Breville Group Limited (BRG) Earnings Call Transcript & Summary

Thank you for standing by and welcome to the Breville Group Limited 2021 Full Year Results Investor and Analyst Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Martin Nicholas, the group's CFO. Please go ahead.

Good morning to everybody joining today's call. I'm Martin Nicholas, Breville Group's CFO. And it's my pleasure to welcome you to our financial year 2021 results call. I'll start by walking you through the group's trading performance and then Jim Clayton, our CEO, will provide an operational and strategic update. We'll be talking to the slide pack that was updated on the ASX about 30 minutes ago. So turning to Slide 3 and our headline results. Firstly, sales. We had a remarkable year this year with total sales of nearly $1.2 billion. The accelerated demand we saw in the first half carried on into the second half. Increased consumer demand driven by both the requirement and the wish to work from home, coupled with our continued geographic expansion, outweighed logistical challenges and a weakening U.S. dollar in the second half to deliver 24.7% sales growth and 37% growth in our key Global Product segment in constant currency. Our gross margins improved year-on-year as our increased average selling price, driven by improved mix and lower promotional activity, outpaced the headwinds of cost inflation, including increased manufacturing and shipping costs. In FY '21, the tailwinds more than balanced these inflationary headwinds. As we look to FY '22, inflationary pressures seem set to continue, and we will take price rises where appropriate to protect our margins. In FY '21, with core overheads kept in check, we reinvested our operating leverage into medium-term growth drivers of R&D, marketing and IT, while still delivering and accelerating absolute profit growth. FY '21 EBIT grew 24% over normalized FY '20 EBIT or 39% over [indiscernible] EBIT. We had adopted accounting policy and estimate changes in the second half, SaaS capitalization and NPD amortization. These 2 largely offset each other at the EBIT level. So I won't spend much time on the technicalities today, but a full explanation of their impact is included both within the results announcement and notes to the accounts. In terms of cash flow, we ended the year with net cash in line with prior year despite finding strong business growth and the purchase of Baratza. Our working capital remains below equilibrium by approximately $80 million as delivery challenges, including the Suez Canal blockage, the 4-week closure of the Yantian port in China and inbound port delays, suppressed our in-country stock levels and customer deliveries late in the half. With EPS at $0.658 our full year dividend of $0.265 per share, 100% franked, reflects the group's previously announced targeted payout ratio of 40% designed to encourage our ability to internally fund numerous growth opportunities. In summary, FY '21 was an operationally challenging, but positive year. Sales grew strongly, and we reinvested these gains into future growth drivers. And overall, I must say, I'm delighted by how our team and processes absorbed the volatility experienced during the year and kept delivering for our retail partners and customers. Turning to Slide 4, we see key segment performances. Our Global Products segment carried its sales amounting from the first half through to the second half, delivering 37% sales growth for the year on a constant currency basis. The continued working from home reality, even outside of lockdowns, supported broad-based category growth, and we continued our strategic geographic expansion even during lockdowns. Our Distribution segment grew 8.4%, with double-digit growth in the more premium Breville Local offering offset by lower growth in Kambrook and Nespresso. And of course, most importantly, the Distribution segment fulfilled its strategic role delivering $2.4 million in incremental EBIT to reinvest in the Global segment. Turning to Slide 5. In terms of Global Product sales by geography, all theaters delivered strong double-digit growth, with gains across all categories. Working from home reality, accelerated growth in all our geographies with the impact varying with different consumer and retailer experiences as well as lockdown patterns across the key markets. In the Americas, the group delivered 27.6% constant currency growth with bricks and mortar retailers largely opened by the end of the period, but disrupted during the year. The theater was somewhat constrained by deliveries late in the year, but still posted growth comfortably above the long-term average for the geography. We also entered Mexico in the fourth quarter. In EMEA, despite on-off retail lockdown disruption, the region performed well, delivering 58.4% growth. The U.K. sales held up across the year, and mainland Europe posted strong growth in both new and existing markets. Our entry into France was completed in quarter 1, and Portugal and Italy were added in quarter 4. In dollar terms, EMEA's Global Product growth outstripped both the Americas and APAC. APAC itself achieved good second half growth of 24% after a remarkable first half of over 49% to deliver full year constant currency sales growth of 37%. In APAC, retail stayed largely acceptable to consumers throughout the year, and the region was supported by nimble supply chain management, with inventory levels almost restored to normal by the end of the period. Nothing special to say about relative gross margins, which remained similar across the key geographies. Jim will cover this more in his section, but it is noteworthy that in the Global Products segment, EMEA is now larger than APAC and the 2 together now match the Americas. Turning to Page 6, funds generation and usage. On this slide, we pictorially show how we've reinvested our gains in gross profits while still delivering and accelerating EBIT growth. All the numbers on this chart have shown movements against the normalized FY '20, which was $12 million above our statutory EBIT in that tier. In FY '21, sales were strong and gross margins were boosted by a premiumization of mix and lower promotional spend, more than offsetting inflationary pressure. Overall gross profit dollars grew by $92 million or 29%. However, with the objective of driving medium-term growth, more than 50% of this incremental gross profit or $49 million was reinvested in go-to-market capability and specifically our digital events, in new product development and in our IT team and corporate platform. This is consistent with our strategy of increasing our investment year-on-year to enhance our go-to-market effectiveness, to upgrade our new product development capability and to increase our technology-based competitive advantage. Outside of these 3 priorities, core overheads and OpEx were well controlled, delivering operating leverage. We did invest in extra customer service heads and supply chain heads, incremental Baratza overheads were acquired and the team were awarded bonuses in FY '21. Outside of these increases, overheads were kept largely flat and overall decline as a percentage of sales. Our resulting EBIT was increased by $26.5 million, growing at 24.1%, an acceleration from the 16.2% in the prior period. We both generated and invested incremental funds, healthily accelerating our bottom line. Turning to Slide 7 on the balance sheet. Here, we see the impact of our below equilibrium working capital flowing through our reported numbers. Under normal conditions, the group structurally invests in working capital to drive growth. However, despite 24% sales growth, FY '21 working capital was on a par with the prior year, which itself was low. June 30, 2021 working capital is, as I said before, approximately $80 million below normal or equilibrium levels. Reported inventory levels recovered a little towards the end of the year. However, over 1/3 of this was still on the water at June 30, with in-house -- sorry, in-warehouse inventory only recovering 10% from the low of June 2020. Our receivables balances actually dipped below prior year, with an excellent improvement in collections and debtor days across the group, coupled with a weakening U.S. dollar and constrained deliveries at the tail end of the half. Our payables balances largely grew in line with the business. And collectively, this resulted in working capital flat on prior year at about $80 million below equilibrium, with cash of about $80 million higher than the norm. This imbalance should unwind during FY '22 as we aim to rebuild our inventory balances and receivables normalize. Our intangible assets of $230 million grew by $86 million over the prior comparable period due to the acquisition of Baratza in September 2020 and our continued NPD, new product development investment. IT capitalization has largely been removed from both this and last year's balance and the new SaaS accounting policies. At 30th of June 2021, the group had a net cash position of $129.9 million, which reflects our below -- our above-mentioned equilibrium with capital position. We are planning for a significant rebuild of working capital and cash outflow in FY '22 as we transition back to a more efficient state. We have adequate cash and debt facilities in place for this time to rebuild. And now finally, turning to Slide 8. I hope that the unpacking of our reported numbers has been helpful in what I can only describe as an interesting year. And the key messages I'd like you to take away from this year's financial results are, firstly, we had a strong sales year, and the global working from home tend driving the year of accelerated revenue and gross profits. We used this accelerated gross profit to lean into our key medium-term growth drivers namely marketing, product development and IT, while still delivering a 24% increase in EBIT. Outside of these priorities, other costs were well contained, and our working capital, the net cash positions are not at equilibrium, and we plan to correct this in FY '22. So with that summary and on that note, I'll now pass to Jim Clayton, our CEO, to provide an operational and strategic update.

So thank you, Martin, and good morning to everyone. Turning to Slide 9. Now that Martin has covered the results from what was a very dynamic and interesting year, I'm going to summarize our execution in FY '21, take you through an analytic backtesting of our acceleration program. I will end with an update on COVID and the current state of play. Before we get started, I want to touch base on what you won't see. As we have grown, we have become more visible. It appears as though some of our competitors are now copying almost everything we do, both in our go-to-market and product. While we appreciate the attention, there's no point in making things any easier than they need to be. Considering this, I will revert to the reporting approach we used in FY '16 through FY '18, meaning I will only disclose things after they've happened. Specifically, you will not see product that is not launched, nor will I discuss geographies on the to-do list. I will report out on these activities once they've occurred. Turning to Slide 10. In first half of FY '21, I said that COVID had not materially impacted the cadence of our acceleration program execution. I believe the next few slides will support this statement. In FY '21, we launched 3 new colors across the range. I'm using a toaster as an example, but these new colors are available across many SKUs, a particular note is black stainless steel given the association between stainless steel and our brand, this one will be interesting to watch. We launched a series of new products across beverage, cooking and food prep. The Fast Slow Pro is a more approachable pressure cooker, the Bambino solidified the bottom of the coffee range delivering the 4 elements of café-quality coffee and a compact footprint, and the Creatista Pro redefine the top of the range for our Nespresso capsule products. The HydroPro and HydroPro Plus delivered commercial quality sous vide performance. And the FoodCycler is a product designed to help customers recycle food waste. With the Combi Wave 3 in 1, the Compact Wave and the Pizzaiolo, we launched the 240-volt versions into Europe and Australia. Turning to Slide 11. FY '21 was an active year for geographic expansion. COVID extended much of the France entry into FY '21. The EMEA theater then followed with both Portugal and Italy, while the Americas went live in Mexico. This was the first year we had 2 theaters executing geographic expansion simultaneously. All new geographies are performing as expected this early in their launch cycle. Turning to Slide 12. We acquired and integrated Baratza. Baratza brings a team that extends our coffee expertise, and it delivers a coffee grinding range from entry to light commercial. Baratza is performing exceptionally well [ for these quarters ]. Baratza also gave us the opportunity to test our new corporate platform. Did we design the system to quickly integrate an acquisition? The answer is yes. Baratza transactions are executing 100% on the corporate platform, all that remains is porting their website to our infrastructure. Turning to Slide 13. FY '21 was a busy year for the Technology Services team. With Canada and Baratza going live on August 1 this month, all that remains is Australia, which we will take live in the second half of FY '22 as well as any new geographies we enter in FY '22. With the corporate platform now fully deployed in the Northern Hemisphere, we are well prepared for future acquisitions. While it is too early to tell, the next few years may hold interesting opportunities on this front. Turning to Slide 14. In FY '21, we achieved a few milestones with our acceleration program. Breville as a whole crossed the $1 billion revenue mark. In our Global segment, EMEA is now larger than Asia PAC, and Mainland Europe is now bigger than the U.K. But we still have a long way to go, all appears to be heading in the right direction. Turning to Slide 15. We've been executing the acceleration program since FY '17. Enough time has passed for us to analytically backtest the success of this program. Slide 16. In FY '17, I used this framework to describe the acceleration program, selling more product into a larger market on a scalable platform with a growth-oriented business model. Slide 17. Followed with a slide that showed if we pulled this off, we would create a reinforcing route, which would sustain the acceleration. Slide 18. Typically, when a company adopts a strategy of invest heavily with the promise of a revenue hiking 6 years later, EBIT tends to suffer in the early years. While our acceleration program shared the investment characteristics, I made a commitment at the beginning of the program that we would execute the business model transformation without stealing from EBIT. And at least on this, we have held our commitment. Not only have we not stolen from EBIT, but we have grown EBIT at an increasing rate over the period we've been executing the acceleration program. Turning to Slide 19. As I mentioned when we started the program, public companies typically don't execute business model transformations. Instead, the company is taken private, the business model is fixed and then it is refloated. But given the strength of Breville's innovation engine, I believe we could fix the plane while it was flying. The core challenge was figuring out how to evolve the business model, moving from spending 8% of net sales on marketing and R&D to 12% as the floor while simultaneously growing EBIT. There are 4 EBIT-neutral levers you can pull to accomplish this, and we have pulled all of them over the last 5 years. First is operational efficiency. Find ways to improve productivity and nongrowth-related functions and reallocate those savings to marketing and R&D. Second, leverage the Distribution segment as an internal funding mechanism, turn the segment around so that it grows and taking incremental EBIT growth and reinvest those dollars into the growth engine of the Global segment. Third, create operating leverage in the business as it scales and reinvest the incremental dollars into marketing and R&D. And finally, four, grow the business in constant currency faster than EBIT growth and invest the incremental gross profit dollars into marketing and R&D. The table on the slide shows the relationship between the constant currency growth rate of the Global segment and our annual EBIT growth. While we have not yet achieved our target business model of spending at least 12% of net sales in marketing and R&D, we have made significant progress against this goal using all 4 EBIT-neutral levers. COVID certainly threw a wrench into the program's timing, but I'm confident we will get there. Turning to Slide 20. Before analytically testing the success of the acceleration program, I want to first set some context. Acceleration program began in earnest in FY '17. We have 3 levers we can pull to accelerate the top line: first, investing more into marketing and R&D as a percentage of net sales, which gives us more product and more marketing; second, geographic expansion, which is more merger and acquisitions, more product and maybe more market as the third lever. This slide shows which levers have been in play across each of the 3 theaters over time. In Asia PAC, whatever growth it has experienced has come entirely from improving the business model. In the Americas, apart from the nonmaterial acquisition of ChefSteps in FY '20, the Americas has been solely dependent on increased spending on marketing and R&D through FY '20. In FY '21, the Americas entered Mexico at the end of the year, and we acquired Baratza. EMEA initially did not benefit from the business model change, except for the U.K. because we have a distributor-led go-to-market model across the region. In FY '18, we started the transition to a direct model in Western Europe by entering Germany. As we put countries to a direct model, the region was able to leverage the increased investment in marketing and R&D. So to summarize, for Asia PAC and the Americas, any acceleration would come solely from increased spending on marketing and R&D. And for EMEA, it would be a mix of geographic expansion and increased spending on marketing and R&D beginning in FY '18. Turning to Slide 21. Looking at Asia PAC theater relying solely on the growth lever and increased spending on marketing and R&D, we see the average annual growth rate of the global segment has increased from 3.3% during FY '14 through FY '16 and to 11.1% during FY '17 through FY '20. This is a 7.8% increase in the average annual growth rate. At least for Asia PAC, the historical performance data suggests that our decision to invest more in the marketing and R&D has resulted in annual revenue acceleration. You'll notice that while I've included FY '21 on the slide, I have not used it in the CAGR analysis. FY '21 is a COVID year it's [ excluded ] from the CAGR analysis. FY '21 data is COVID-infected data and thus not considered valid for year-over-year analysis. Turning to Slide 22. Prior to changing the business model, the global segment in the Americas was growing at 8.7% in constant currency, the CAGR from '14 through '16. As we began incrementally improving the business model year after year, the average annual top line growth accelerated to 12.3%, the CAGR from '17 through '20. This is a 3.6% increase in the annual growth rate for the theater. Looking beneath the numbers, the impact is understated. The FY '14 through FY '16 growth in the Americas was driven by Canada coming online. To help you appreciate the magnitude the U.S. grew 1% in constant currency from FY '14 through FY '16. Again, another data point suggesting the drive to spending 12% of net sales in marketing and R&D is working. Turning to Slide 23. With EMEA, we see a much larger amount of change. From FY '14 through '17, a period where we were in a distributor-led go-to-market model, except for the U.K., the average annual growth rate for the global segment was minus 2.1%. It's worth noting that the U.K. was growing during this period. Once we kicked off the transition to a direct model, the tables turned and we began growing rapidly in the theater. This go-to-market change, coupled with increased investment in marketing and R&D drove the average annual top line growth rate from minus 3.1% to 34.4%. Turning to Slide 24. Drawing all 3 theaters together from FY '14 through '16, the global segment had an average annual top line growth rate of 3.1. Once we started investing more in the marketing and R&D and pulling the other growth levers, the average annual growth rate increased to 14.6% across the financial year of FY '17 through '20. Turning to Slide 25. Focusing on our new geography offense, we can see improvement there as well. In this slide, when comparing Breville's entry into the U.K. with Breville's entry into Germany and the other Western European countries, this bar chart starts with the first full year of revenue for each geography. Using our more aggressive approach for entering new geographies, Western Europe has generated more revenue in its third year than the U.K. did in its eighth year. If you look at the CAGR lines for the U.K., you'll see that the U.K. showed the same acceleration pattern as the Americas and Asia PAC from our decision to invest more in the marketing and R&D. Turning to Slide 26. Put all of this together, and you get an accelerating business that is improving the geographic diversification of its revenue base. While the Americas has grown at a steady clip from FY '17 to FY '21, it now represents 50% of the business, down from 57% in FY '17. If all theaters continue the current trajectory, this diversification will continue to improve. Turning to Slide 27. Looking at the company's performance from FY '14 through FY '20, the data thus far supports the following inclusion: first, strategy of an innovation-driven company, migrating its business model to spending more on marketing and R&D is working; second, geographic expansion is helping to drive the top line and further diversify the revenue base; and third, the more aggressive approach for entering new countries is delivering accelerated performance. Turning to Slide 28. Now on to the topic of the day, which is COVID. Slide 29. Before we get to the tactics of COVID, it's worth mentioning that this once in a 100-year pandemic is touching everyone in one way or another. So far, we are thankful that we have not lost a Breville team member to the virus, but we have lost family members. We now find ourselves in a global drag race between vaccine rollouts and the spread of the Delta variant. To repeat commentary from my first half report out, we are not done with COVID. This is a marathon, not a sprint. Assuming the vaccines are successful in significantly reducing the mortality rate of the Delta variant and whatever the next variant will be, FY '22 looks like it is shaping up to be a transitional year of sorts. We're moving from the entire world being in lockdown to country-specific vaccine rollout cadences with different rates of opening up while still experiencing regional lockdowns. At the macro level, consumers have pent-up savings and economies grow as they open. But as they open, consumers will begin to diversify their spending pattern to include services. It's too early to tell how these countervailing forces will play out for the small domestic appliance market or how it would play for Breville specifically, as we sit on top of the constant currency prior year of plus 37% for the global segment. On the front lines, we are wrestling with everything reported in the news. The U.S. dollar has fallen across all currencies, though it stabilized as of late. Supplier costs have increased in the way of intermittent part shortages, though so far, we have resolved each instance that has arisen. The global logistics backbone is stretched and erratic as it is impacted by local events, which, coupled with increased demand, drives up transportation prices. And finally, as the Delta variant spreads across the world, the unpredictability of how countries or local regions will respond is on the rise with the potential to further disrupt supply or demand or drive additional delays into logistics. From a global perspective, COVID is a tactical ripple and demand supply line like Trump's tariffs or Brexit. The primary difference being it is global, a global multiyear phenomenon. As such, we have seen nothing during the COVID period that has had any measurable impact on our go-forward strategy, more products into a larger market and a scalable platform with a growth-oriented business model. To offset some of the net input price increases, net of currency, we will raise pricing similarly where appropriate. Our tactical approach to the certainty of FY '22 is a more refined and targeted approach to the offense we ran in FY '21, which is high/low. Our inventory for the high side of planned variance with the goal of overshooting and then selling back to the demand line in the second half, while running costs tight as the hedge again low side of the variance range. As long as actual demand falls within these 2 high/low [indiscernible], we will converge our execution across the year to meet the actual demand line. With that, I will now hand back to the moderator, who will open the call for questions.

[Operator Instructions] Your first question comes from Alexander Mees with Morgans.

So my one question will be around average selling prices. Martin, you mentioned that they're up on the basis of improved mix and lower promotional activity. I just wondered if you could comment on your experience with like-for-like sales price increases to the same product please?

Yes. Thanks, Alexander. 2021, we didn't take any significant price increases, product to product. It was much more about the lower promotional spend. There were a few that flowed through in Australia early in the year, but it was more around less promotional spend rather than an increase in existing prices in FY '21.

Your next question comes from Tim Lawson with Macquarie.

Just on Slide 6, that EBIT bridge FY '20, FY '21. Can you just expand on your comments around marketing, R&D, IT and overhead in regard to whether you can sort of talk through what's [indiscernible] and what's pulled forward, what is [indiscernible]? Just trying to understand those [indiscernible] going forward, please?

Yes. Should I start with that, Jim?

Yes, go ahead.

Okay. So of the $49 million, looking forward, about $29 million was in marketing or go-to-market and about $10 million and $10 million across tech services in Global Product. But the amount that was in marketing, about 2/3 of that was on platforms, experience hubs, content development, I can put -- yes, we're pulled forward, but didn't necessarily drive demand in that period. So as we move into FY '22, if we spend about a similar amount on marketing, more of it will be orientated towards demand generation or media in the market. So the stuff we pulled forward was about capability development.

Your next question comes from Apoorv Sehgal with UBS.

Guys clearly, some continued strong top line momentum in the second half of the year. Just interested in the outlook commentary for FY '22. In your slide deck, you talked about the challenges the cycling FY '21 comps and consumers likely to shift share of spend to services. Have you actually seen any changes in customer behavior or demand trends over the last couple of months in places like the U.S. and Europe where vaccination programs are well developed and people are sort of going out to restaurants and pubs and bars?

So I mean, the window that you called is very tight. So I think the best I can say is we've started '22 in a solid position. And I just -- I don't think there's enough data honestly to judge one or the other. So, so far, we haven't. But I could flag it as a thing to watch.

Your next question comes from Sam Haddad with Bell Potter.

My question is in terms of the supply chain, can you talk about what you're seeing now through July and August? And how you plan to build your inventory ahead of the key trading period in Black Friday and Christmas. From memory, you like to plan ahead early, ahead of some of the other global players. So I just want to see how you're going to have to adjust the strategy to -- given the constraints you've seen and what you're actually seeing?

I mean, it's not -- we're not adjusting the strategy. You're just -- you're living with the reality, so to speak. So one of the things that Martin talked about was the kind of tails that we saw a tightening that we saw at the end of this period, another phase to the Yantian shutting down for 4 weeks. So that's kind of like pulling on that -- pulling the rope while you're water skeeing or something, right? So it just created some slack. So what we were seeing as we went in, and this is March, April, right on plan. We saw April inventory past the year before, and we were up in to the right and then you see this kind of 4-week lag. So that just pushes everything to the right, so to speak. And so you just -- the orders are there. The good news, I mean, if you really break this thing down into its pieces that you have to manage, it's: first of all, are you going to get the parts you need; second, are you going to get them made; and then third, get them on in the water and across. And the good news for us so far is we have completely managed 1 and 2. And now it's just about putting them on the boat and moving it across. So it's not -- the orders are there, the products are there, now we just need to move them. And you'll be -- as container rates going up all of the sudden, but we're on the moving stage.

Your next question comes from James Casey with Ord Minnett.

I just wonder if you could make a comment on new -- potential new geographies for this financial year. Obviously, you added multiple territories in FY '21. Have you got enough on your hands at the moment? Or are there plans to add further geographies for FY '22?

I really do the best I can to make sure my team doesn't get bored. So if I have been going into new countries in FY '21 during hard lockdown, you can guess that we will be going into more countries in FY '22.

Okay. And I guess your comments earlier with not flagging things to your competition, we'll just see those announced as you, I guess, enter those countries. Is that fair?

Exactly.

Your next question comes from Ben Gilbert with Jarden Australia.

Just a question just around some of the structural changes in specifically COVID, and what are a few of the global leaders such as yourself are talking to and some brands, it seems like sort of Nike, Samsung, et cetera, talking about sort of 2 big opportunities. One, around online and more direct to consumer; and secondly, around trying to sort of make this more structural in terms of reduced levels of promotional activity. Just interested if you could talk to those 2 opportunities for your business in terms of DTC and ability to sort of bank some of the reduced levels of promotional intensity you've been able to do over the last 12 months.

So we've been working on kind of improving our online execution since FY '17. So there's nothing about COVID that had changed, other than our ability to pull some of the to-do list forward into FY '21, what Martin was talking about, which is pulling accelerating capability building on the digital offense. So in that world, and then the good news is we didn't wake up in COVID and say, my goodness, we should focus on online. We were always doing that, and it's just a function of what we thought was going to be the right answer in the long run anyway. So effectively kind of no change there. And then on banking, kind of the reduced promotional spend, I mean, effectively, that was if you look at the waterfall chart that Martin showed, that's exactly what we did. And then we took that and reinvested the lion's share of it back into the media and growth drivers. So I guess I would say I agree with Nike and Samsung in that way. I mean that was the advantage of FY '21 at some level.

Do you think you've got to hold on to that looking forward? I know you've talked to sort of promotions might need to come back. But do you think you're going to hold on to some of that?