Adairs Limited (ADH) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Adairs Limited release of the First Half Year 2023 results. All participants are in listen-only mode. There will presentation followed by a question-and-answer session. [Operator Instructions] . I would now like to hand the conference over to Mr. Mark Ronan, Managing Director and CEO. Please go ahead.

Good morning, everyone, and welcome to the Adairs First Half 2023 Results Call. Joining me this morning on the call is Ash Gardner, our CFO; and Jamie Adamson, our Head of Investor Relations. First half of 2023 saw the group deliver record sales of $324.2 million with Adairs recording a record half year sales result. Focus on Furniture continuing to deliver strong sales and margin growth and Mocka restoring customer confidence after the challenges of the 2022 financial year. Across the brands, we saw the consumer continuing to choose to shop in store, benefiting Adairs and Focus and highlighting the benefits of our omnichannel strategy. Gross margin was down at a group level due to the full half of Focus, which operates at lower gross margins, elevated import costs across both cost of goods and international shipping and domestic distribution costs. As we look forward, we are seeing a material decline in international shipping rates and reducing cost of goods coming from across our supplier base. Underlying EBIT of $35.5 million is up 7.9% on last half driven by the acquisition of Focus, offsetting higher supply chain costs in the Adairs business and Mocka investing in rebuilding its operational platforms. Importantly, for the group, each brand has continued to make progress on the strategic priorities that will drive the ongoing growth of the group in the years to come. The acquisition of Focus on Furniture has added a strong brand to our portfolio, increasing the exposure of the group to the bulky furniture category. In its first full year of ownership, Focus has delivered $30.8 million of EBIT by providing a quality product range and good in-store service, combined with high levels of product availability, resulting in an excellent customer experience. Whilst we have made limited progress on opening stores due to the high demand for homemaker space, we continue to build a pipeline of opportunities to grow the store portfolio across Australia with one new store expected to open in the coming half. The Adairs brand continued its investment in its omnichannel strategy, launching an enhanced website in November. The new website provides an improved customer experience and as importantly, provides the foundation for future omnichannel initiatives with a number of these currently in development. Adairs has increased its store space opening 2 new stores, closing 2 smaller stores and upsizing a further 4 stores. As I've talked to previously, these larger stores support the growth in Adairs product categories, deliver a better shopping experience and are more profitable. Like Focus, Adairs has spent the half building a pipeline of opportunities, which we expect to deliver profitable space growth over the coming years. The Adairs National Distribution Center saw Adairs transition its multiple warehouses into one national distribution center operated by DHL. Whilst we expect that this would see significant operating efficiencies that would reduce costs and improve the customer experience, the transition has not gone to plan. Across the half, the operational outcomes were significantly below expectations as the sites struggled with some of the complexities of our broad product categories and omnichannel expectations. The Adairs and DHL management teams have been working collaboratively over the last few months to improve the throughput and service outcomes with early signs indicating that this is delivering results. And finally, at Mocka after the back of an operationally challenging 2022, the Mocka team has spent the first half rebuilding its operational platform and restoring customer confidence. This has seen Mocka build out a more robust domestic supply chain network, reduce inventory with the buffer and enhance the website functionality to deliver an improved customer experience. Whilst the half did not deliver the longer-term financial results we expect, the strategy is delivering improved customer experience and gross margins that will support the future growth and profitability of the brand. I will now hand over to Ash to walk through the financial results in more detail.

Thanks, Mark, and good morning, everyone. Let's start with Adairs brands. Total sales were up 13.1% to $220.4 million with no COVID disruptions during the period. With stores open, we saw store sales grow 22%, whilst online stepped back 7.4% and represented 26.5% of total sales for the half. Gross margin also stepped back with all stores open in the business operating to a normal trading pattern. Higher inbound container rates put downward pressure on margin. However, these have now reduced significantly and provide margin support moving forward and the group's hedging strategy limited the impact of the weaker AUD during the half. Supply chain more broadly presented a number of challenges during the period. In addition to the higher cost of inbound freight, local delivery and distribution costs were also higher as partners passed on their higher costs. The DHL operated national distribution center, which commenced full operations in July saw performance well below expectations. Delayed delivery to customers, lower-than-planned store replenishment and lower productivity resulted in unacceptable customer experiences and approximately $5 million of additional costs. More recently, though, we have seen performance from the NDC improve. And combined with the new pricing agreement that became effective in January 2023, we expect to see average variable cost per unit dispatched reduced by approximately 20% with better service levels and output. The Adairs brand reported an EBIT of $18.7 million for the half, $5.7 million below the same period last year, with the higher supply chain costs, the primary reason for the decline in profit. Focus on furniture delivered an excellent result for the half, and the sales up 20% in the prior year. Margin up and costs very well controlled. The focused value proposition of quality product, excellent service and short lead times and delivery continues to resonate well with customers. EBIT for the half was $16.6 million, up 27% on the same period last year. However, this resulted in an increased contribution to the group of $13.7 million for the half, with only 4 weeks contribution in the first half of last year. Mocka had a challenging half with sales down 26% to $25 million and an EBIT of $300,000. However, significant progress was made in addressing the operational issues experienced in FY '22. Gross margin for the period was also well down in the same period in the prior year, margin has been improving throughout the half, and that improvement has continued into H2. This, combined with the lower inbound freight costs moving forward will assist with restoring future profitability for the brand. Inventories across the group are clean and in line with our plans, given the later timing of Boxing Day and the earlier Chinese New Year this year. As offshore supply chains continue to stabilize, we expect to progressively reduce the inventory buffers and consequently expect inventory levels to reduce over this coming half. Cash flow improved during the half and group net debt closed at $81 million or approximately 1.25x EBITDA for the last 12 months, which remains well under our covenants. CapEx for the half was directed to opening and refurbishing stores within the Adairs brand as well as continuing to invest in digital and technology initiatives across the group. The Board declared an interim fully franked dividend of $0.08 per share, with a record date of 21 March and a payment date of 6 April. Going to hand back to Mark.

Thanks, Ash. As part of the presentation this morning, we have provided a trading update for the first 7 weeks of second half FY '23, which has seen the group grow sales by 1.8% with Focus delivering 14.4% and Adairs 3.1% sales growth on the back of a strong January sales period. Mocka sales were well down on last year. However, in line with our strategy, and as Ash just mentioned, the team have delivered a gross margin 570 basis points higher than the same period last year, ensuring we are restoring our profitable sales model. Gross margin across the group is expected to be supported in the second half by a reduction in supply cost prices, a materially lower inbound freight cost and a relatively consistent USD exchange rate with the second half of FY '23 purchases fully hedged at 72.5 cents. We have also initiated cost out programs across the group to look to manage our cost of doing business in light of the generally high fixed cost base of the store networks in a potentially weaker economic environment. With the first half completed, we have maintained our sales guidance whilst revising our EBIT guidance to $70 million to $80 million on the back of elevated supply chain costs impacting both gross margins and our cost of doing business. Whilst the second half is likely to be a more challenging environment, we believe we are well positioned to navigate this. Our brands are product led with each brand famous for delivering great product for customers' homes at a good value price point. By focusing on the middle market with strong value propositions, we're well placed to capture those customers who are looking to make changes to their homes without needing to make a significant investment, as highlighted by our relatively lower average item prices. This is supported by our commitment to omnichannel retailing that enables us to service all customers regardless of how they choose to shop, providing them with a complete customer experience and importantly, providing the group access to the entire customer market. And just as importantly, our large and loyal customer base gives us the ability to directly communicate with our customers as we showcase new ranges and offers providing them a compelling reason to shop. Just before I finish, I'd like to thank a few people, firstly, to our large and loyal customer base. Across our group, we get the privilege of being a small part in helping them create a home they love. Our aim every day is to continue to inspire and delight them, and we thank them for their ongoing support. I'd also like to thank all the teams across Adairs, Mocka, and Focus throughout Australia and New Zealand. Your passion for our brands, and importantly, our customers help provide a real point of difference in shopping with us and delivering the growth for our shareholders. I'll now hand over for questions.

[Operator Instructions]. Your first question comes from Aryan Norozi from Barrenjoey.

First one for me, please. Just doing the trading update. So the timing is a bit different this time which increased boxing day. But last year, it didn't, you closed on the 25th. So I mean, can you please quantify what benefit that had to the trading update and maybe a more like-for-like number?

Yes. We probably can -- in effect it will drag it down obviously because boxing day last year, the one day was in first half of this year, it's in the second half. We haven't put the numbers out there, Ari, but I think you can allow for circa 5% on the individual brands in the 7 weeks as you start to think about it, that's about the number that they come back. So it'll see Adairs slightly down, but equally, if you take 1 day and you apply that, you don't factor in the fact that over the January sales period, we were actually stronger over that entire period. So whenever you adjust for one day, it gets a bit odd and just you taking boxing day out. So that's why we didn't take those numbers out in that time period because effectively, we think about it more over the full 7 weeks and how we were running the business over that entire time period.

Yes. Okay. So basically, it takes the group of 2% you delivered for the first 7 weeks ended up 5% points off it, which will give you a rough guide around [indiscernible].

[indiscernible].

Yeah. And then obviously, the first half result was actually underlying strong now because obviously, if you can adjust for that.

Yeah.

Yes. Okay. And what would have been -- like is it a similar impact for the first half to add -- sorry, it won't be the same impact, it is just proportionate for the first half? Or how do we think about that?

You're sort of talking circa $1 million, $1.5 million for Adair that will be. So Focus will be -- yes, so it's $1 million, $1.5 million of Adairs. Focus is circa $700,000, Mocka doesn't really matter.

Okay. And that's sort of -- yeah perfect. Just around Mocka as well, you did basically no EBIT this half, pre-COVID you're doing about $4 million of EBIT or 8% EBIT margin, could you just break down the buckets that's gone from -- made EBIT go from 0 -- from $4 million to 0, please? And just how do we think about the second half '23 margins and onwards, please?

Yes. Largely, if you think about trading margin with an investment in capacity, which we always said was going to be over the course, but it's trading margin where the biggest impact is. And that's happened. If you think about that first half, we were clearing the inventory through the first quarter, which we called out in the release there. So you've seen a trading margin decline in Q1. On top of that, what we're seeing in that business is the cost of domestic freight has significantly impacted our ability to -- in an older economic way. So we've been reworking our domestic freight channel. We're now built the partnerships with a couple of key domestic freight providers in Australia, New Zealand, less so. But I think New Zealand, we expect to see that continue to come under challenge. What we're seeing is that local delivery costs grow significantly. And ultimately, the lower margin that Mocka was providing and some of the product we moved into, which had a higher cube impacted that trading gross margin. So what we're seeing or delivered gross margin, if you think of it that way. So what we're seeing Ari is, I expect over the second half, we will grow our delivered gross margin now that a lot of the challenges of FY '22 and the cleanup of them in Q1 are behind us, which is that 570 bps that we're seeing there should flow all the way through that P&L. Equally, that's sort of 280 bps up on last year. So I expect over the second half I'd like to think that we eke out a little more in the profit line. But I think for us, at the moment, it's continuing the stabilization and rebuilding the sales on top of that because the other piece, if you think about it, that's the biggest impact, but there's probably also $2 million to $2.5 million in costs that we've built into the CODB of that business in terms of investments in people and website where those 2 lines are probably higher than -- well, they were well supported by the operating model pre the challenges of FY '22. But we're reviewing those in line with how that business trades going forward. But to grow the business, we knew we needed to invest in people. So largely it's come out of the those 2 lines, I would say, are where it's come out. We haven't invested significantly more in something like marketing or anything like that to drive those sales. It's been largely that delivered gross margin line, that's likely will be an element.

So the rough ways we should think about it is, obviously, your gross trading margins improved about [indiscernible], I think it's tracking at 50.5% year-to-date. And your cost, you did it was $7.5 million of costs in the first half, which includes that $2 million, $2.5 million of investment and sort of that cost won't move that much more in the half. So kind of freight -- and freight remained elevated at around 16% of online sales? Is that the way to think about the 3 buckets there?

Yes. Correct.

And medium term, how does that change [indiscernible] earnings power? I think the margins, you've historically talked about 18 or 20, I think you sort of lowered it last result. How are you thinking about that now, please?

Yes. Look, I think time will tell to be honest with you, Ari. I can sit here and obviously try and predict that. But I think we'll continue to invest in growing the gross margin. So I think we will continue that piece. And obviously, I think what we've got now is a fairly full cost base. So if we can grow the top line, you'll see the operating leverage of the brand start to fall to the bottom line as we roll forward. So we've made the investment in people. We've made the investment in systems. And on the back of that, we'd like to think that we can grow the top line. But obviously, the shift of the consumer back to the shopping in store is having a much bigger impact on Mocka than our other 2 brands, given it doesn't have a store network. So that's also something that we've talked about before that we'll consider as part of how we build the brand out going forward given the strength of the omnichannel businesses around the table. So that's why I'm a bit -- I'm not going to sit here and suggest an EBIT margin in the future because I think the model is still one that we're working through in a new world.

Yes, perfect. So if I can just squeeze one real quick one. Just around Focus on Furniture, you've historically said the ex-COVID benefit earnings power of that business is $12 million to $14 million of EBIT or about 10% EBIT margin. You're doing double that at the moment at 20% EBIT margin. Has it been changed around what that business can earn in terms of a margin perspective? And is the sale -- are you over trading around the sales? Or is that sort of a new baseline for the business, please?

That's not a quick question, Ari. I think -- so we've definitely seen a margin improvement. I think the gross margin line in the Focus business will come off a bit over the next while. Because one of the things we've had a good advantage of is that immediacy of product, a lot of the -- I mean, it's well documented in the furniture space and a lot of people have had to wait a long time for their deliveries. We've been able to have a benefit of we can get you that stock much faster. And off the back of that, there's probably been less haggling on prices as it happens in the furniture world. So I expect that the -- I don't expect to continue to run at 20% EBIT margins in that business. Equally, we haven't opened any new stores, which is a key part of our rollout strategy. We want to take that to be a national retailer, and we know that opening new stores will be a drag on margin as they take time to mature. So I don't think anyone should be sitting here banking 20% EBIT margins of focus going forward. But we probably think that we're capable of delivering more on the gross margin level than the business case suggested. I mean we had margins in that business case of to mid- to high 40s, and I think we can comfortably sit in the low 50s as we look forward in that business. So that's a good outcome at that gross margin line, I'm pretty comfortable that we should be able to hold on to a fair bit of that. But equally, as we expand the store network, we're equally going to incur a higher delivery cost into places like Queensland and New South Wales versus at the moment, we've got a high proportion of our business in Victoria. So I'd like to think that it probably trades in the mid-teens, you know around that 15%, 16%, 14% that sort of range going forward as we roll it out. But equally, we want to roll out the first of the new stores and see how they go in this post-COVID world.

Your next question comes from Alexander Mees from Morgans.

Just firstly, with regard to a comment you made in the presentation that the second half is likely to be a more challenging environment. I'm just wondering what you've seen so far to provide evidence of that environment getting more challenging, please?

Yes. I think we're seeing it's a little more choppy out there, week-to-week trading. That's normally the first sign that is likely to be a bit more challenging. And I think the other thing is consumers are definitely coming out for a deal. So if you don't -- Adairs being high low, we're able to play around with that pricing structure. And if we pull back too far on offers, we are seeing the customer step away a bit faster than they have historically. So that just means we need to think about that a bit more on how we make sure the offer appears to provide real value to the customer and we look to provide that value. So they're probably the first couple of points. Interestingly, traffic remains pretty solid across the store network, probably seeing a bigger decline in traffic in online rather than the store networks, which then just comes back to conversion. And more so shopfront conversion. We're continuing to see customers who come in are likely to buy, and we think that the deals are there for them to buy. But the -- that shop front conversion, there's plenty of traffic out there in shopping centers, but not as much of it walking through the door as perhaps was a little while ago, which suggests that consumers are using the shopping centers for that entertainment value a little more than they were 12 months ago.

That makes sense. And you referred to some cost-out programs. I'm just wondering what they entail and whether you can share your targeted savings.

Look, I probably won't share the targeted savings, but I think we've thought about, obviously, the strategy we're applying and how we're rolling that out and probably delayed and deferred some additional spend in particularly the online space. So we're very focused on continuing to grow loyalty, but winding back costs associated with online business, particularly at Adairs, where that business obviously was trading really well through COVID, and we're just rebalancing places like our marketing and digital teams to realign them perhaps with the -- how we perceive the store footprint and store sales to online sales ratios going forward. Also just thinking about width of offer. For a while there, it didn't matter what you bought in at sold. So as customers get a bit more discerning in a different environment, we're just thinking about our product team and where they spend their time and energy and therefore, where some of those investments go. So I think what we've largely done is thought about a program that sees us probably wind back a bit of our support office costs across each of the brands, wind back a bit of our digital expenditure and try and really target that as to where that will truly deliver an omnichannel experience rather than perhaps a pure-play experience, improve our store productivity with some initiatives that should help the team out there. And equally, obviously, we've got a big piece in supply chain that we're continuing to work through with both DHL and across all of our brands as supply chain costs continue to come under pressure with price increases.

Excellent. Just an easy one to finish. With regard to new store rollout, and obviously, you've made the point that the homemaker market is very tight. What are you expecting in terms of new stores in the second half?

Second half, Adairs should do 2 to 4. And I'm hopeful we'll get one focus, one away. We're very close on a deal, but we should have that locked away, hopefully, in the next few weeks. So that will deliver first half -- or second half store growth of between 3% to 5% for the group.

Your next question comes from Sophie Carran from Goldman Sachs.

Just a couple for me first around the cost savings from the new DHL pricing. And I guess just thinking about the $5 million incremental costs that you've called out, I mean, how much of this do you expect to normalize in the second half from that new pricing? And then is there any path that you see now to those previously flagged cost savings? Or you think that maybe that won't be able to be achieved anymore?

I think, Sophie, the key difference between first half and second half costs and what we emphasized in that note was around cost per unit dispatched, which basically means that we're getting a service for our -- for what we're paying for, which is a key part of the renegotiated arrangement. So in terms of absolute cost, there's every chance that will be the same if they get all the units out. I suspect that will be lower than what it was in the first half and the cost per unit will be significantly lower. But if they do process everything and meet demand and that leads to an increase, then obviously, sales will also benefit from that. In terms of the objective of saving the $3.5 million that we set out when we went into this arrangement with DHL, we're not going to see that anytime soon. So our focus is on getting it to an acceptable level of costs and a better -- far better level of service to our customers and our stores. And then as we move forward, we'll continue to hunt for every efficiency we can find in that facility with DHL.

Great. That's helpful. And then maybe just to follow-on on the previous question around new store rollout and just the challenges in securing homemaker site. I mean, how do you think about, I guess, taking sort of looking into '24, but sort of stepping up that focus still rollout cadence to that 4 to 5 stores that you previously flagged?

Well, I think what we'll find is we will get -- as I call out there, there's a pipeline of opportunities. So some of these are new builds, sites that we know are coming available in '24 as other people take other sites. So I think what we're finding over the course of the last 12 months is a lot of people refining their feet in the store space off the back of obviously a couple of years of disruption due to COVID. So I'm comfortable that I think we should be hitting that 4% to 5% sort of number as we roll into 2024. Probably more likely in the latter half based on the pipeline I've got at the moment in front of me. But that's why when we actually sat down and started working on it this half or even the half before, we were as keen to think about a longer-term play and a longer-term view here because more and more as these centers are being built, if you're not on the plan initially, you won't get in there. So we've taken a view to try and make sure that we secure those sites. So I feel pretty good about 2024 and us being able to see a much faster focused store rollout in that period than what we've achieved to date.

That's helpful. And then just one more for me, just around Mocka and looking at the trading update, it looks like that sort of sales decline has accelerated a little bit into the second half of '23. I guess is there anything to call out there, whether it's sort of any impact of Omicron wave or just any sort of underlying shift you've seen in the Mocka consumer.

Yes. No. I think that's where numbers can be a little misleading. Whilst it has accelerated last year, we -- at this time, we started to trade through some inventory that we weren't happy with, and we really drove sales hard in that January, February period last year. And that's why you're seeing the big margin uptick of 570 basis points as we started to move through a lot of that stock. And on the back of also, I think there was still -- particularly January last year, we did see consumers -- they were very happy to still shop online and lots of people were staying away from stores, as you point out, that was the Omicron wave. So there's an element of that playing through. But I would think more so that decline is us being more disciplined thinking about how we put together a profitable sales sort of period rather than just drive higher volumes at a relatively softer margin that actually net-net doesn't deliver the financial results. So I think that it is a call out that it was trading up against some pretty aggressive discounting at that point in time.

Great. That's helpful.

Your next question comes from Wilson Wong from Jarden.

Just a few questions. First of all, we just the online sales, how have they fared over the first 7 weeks of the second half? And any sort of indication there would be helpful.

Over the first 7 weeks, the probably -- well, they're trading slightly down on last year off the back of some similar sort of commentary to what I just provided before there. So they're not trading -- we've certainly seen the store take the bulk of the increased piece. And it has traded better in, I guess, offer-driven. So in January, it was definitely a stronger result than it has in February when we moved back away from some of the sales sort of driving and discount-driven promotions to a more inspirational sort of piece. So we think online is probably starting to flatten out. And whilst it might fall back a bit in the second half, it will be less stark than the first half.

And just in terms of conversion rate, is that something that you guys track?

Yes, we do. Conversion rates -- conversion rates at Adairs online are actually up slightly year-on-year and against the trend. But one of the things I call out is we've got a new website that's actually converting better than our old website. So I'm not sure whether at the moment, the guys who put in the website would certainly be deeming that that's a website-based piece as opposed to a consumer piece. So I don't want to confuse the matter there. But they -- but equally, what I think what we're seeing is the trend online is conversion stays pretty good at the moment and is maintaining, its more traffic and getting traffic to the website is where the bigger challenge is particularly across Adairs and Mocka. Obviously, Mocka being 100% online and Adairs being a circa 26%, 27% online where we've got the volume coming through where its focus is just that ticks along, and we see that continuing to play that sort of role in such a bulky goods sort of category.

Right. And how about the average order values -- how have they been tracking across the business?

Largely in line, not a lot of movement in average order value. Mocka is up because we're not running the promo and not discounting as hard and not clearing a bunch of inventory. But at Adairs and Focus, we've pretty much held the average order value. What we're finding is when we run the offers, we tend to add items into basket rather than see AOV actually decline with a slightly stronger offer. So obviously, Focus probably is the one that I think will unwind a little bit on the back of particularly shipping costs coming back, we'll have a bit more margin to play with and something that we can think about how we reinvest that for customers, given the relatively high proportion of cost of goods sold that shipping related to in the Focus business.

Sure. Just my last question, just around just the comment around the elevated supply chain costs continuing into the second half. Can you give us some color just around the level of that the impact in the second half from a margin standpoint versus the first half?

I think I wouldn't suggest that the supply chain costs are the same, they remain elevated. So first half is a good guide for second half. With the knowledge of everyone on the call have followed us for a long time is that generally Adairs steps back a little bit on gross margin in second half off the back of mix. Things like bedding and those sorts of categories operate at a slightly lower gross margin, but a higher gross margin dollars. So I don't expect that the supply chain costs will necessarily drive margin whilst they're maintaining there. I don't expect margin to go any further -- any lower. I'd expect that we might get a little bit back. But I'm just wary of that given the consumer and depth of promo and other elements that will need to play out in that second half.

Next question comes from Apoorv Sehgal from UBS.

Good day Mark, Ash and Jamie, hope you're all doing well. First question, a bit of a follow-up, I guess to the previous question on Mocka. So second half sales so far tracking down more than 30% year-on-year. And you're saying that's in line with expectations. Just wondering why you believe that sort of outcome would be expected? I know you called out obviously Omicron and the PCP, but I'm just wondering, is there an element where image of the brand in the minds of consumers still remains well below where it needs to be, and that's part of why it's still in that sort of decline?

I think we've done a -- I don't think we've rebuilt the brand, that continues. I think when we think about expectations, we're obviously looking at daily sales, weekly sales and run rates and those sorts of elements. So when we play all that in, that's how we come up with our expectation, obviously, for the business over the second half and what we want them want to do to obviously move that higher. But we look at it far more on that weekly cadence rather than thinking about what did it do last year, how do we comp last year, what it was last year. Given particularly last year, we had so much noise in those numbers. And -- but we are seeing the decline come out of Australia. So a lot of that decline is probably -- it's a heavier weight to Australia than it is to New Zealand in the Mocka business. So I probably don't spend any time looking at Mocka's last year numbers. I probably more look at the forecast and think about how do we continue to deliver those numbers and upweight it from there versus thinking about what was it last year and what was delivering the sales results. Because there was so much promotional activity going on in terms of moving inventory and reducing the inventory balance that I think it was probably an unrealistically high period on top of seeing that consumer continuing to choose to move to store and shop in store, which has continued to build traction and gain traction and strength over the course of the year throughout, I guess, calendar year 2022 and now into the start of 2023.

Okay. That's clear. And then one more on Mocka as well. Just looking [indiscernible] , marketing costs went up from $1.6 million to $2.2 million despite revenue going backwards, presumably that's a reflection of the discounting that happened earlier in the half. And then just on that -- your expectations on advertising expenses into the second half?

Yes, it went up slightly. There will be a bunch in that line that also relates to some fixes we needed to make to the website and how we are playing that through. But we have -- we continue to think about those advertising expenses and how we run them as a percentage of sales. There will be an element there where we drove it a little bit in Q1 to move inventory, and that should wind back. But we'd expect the advertising expenses probably to come back more -- it will be less than that in the second half.

Got it. And then just one more for me. Your EBIT guidance for the full year, it's been reduced to about $5 million at the midpoint. Now the first half result itself was about a $4 million to $5 million miss to consensus expectations. You've obviously got Mocka that has started the second half below PCP. So I'm just curious as to why that guidance range maybe wasn't cut more. Just given where the first half landed. You talked about the elevated cost inflation, trading conditions is a bit choppy in your words. And just given how Mocka is also tracking second half so far?

Yes. See, I think Mocka will beat first half, second half, so at an EBIT line. So that's the challenge of taking a sales number and then punching that in and expecting how that flows through that P&L, particularly given the improvement in GP. So I'd like to think that Mocka will deliver an improved EBIT performance over the second half. Adairs has obviously got -- had a higher level of supply chain costs in there, which whilst to Ash's point before, if we deliver the sales, those costs will remain the same, but that will have meant that we've delivered probably a sales result in the top end of the range, which would support an EBIT result there, and Focus continues to trade week-to-week pretty well. And unlike the Adairs and Mocka business has that sort of 7 to 8 weeks sales already completed when you think about the only book it on delivered costs. So at this stage, we think we've got -- by the time we do margin it should at least be about where it was for the first half in terms of a gross margin level given some of the tailwinds we've got in terms of international shipping and the cost price reductions we're getting from some of our suppliers, probably more helping Focus and Adairs than Mocka. Then you've got the cost out, you've got the supply chain. So there's a bunch of moving parts that start to go into that number and that cost. So we think first half was probably more impacted by some of those elements, and we'll trade the second half in the environment that we're in. And if it continues in the way that we see it playing out from today, we're pretty comfortable we should be able to deliver something in that range.

Okay. That's clear. Just one final quick one as a follow-up. Within the Adairs brand in the first half, obviously, you called out the $5 million of incremental warehousing costs. Were there any other cost buckets that surprised to the upside in the first half that may potentially normalize to some degree in the second half?

Nothing I'd call out significantly, except we continue to call out a little bit the cost out program that we think will deliver a bit over the second half. And the other ones that are up are things like toll and Australia Post, but I don't think there'll be significant savings on those in the second half. I think the lines that we'll go after I think is in probably a little more in our control and just managing that productivity piece, particularly through that supply chain, which includes toll and Australia Post if we pack and ship it well, we should see a reduction in costs more broadly than just the DHL piece. So there's nothing significant there that I'd call out. I think the bigger impact on the second half cost line will be the work done in this cost-out program at Adairs that will drive some element of cost reduction over that second half.

Your next question comes from Mark Wade from CLSA.

Sales look really strong to me. And so clearly it's more of an issue with getting the costs in check. Just like on the Adairs brand, I mean we had this EBIT margin in there of about 8.5%. That's the [indiscernible] in a decade market. So I'm just trying to get a sense of how much of that is just an aberration? Or is this kind of like the new normal for that brand, given the some of the challenges you might come up against?

Yes. I don't think it's a new normal for the brand. I think the supply chain costs, we've never had supply chain costs run at that sort of percentage of sales in the Adairs business. So that's the big call out there. And equally, we made a series of investments in people to continue to drive online but probably haven't delivered as much as we would have liked, which is sort of enabling, I guess, a bit of that cost-out program for us to think about, you know, is that the way the consumer wants to shop, how do we wind some of that back? How do we continue to take the ones that were working and drive those and perhaps park some of the more adventurous ones and pull back some of the costs associated with that. So I think you'll find it's a half where the Adairs business has incurred a bunch of costs that probably got a bit ahead of itself in terms of where we thought online could go. So we're winding them back in that supply chain piece. So I'd like to think that we put that EBIT margin back towards a more historical sort of number in the 12% sort of range in the second half. And that should also allow -- we've always said that we should trade at 12 to 15 in the Adairs business. With 15 being when times are good and margins are strong and all the rest of it. And I think we're probably not in -- we're sitting out certainly predicting that the consumer is going to be in such a mindset over the second half that they will be at the top end of our gross margin sort of expectations. So that's why I think the sort of more the bottom end of that 12% to 15% in the second half is where we think we'll come out at.

Excellent. And that 5-year aspirational target on sales of $1 billion for the group. How do you feel that's shaping up?

I still feel like we've got plenty of opportunity there. I think store rollout will contribute significantly to Focus. I think Adairs as you said, it's not a sales problem here in terms of the underlying results. I think the sales result was strong in the half but had some -- still had some headwinds in the consumer potentially seeing elements of it. But I think there's still lots of opportunity for Adairs. We've talked about doubling the size of Focus and Mocka is about how do we get the model right. And -- but I keep coming back to -- the unique part about all of our brands is that real focus on product, how we think about what the consumers want, how we get that in front of them. And I think the Mocka team, I think, have done -- using them as an example, a good job on really narrowing down the widths of offer, making sure the product itself is very good. Now it's about how we get it in front of the Australian consumer efficiently and effectively rather than potentially sitting here today and say, let's build out 100 stores to get it to the consumer. We don't think that's the right way to go. But what we're finding is that shift back to store and something like a Mocka business doesn't allow the quality of that product to really come to hands of consumers. So I'm not -- I certainly wouldn't step away from that $1 billion sales target over that 5-year period. I think we've still got 3 really good brands. We've got good opportunities. We've got to trade through potentially a slightly a tougher economic environment. But that's retail and that's trading. You can't expect clean sailing all the way along and tailwinds all the way. It's about how we execute through here. We're good at that operationally. We certainly learned a lot through Mocka's challenges over the last couple of years that has enabled us to think about how we operate that business a bit differently. The Focus team are very good at executing. And I think largely, the Adairs team are too, I think the DHL piece and working collaboratively with them will get an outcome there. So I feel pretty good that we've got the right ingredients. We just got to make sure that we put it all together and execute the way we want to over the next couple of years, in particular, as the consumer perhaps feels the impact of the interest rates and the like over the next 6, 12, 18 months.

Good to hear. And the lastly, just the reference is the like-for-like sales growth, can't see anything in there. I know we're cycling the store reopenings and stuff, but this is a metric that's permanently being removed from the lexicon?

Well, I have for the time being, yes, because I find that every time I give it, I have to explain 14 dot points underneath it as to why it's no longer relevant. We're not smashing out opening heaps of stores. I think if we were rolling out 5 and 6 Focus stores, I think for sure, we give a number in terms of that like-for-like because ultimately that would to be quite an important number in understanding the impact of the existing store network and then the new store network. But given we're not seeing those big store growth numbers, it's a bit easier for us to report the net sales growth, and there's just not a lot of dot points that sit underneath that.

Okay. We look forward to seeing the day it comes back as a sign of the business in really good health.

Thanks, Mark.

Your next question comes from John Hyde from Wilsons.

Good morning, Mark, and Ash. I was hoping to look at -- a follow-up on my earlier question on Focus. You said you didn't give away or you didn't have to give much away on price because of the conditions. I'm just thinking, trying to think how this business looks going forward. The store sales were up close to 30% online sales down at 40%, growth margin percent didn't move materially. If I could just understand that movement there. And then also, with the cost of doing business line, I think it's up about $3 million. Obviously, as you get your hands around the business, there's cost that goes into the business, can you maybe do some color on what those lines are, what the main buckets there are? And if we're looking at a cost base of around about [indiscernible] going forward, please?

Yes. So when I think about Focus -- let's start with the cost question. Yes, the cost was up, but the cost was up because the stores were open. So that's -- it's a bit of a funky half because last year you had -- and in focus of state, we had 17 of our 23 stores are in Victoria. So they were significantly impacted by the lockdown of first half '22. So realistically, we haven't -- there's not a lot of extra costs going into that Focus business. What you're seeing there is that, that half is more reflective of a fully operating store network. You should think of it in that mindset. And I think the same with online, as you play through those numbers there, John, we don't expect Focus to be a significant online business. We think most customers and consumers as your average order value goes up and you're buying sofas and dining tables and large furniture items that they find it more important to see, touch, feel, engage with the product in store. So we think that half is probably a far more reflective half of how that business sort of trades out over time with the exception of the EBIT margin if we invest in new stores, they will operate at a lower EBIT margin or trading or store profit margin in their first couple of years. What we've seen historically and what are the guys at Focus tells is your best store needs 12 months to 24 months to really start to hit its straps. So we'll see that come back. As we roll out more stores, we also need to invest in a supply chain that supports that. So at the moment, being heavily Victorian centric, we have our main distribution center in Victoria. As we roll out the East Coast of Australia, we're going to need to put distribution centers of some sort, not to the same level as the Victoria one, but we are going to need to invest in that cost of doing business line in terms of additional supply chain capacity and capability up and down the Eastern seaboard supporting the store rollout. So what you'll see is that investment obviously will also take time to get its scale and allow it to actually pay off. So we expect that will also be a drag on that EBIT margin. And what you saw at the gross profit line or gross margin line over the half was our holding of prices meant that really, the shipping costs flowed through in that half. So if you think about when we buy the stock and then when we deliver the stock, we would have seen there was -- that had a -- the international shipping costs had a reasonably big impact on the gross margin over that half, which is now unwinding. And what we'll see going forward is we'll be able to give back a little bit in price but probably hold, if not potentially even grow gross margin, but I think more likely hold going forward that will support that higher EBIT margin than when we originally put together that business case to sort of 10% to 12%, which is where we started that when we put it together. So we're expecting, as I said before, that we'd like to think that we can run it in the mid-teens EBIT sort of percentages. I think I answered all of your questions.

No, look, it was a long question, and I think you have answered this all of my points. Just on the store sales, have you -- was there any rebasing or recutting of pricing old legacy positioning versus your current positioning. What have you learned as you've put product on -- the new product on the ground and probably revamped of some of the footprint, the store footprints from previous, I guess, previously set out.

Yes, yes. What we found is that the customers got a similar bent to Adairs when I think about it. They like new. So we've got to keep bringing in new product, new versions of change them through. The beauty of this is that we don't have to drive as much newness through that business. And equally, the products generally have a longer life cycle. But as we've been delivering new, we've also been able to increase a bit of that fashionability in there, and the guys are quite -- they're well aware of what customers are looking for and whether that's fabrications or styling, bigger, smaller and those elements that all play through that. So what we've seen is that customers in the Focus stores are very happy to invest in the new products. They like to see the new product, though, it doesn't sell very well online before it gets out to store. So we have to keep turning that over and changing it over. But equally, what we find is if we change the product over in store slightly more frequently than we actually generally get our costs back on the items that are on the floor. The customer is far more likely to take one off the floor at 50% off, given we don't sort of run that depth to promo than us having if it's only been there 6 months than if it's been there 12 or 18 months, often that ends up being given away to charity on the basis that customers won't pay for that given it's been in the showroom too long. So I've been impressed with the team. I've been impressed with the newness, the product is working really well and they're really [indiscernible] with what's going on in that space, which comes back to our business case as we thought about how do we attract -- go after the bulky goods space was how do we make sure we hire a team who are real experts in this space. And that so far has certainly been the case. And I think that the results are a testament to the team out there and what they've delivered.

Okay. One -- just one more, on the DCs. Can you give some more detail on the actual issues there and what -- why the costs were -- did need to step up? And did it only affect the online business? Or was it across the board? And then, I guess, the 20% recovery, is that offsetting what's rolled through this on that $5 million this half? Or is DHL giving you a little bit back for the issues that they have caused?

So in terms of the first question, the fundamental issue is lack of productivity and, therefore, a very high cost per unit. So the DC during the ramp-up phase, there's more of a cost-sharing arrangement or cost arrangement where we're responsible for those costs. And with the performance issues resulting in very low levels of productivity, we were getting a very high cost per unit dispatched in simple terms, and that has flied through both parts of the business. And we had challenges in stores, restocking stores after major events and maintaining stock levels across all the different departments. And we focused on those big [indiscernible] departments. So therefore, some of the other smaller departments suffered. And that -- that would have been a sales impact, but what that would be is difficult to quantify obviously. As we look forward, the new model essentially has that cost per unit dispatched as an agreed rate. DHL will likely be investing costs in order to provide the service at the current productivity levels. They are improving. They still have a long way to go to get to the point where both of us will be happy with the outcomes. And that's what we're working together on to address moving forward.

Okay. Just I guess one more iteration there. The issues you faced at DC, it's not comparable to the issue you were facing with Mocka and that third-party supplier provider.

No, totally different. That was a delivery partner that just stopped delivering.

Yes. Okay.

There are no further questions at this time. I'll now hand back to Mr. Ronan for closing remarks.

Thanks again, everyone, for joining us on the call this morning of the first half results, and we look forward to keeping the market and you all updated as we progress through the second half. Thanks again.

That does conclude our conference for today. Thank you for participating. You may now disconnect.