revised guidance, which I'll come to in a moment. From a margin perspective, Mocka is a highly profitable business, delivering EBIT margins of circa 20%. That will add circa 100 basis points to the EBIT margins of the combined group on a pro forma basis in FY20. In terms of our guidance moving forward, we have updated our guidance to include Mocka. There's been no change to the underlying Adairs guidance that we published previously.
Inclusive of Mocka, we're now anticipating our EBIT for FY20, including the 30 weeks of contribution from Mocka, to be in the range of AUD 48 million-AUD 52 million, or on a pro forma basis, if Mocka had been included for the full year, to be in the range of AUD 52 million-AUD 56 million. On that, I hand back to Mark.
Thank you. In relation to the acquisition, we're excited that this is the first acquisition of Adairs and believe that the great strategic fit between the two businesses will see us continue to grow the business going forward on a combined basis. With that, we're happy to open the line up to any questions.
Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star two. If you're on a speakerphone, please pick up the handset to ask your question. Your first question comes from John Hynd with Wilsons Advisory. Please go ahead.
Good morning, gents, and thanks for taking my question. Perhaps if we could start with the business of Adairs in the near term. How quickly is this acquisition going to impact the group, and how quickly do you think you could translate those attractive margins in the online business across to your business? What and how does this change your online strategy that you've been talking about for the last 12 months? Whether you can get some alleviation through some of the warehouse synergies, and does it change the strategy at all? Thanks.
Thanks, John. The simple answer to that is we've done this transaction with a view that we continue with the strategies that Adairs has been focused on for the last number of years and continue to deliver well against. We don't see there being any specific synergies in relation to the warehousing and the solution to our supply chain challenges that we've been documenting for the last little while with this acquisition. We continue to see that will play out in the way that we have forecasted earlier with us coming to market as part of our results for the first half with a view as to how that will play out over the next 12-18 months. What we do believe is there'll be some ongoing learning and no doubt sharing of opportunities between the two businesses as we progress.
In the short term, we don't see that impacting the Adairs results. As a result, what you're seeing at the bottom there in our guidance is very much the addition of two businesses rather than any significant synergies being built into the model going forward. We do know that collectively, the two businesses will enhance their supply chain capability over the next 12 to 18 months, and we should see ongoing improvement in that space.
Thanks. Can we expect you to consolidate this in your accounts at 100%? I'm assuming you're going to break out the performance of Mocka at least in 2023?
Yes. We will be fully consolidating. The deferred consideration will sit on our books as debt, and we'll ensure that the information we provide gives you enough information to understand how the business is performing, both businesses separately.
Thanks. The last one from me before I jump back in the queue. Can you maybe, Mark, give us a little bit of color on, I guess, why the family would be selling here and the reasons that they'd be selling, and I guess help understanding some of the terms of the earn-outs as well, please.
Yeah. I'll cover off the reason behind the sale. Ultimately, it's a family business being owned by some parents, Trevor and Judy Blake, as well as their two sons and their collective family. The parents have decided that they wanted to exit the business in a retirement phase of their life. They want to step away. That is what caused the business ultimately to come to market. The underlying family, the two brothers who are heavily involved in the business want to remain in the business and hence the earn-out component that we've built into this is for them to share in the upside that we expect to see them continue to deliver the results over the next two to three years. With that's the overarching reason for the sale.
Was not a full sale, was more aimed at making sure the parents could exit well and we would then partner with the family members. I think that's where Adairs adds real value to this transaction, in that we bring a lot of expertise and assistance to the family, having done a lot of this work in the past, and we can really add some strategic value whilst they continue to execute on those underlying strategies.
Thank you. Just some detail around the earn-outs, if possible, the earn-out terms.
In the deck we've distributed, appendix one, page 12 provides quite a bit of detail around how we see this playing out. 35% of the consideration is yet to be paid and will be paid based on earnings in FY 2021, which will be 15%, and then earnings in FY 2022 up to another 20% or potentially they could defer a component of that FY 2022 earn-out to FY 2023 up to 8% of that remaining 20%. Essentially what we'll pay is a defined multiple based on where the result lands in those years of the remaining balance of the consideration that they're due. It very much aligns our objective to drive good results out of the business, as well as their objective to maximizing and realizing value.
During that timeframe, it allows for us to develop strong succession and strong capability in the business that will let the business continue to thrive and grow post the exit of the management shareholders, if they choose to exit at the end of the earn-out period.
Great. Thank you very much.
Your next question comes from Jordan Rogers with UBS. Please go ahead.
G'day, guys.
Jordan.
Just a clarification on that earn-out, Ash, if you can? On slide eight, you've got the NZD 80 million plus the 20, gives a max of 100. In the slide 12, we've got total consideration in the range of NZD 90-96.
The AUD 20 is part of the AUD 80. The AUD 20 is the minimum amount that the deferred consideration could be.
Yeah. Okay. That makes sense. Cool. Thanks for that. Mark, you mentioned not a whole heap of synergies across the Mocka in terms of supply chain, can you just give us an update on the new DC? Did this come into your thinking around how much set up you'll have for increased furniture capability versus accessories or just none at all?
Yeah, okay. Well, we're still in the same position that we have been in relation to the supply chain project that's underway at Adairs and in those commercial negotiations. There's no real update other than to confirm with everybody that we are on track to both provide a further update as part of our first half results release. Secondly, that we remain on track to be fully operational for July 2021, which is in line with everything that we've put out there beforehand. That piece of work continues, and we are making good progress on it. As we've said with everybody, we'd prefer to keep working and lock down some of these contracts without compromising it by publishing too much out there. None of that is actually signed, so it's not really locked and loaded yet.
We are well and truly along that path. In relation to how this correlates to thinking about our supply chain project, we will have additional space in the supply chain project that we are putting together. Obviously, the warehouse or the DC will be built to be bigger than what we require in FY21. We will give due consideration to what that looks like going forward. In terms of the way we've thought about this deal and put it all together, we continue to see them running as quite independent businesses, and we'll look for those opportunistic synergies as they come to fruition, as opposed to necessarily sitting down and thinking we need to develop a whole bunch of synergies in order to make this transaction stack up. We think they run a good ship today. They know what they're doing.
If we can grow the business like we want to grow the business, and all parties expect that there will be ongoing need to build supply chain capability in that business, just like there has been at Adairs. The one thing we have learned is we need to look a bit further ahead than perhaps we did at Adairs at a point in time, such that we make sure that it doesn't stymie the growth or incur the same step-up in costs that Adairs has incurred over the last little while. We're definitely thinking about it as part of that strategy. Primarily, we see them as running independently too, so the nature of the product. There may be that furniture element within Adairs, we do think there's an element where some of that might come together in time.
In the near term, it's independently run and don't rock the boat while we continue to build the supply chain capability of Adairs.
Okay. Sure. Ari's got a couple other questions. I'll let him have a go.
Thanks, Jordan.
From Jo Letter with Morgans. Please go ahead.
Morning, guys. Just firstly, you've given us some margin detail. What's the gross margin running on this business? Is it 40-odd%?
It depends again, Jo, how we're going to define gross margin in this conversation because if we include all shipping costs, et cetera. If you're including that, it's around that 40%.
Okay, thank you. Should we think about this as a potential omni-channel proposition down the track? Is there a physical store rollout possibility here?
I think there's always something that we would give due consideration to as the business evolves and we get in and understand it further than we do today and think about that. I think omni-channel, we've been a big believer in the fact that omni-channel, we think, wins in the long term. Obviously, we have good capability in stores within Adairs, so it's definitely something that there'll be an ongoing conversation around the board table at Mocka to think about what other opportunities there are to drive additional growth as opposed to on top of the growth that we expect to just deliver through the pure-play online business as is today.
Okay. You've given us an FY22 EBIT multiple, which implies, I think, about AUD 12.7 million EBIT in FY22. Within those growth assumptions that you've made, is there any store rollout or is that just consistent growth as you've seen in recent years from, and then you being able to accelerate that?
Yeah, that's consistent growth. There's no store rollout included in those numbers.
Okay, great.
Thank you.
Yep. Ash, just on that leverage ratio you talked to on page eight, it says one times leverage over three years, then it excludes the deferred consideration. Can you just explain that I guess your comfort with the balance sheet and you're going to have to invest potentially in the supply chain program, et cetera. Thank you.
Yeah. As we look ahead, we assume that we would be doing the supply chain, which is obviously the most highest cash cost scenario within the next three years. We factored that into our forward plans, and that net debt ratio is effectively net bank debt, inclusive of us funding the supply chain to the tune of circa AUD 15 million. Still leaves us with a leverage ratio that is comfortable, well under our covenants, and something that we can comfortably service.
Okay. Sorry, it doesn't include the deferred consideration, though, on Mocka, is that right?
It includes payments over the next three years, but it doesn't include the actual deferred consideration on day one sitting on the balance sheet.
Okay.
It assumes that we pay these amounts in FY 2022.
Yep.
FY 2021.
Yep. Perfect. Thank you. I guess lastly, Mark, can you just give us maybe, it's a bit of a different market niche here, but maybe what you think the size of this market is that Mocka's operating in, the competitors, who's winning out there, who's got the closest offering? It feels like it's a higher price point than a Kmart. Yeah, where are you trying to position it?
Yeah, good question. Ultimately, I think it does position quite nicely between Adairs and Kmart. If you think about, we're at opposite ends of the spectrum to a degree. We do think there's a market in there. I think its key competitors in Australia will be guys like Fantastic Furniture, IKEA. If you think about the flat pack furniture sort of business, that is very much a large part of the Mocka DNA. That market is pretty big. We'd easily see it as being north of AUD 1 billion in terms of just in Australia by the time you put all those guys together.
We think there's massive upside for these guys to get involved in there, and we do think the beauty of this business is it sits neatly between Adairs and Kmart, and it isn't a business that necessarily sits right alongside Adairs and we're going after the same customers, even though we all know that customers shop up and down that spectrum of retailers within the Kmart or Sheridan sort of view of home. We are definitely continuing to support their proposition that they believe they sit between Adairs and Kmart, and we agree with that. We think that that market is quite sizable in relation to the furniture component of it, plus soft furnishings on top of that.
Thank you. Just lastly, that 20 odd % margin or 21%, is that sustainable or a bit over, or how should we think about that?
Look, I think there will definitely be some investment to drive growth going forward, but I would expect the EBIT margins of this business to remain higher than the Adairs EBIT margins and therefore continue to support the combined business growing our total EBIT margin, as Ash commented on before, of 100 basis points. I think we'll continue to learn, but it's going to sit in the high teens would be where I think it sits long term.
Fantastic. Thanks so much, guys.
Thanks, Jo.
Your next question comes from Aryan Niroosi with UBS Investment Bank. Please go ahead.
Hiya.
Morning.
Just one from me, please. If you look at the FY 2022 implied multiple, you're implying around 20% earnings growth over that period. Just wondering what's driving that growth and what you guys or Adairs bring to the table for Mocka, and whether there's potentials, for example, for cross-selling Mocka products into Adairs and vice versa?
Well, if I start with, I think what we've seen in this business and what we're comfortable with and continue to support them on, will be that ongoing growth platform around the category range expansion and increased brand exposure, particularly in Australia. We think those two key platforms, or pillars of their growth strategy, will drive the revenue and EBIT growth that we expect to see over the next two to three years, supporting that FY 2022 number. Before we even get to things like how Adairs can support that via ongoing utilizing our database, our reach, our knowledge of the home consumer, and how we can start to test and trial how the two businesses can support each other in driving growth. If you think about it in a two-way street, obviously they've got a really big customer database in New Zealand.
We have a much bigger customer database in Australia. In that, we also want to be really careful. The businesses need to stand on their own two feet and continue to build that database. There will be some work done internally as to how we work through that and support the ongoing growth of both businesses by utilizing the combined assets of the businesses themselves in terms of that customer reach. We don't see significant product moving between the businesses. They are aiming at a different market. That's not something that we sit here today thinking that in three years' time you see a whole bunch of Mocka product within the Adairs business.
I think we can certainly learn some things about what style of product works and those elements, but then we are looking at two different price points and two different customer sets in this transaction in between the two businesses. I think what we'd learn is expertise and how we think about developing and designing product and what works and how we tweak and change that to make sure it suits the right market that it's in. We are definitively looking at this as two markets to make sure that we don't compromise either business. They both have a DNA, they both have a way of working, and they both have a customer expectation, which is slightly different.
We need to make sure that we maintain that difference to ensure that what we're doing is capturing more and more market share between the two businesses rather than trading share between them.
Sure. Just a second one from me. I know you guys mentioned there's no synergies from a BC perspective, but what about other sorts of synergies like head office consolidation, et cetera? Do you guys see any scopes for that and is that factored into the growth forecast within the numbers?
Not in the short term, it's not factored in. As I said, I really think it's important when you think about these businesses, this is a business based in Christchurch and Brisbane. When you're doing this sort of thing, you're working and building a partnership with people, making sure that the people that have delivered the numbers and have delivered the business to where it is today, continue to do so because they are the key part of the business. We don't see significant synergies and certainly haven't built them in of relocating head office or doing anything like that. We don't expect any of that to happen. There may be over time, opportunities to think about some of the functions of the business and how they work better.
We do have a firm philosophy that when you run retail businesses, you need to make sure those retail businesses stand alone, focus on their customer, know who they're focused on delivering product for, what customer experience they're trying to deliver to that customer set to ensure that you don't lose that DNA of the brand. That can happen as you bring businesses together, and we are making sure that we don't dilute the capabilities of either businesses by bringing them together. I know it hasn't been factored in, and we don't see it as a short-term piece.
Yeah. Just final one from me, please. Does this sort of delay any potential for offshore expansion outside of New Zealand if you buy Active? Should we hash anything about that, please?
I think for the underlying Adairs business, our strategies remain unchanged and continue to be worked upon by the management team at Adairs. As we continue to develop those strategies and the underlying pillars of the Adairs business, we don't see this as slowing down any of that. This is a business where we are partnering with a management team. We're not having to parachute in a whole bunch of Adairs people to help them deliver the numbers that are in these forecasts. They have the capability. They are the right team to partner with, and we look forward to that partnership delivering that whilst the underlying Adairs business continues to drive its own growth strategies and deliver ongoing growth from within that business as well.
Perfect. Thanks, guys.
Thanks.
Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Your next question comes from Mark Wade with CLSA. Please go ahead.
Good morning, gentlemen.
Morning, Mark.
Good ages]. I think you've covered off pretty well around us. You're not taking any synergies from customer overlap and supplier overlaps. I like to go down that path. I was just more interested in the core Adairs business and how you're seeing things progress there. I know there's some comments around promotions are doing well. I know at the start of the financial year, some plans to try and cut back on promotions a little bit, and just curious if you know about that, how that seems like you're progressing down that path as far as just how we did in general characterize the health of the consumer?
Yeah. Well, I think, we obviously had a plan for this half, and as we sit here today, we're quite comfortable that we are on track to deliver the numbers that we expected to deliver for this half. The reduction of depth of discount that we want to execute, the price increases that we wanted to push through the market, and the negotiations with our suppliers have all gone well. Obviously, we're coming up against a reasonably good headwind in terms of the currency decline that we're coming up against. We are seeing good results in all of the strategic actions that we've taken over this half, and feeling comfortable with three, four weeks still to go, and they're big four weeks, that we are in a good position to deliver the half that we expect to deliver.
In relation to your second point around the health of the consumer, I've been talking about this for quite some time. I continue to think the health of the consumer is good. If you are delivering good product and the good value proposition that they are looking for, the consumer is there and they are prepared to spend, and they will spend when you put that in front of them. If you're not, well, then they're not prepared to spend, but I don't think it has a lot to do with the health of the consumer. It's probably more something that you need to look at yourselves. We've always said in our business, we have areas of the business that are working well and areas that aren't working well, and you never get 100% of your product right.
We know that internally, the consumer, we think, is pretty good, and therefore, any area that's not working is something for us to be staring at the product because that's the piece that's missing the mark, not the consumer themselves. I think in saying that, the only other thing I'd add is that I do believe it's easier at the AUD 120 to AUD 150 average order value than it is at higher ticket prices. There's definitely been enough talk about the consumer's probably a little more cautious on the AUD 3,000 or AUD 4,000 purchase, or the new car, and these sorts of things. In our market, we're certainly not seeing that flow through into our customer base, and we think they're pretty robust at the moment.
Okay. Thanks, John. Appreciate that response.
There are no further questions at this time. I'll now hand back to Mr. Ronan for closing remarks.
Thanks, everyone. We appreciate you taking the time to listen onto the call this morning, and we look forward to delivering a good first half and working with the market team to deliver an even bigger business going forward. Again, thank you for your time.