Nick Scali Limited (NCK) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Nick Scali Limited Fiscal Year 2020 First Half Results Announcement. [Operator Instructions] I must advise you that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Nick Scali Chief Executive Officer and Managing Director, Anthony Scali. Thank you. Please go ahead.

Good morning. We will start on Page 2 of our results presentation in terms of results overview. The half year '20 highlights were sales were down 2.5% to $137.5 million, negative same-store sales growth of 7.5%, gross margin of 62.2%, underlying net PAT of $20.3 million above guidance of $17 million to $19 million, net increase in cash of $7.4 million, operating cash flow of $16.6 million, interim dividend of $0.25. The payout -- half year payout ratio is $0.947 -- 94.7% rather. One new store opened during the half year, our third store in New Zealand. Looking at sales. We can see negative sales growth with full period contribution of stores opened in FY '19 insufficient to offset the like-for-like sales decline; like-for-like sales decline of 7.5% with store traffic significantly reduced due to difficult trading conditions highlighted in our October trading update. Written orders were down 5% on a like-for-like basis, with growth of 3.5% in the second quarter, a significant improvement on Q1, on quarter 1. Looking at the profit and loss, Page 4. Net profit, the gross profit margin was 62.2%, a 60 basis point reduction. That was just due to product mix and competitive pressure. Operating expenses increased $4.3 million. Majority of the increase was from new stores opened in FY '19 and in FY '20. Operating expense as a percentage of sales up 400 basis points at 40.2%, which is primarily due to the like-for-like sales decline. Other costs, depreciation and interest, maintained at half year '19 levels. Tax rate unchanged. There was a $1.3 million post-tax gain on the Manly Vale property sold; net profit, $21.6 million; and a $200,000 impact on -- in respect of the AASB 16, which has reduced our profit to $21.4 million. I'll let Chris Malley, our CFO, talk to balance sheet and cash flow.

Thank you, Anthony. Been a notable change to the balance sheet at the end of December, with the implementation of AASB 16, the new accounting for leases. And with the adoption of that standard, we recognized a $195 million lease liability and $174 million right-of-use fixed assets under the new standard. There's also been tax implications in the reversal of the previous provision that we had under our previous accounting policy. So leaving aside the impact of AASB on the balance sheet, overall, the balance sheet's remained very stable. We still have $70 million of owned and occupied retail properties that are recorded at historical costs, which are down from June due to the sale of our property in Manly Vale. But our inventory -- and our inventory levels have remained fairly stable, a slight shift in the mix between the DC inventory and the stock in transit because just of the timing of the business and seasonality. The other thing to note in the balance sheet is the deferred revenue. The customer deposit balance is down against June, which is because of the seasonality and the timing of our key sales period. So against December '18, it's up around 10%, which is reflective of the growth in the order bank against the same period last year. Moving on to cash flow. We had a $16.6 million operating cash flow, and this flowed through to deliver an increase of $7.4 million of cash on hand. Levels of CapEx were similar to last year and fairly modest, with spend on our new New Zealand distribution center and store refurbishments and the purchase of a new property in Auburn adjacent to our existing store. We received $9.8 million in proceeds from the sale of the Manly Vale property and paid out a dividend of $0.20, which totaled $16.2 million in October. And as I said, overall, that led to a net decrease in cash on hand of $7.4 million. I'll pass back to Anthony to take you through the outlook.

As for our store network, one store was opened during the half year in Auckland, New Zealand, which brings our total stores to 3 in New Zealand. The company now has a total network of 58 stores and expects to open a further 3 new stores in the second half of the financial year. Two of these are in Victoria and one in New Zealand. The company's long-term store network target remains at 80 to 85 stores across Australia and New Zealand. In terms of trading and profitability, during the first quarter, the company experienced difficult trading conditions, with a significant drop in store traffic and negative comparable store sales growth of 8.3%. During the second quarter, trading improved, with written orders up 3.5% on a comparable store basis. Most of the written orders during the second quarter will translate to sales, deliveries to the customers in the second half, and hence, the reason the cash deposits are higher as compared to the prior year. For the month of January, written orders were down 1.7% on a comparable store basis, and store traffic was down 6%. Whilst the company gave guidance in October 2019 that NPAT would be in the range of $17 million to $19 million, given the improvement in sales in the second quarter, the company was actually able to achieve a higher underlying NPAT of $20.1 million. Despite seeing a recent improvement in sales and store traffic, there is still uncertainty around the current level of consumer confidence, which has been exacerbated by the coronavirus outbreak and other factors. And consequently, it's very difficult to provide guidance as to the profitability for the full year to June '20. I think now we're ready for questions, any questions that you'd like to ask.

[Operator Instructions] Your first question comes from Sam Teeger from Citibank.

Just the first question, does the fact that you've maintained your dividend despite lower profitability mean you're less likely to do an acquisition in the next 6 months?

No, it doesn't mean that. It's been the reason -- well, firstly, we have a significant amount of cash on hand and we're fairly confident, more confident towards how the business is going to be trading in the second half. And really to capital management strategy, that's where we generate a lot of cash. And so hence, we think we could be -- can maintain the same dividend as the prior year.

Got it. That's pleasing. And next question, given the coronavirus in China, can you talk about whether the employees at your manufacturers have gone back to work yet and whether your Chinese logistics and transport providers are working? Just trying to get a sense here of what types of issues you might have fulfilling orders from China.

Yes. So 40% of our purchasing is from China. And for what -- because the factories are now not yet open and the workers are not yet back, it's a little bit unknown. But we, at this stage, expect, given the fact that we've got some supply in the market, a 1- or 2-week delay in terms of our deliveries. So I think that's manageable. So -- whereas the impact on the business may be just delaying deliveries to customers, which we think we should be able to manage that.

And if you're going to delay deliveries to customers, will you still expect to get the same prices? Or do you think there's potential for discounts here and free delivery and any types of hit to your margin?

I don't think in this case because I think people will understand the reason. That's beyond our control. So I don't think so. It's not as if we've misled them or we've let them down. They understand it's something no one can control. And our lead times are pretty sharp as compared to our competitors anyway, so I don't expect any significant impact at all.

And to say this whole coronavirus continues to become an issue, a bigger issue than it is now, can -- what you saw -- can Vietnam pretty much produce any product China can produce and you could essentially shift all the sourcing? Or only some types of products? And if so, which ones are there that you can only produce in China?

Well, yes. Look, if we talk about -- if we look at different product categories, there's a different answer to that. In lounges, it is possible to shift it to Vietnam. In terms of case goods, some of them are not. It will be unique to China in terms of our dining range, yes. But we'll just see how we manage that. I think -- I don't think we're in a bad position because, 10 years ago, 80% was out of China. Now it's only 40%. And of that 40%, the lounges, the majority of -- all of the lounges could be manufactured in either Malaysia or Vietnam. So the risk is small and on a range of case goods, which is what -- it's -- I mean it will have an impact but not a significant impact.

Right. And on gross margin, when you say the decline is due to product mix, which lower-margin products are growing that's driving that?

Well, we improved our lounge -- we had growth on growth on lounge sales, particularly over the year and loss to be on case goods. So that mix is a larger amount of lounges compared to case goods.

Got it. That makes sense. And sorry, just last question. When you say that most of your written orders in the second quarter would translate to second half sales, you're essentially signaling to us here that December was your strongest month in the quarter given many of the orders from October and potentially part of November probably being delivered by the end of the calendar year?

No. So I would say, how it would be, the first -- the orders written in the first half of October went into the half year. But the second half of October, when we talk about lounges actually, and November and December, the majority of that is going to be second half when we talk about lounges. Case goods vary depending when people want them. So no. And hence, why the order bank is up on margin, deposits are up on last year. So in the first quarter, we certainly got a higher order bank than last year because of the written orders being positive in the quarter, the second quarter.

Your next question comes from Callum Sinclair from Macquarie.

Anthony, just was wondering if you can provide some insight into what you saw in the various regions through the period. And do you think you're seeing sale trends reflective of what's happening and sort of housing sentiment and turnover and if there was any competitive pressures in particular states?

Yes. In terms of across the states, it was -- over the 4-month period, it was fairly stable. The big improvement came from New South Wales. New South Wales has been our most -- has been the market that had pulled us back a lot when you look at the first quarter. So there was certainly an uptick in New South Wales. But the others were fairly, in terms of like-for-like was -- across the board, was pretty consistent in the last -- in quarter 2.

Yes. So it's across the board. And just in terms of the gross margin percentage declined only slightly, but you've called out some competitive pressure. So just in terms of what you're seeing from competitor behavior and discounting aggressiveness through the period and then coming into January, if there's any sort of change?

Yes. I think compared to that, there has been some aggressive discounting by competitors that I think have been very aggressive and probably a little bit desperate. That's what we've been seeing.

Yes. And just last one. I think some competitors have closed some stores in New South Wales and Queensland fairly recently. I'm just wondering if there's been any impact from that or if the discounting was sort of heavily weighted to certain periods where they were closing stores.

Yes. Look, it's always hard to judge that -- the impact of that. We've got a number of major retailers that's discounting because they're trying to clear inventory. And we can see that in the prices and the price of the products they're selling during that -- during the period, the January sale in particular.

Okay. I might ask one more then. Just in terms of the Auckland DC and the -- can you just provide some color or quantification and the impact that might have from New Zealand going forward? Just how many stores it can service and if there's a short-term -- a slight step-up in expenses, that sort of greater operating leverage we should expect from NZ going forward?

Yes. The -- it's actually whether we'll [ partner these in ] New Zealand.

No, no, no, New Zealand, the new New Zealand DC.

Oh, I'm sorry. I didn't understand the question. You're talking about New Zealand?

Yes.

New Zealand distribution center's established. It's got a -- there's a significant capacity in that at the moment. We're probably sitting at around 25%, not even 20% -- 20% to 25%, so a significant, yes, capacity in the new NZ DC. Sorry, I thought he said Auckland. Beg your pardon.

Your next question comes from Shane Bannan from Bligh Capital.

Anthony, it actually sounds as though the half of the 2 quarters for the extreme movements. Could you just put a bit of a narrative around what do you see has been driving that sort of shift in sentiment?

Well, there still is a definite improvement in store traffic, so my guess, what we're feeling, that the consumer confidence improved. So the store traffic, one, is still down but not down as much it was when you compare quarter 1 to quarter 2. So we believe the housing, there's been a recovery in housing sales, only slight, but it's improving. But the price there -- the price uptick in house has probably, given consumers are a bit more helping with the [ wealth tech ] and their willingness to spend. But working against [ out of Coles ] we've got other factors. So I would say the housing improvement sentiment is definitely helping -- has helped the quarter 2 and, in effect, January when you compare it to quarter 1.

Your next question is a follow-up from Sam Teeger from Citibank.

Just wanted to get an update around the clearance store strategy. It's now about 10% of the store network. Just plans from here and just keen to understand what the CapEx on the new clearance store is compared to a regular store and how is -- how does profitability compare.

Yes. The CapEx is negligible because it is a clearance store. It's not meant to present too well. In terms of profitability, they're making a small profit, a very small profit and contribution. I mean the main -- the objective of the clearance stores is to keep inventory levels low on returns and clearance items, to ship those quicker, to alleviate the -- gives us more capacity in DCs for sort of network growth. And that -- we can see that's been working in the last few years and the inventory levels in our DCs continue to fall.

Okay. Sorry, are we going to expect more clearance stores? Or do you think...

No, I don't think so. Not -- maybe 1 or 2 the most.

Your next question comes from John Hynd from Wilsons.

Could we perhaps start on the competitive pressures you flagged? Was the improvement in written orders in November and December, was that -- it looks like it was reasonably material. Was it driven by you pulling the price lever this time around?

No, no, no. That was not a price lever, no.

So you -- I guess in terms of the comp -- what you're referring to as competition is just -- does that mean it's market share loss here? Or it's just -- you're just going to work harder for a sale?

Which quarter are you talking about?

Well, you're referring to competitive pressure.

Yes. In terms of pricing, yes. But we don't -- when I say -- we've had opportunity to probably lift prices that we decided not to just to remain competitive in some of our key lines but not then go across the board and pull the levers and such.

Okay. Great. And just on gross margins, how have they trended into January and February? And are we having -- at what point do you expect the currency to roll through to your margins? And to what degree in second half '20 and maybe into '21?

Well, we expect to be stable. We think the margin is stable. Certainly, our target is 62 and above. So that will certainly -- we expect to 62 plus.

Okay. And so they were around that level in January?

Yes.

Okay. And I'm wondering how do you think about -- how are you thinking about foot traffic and order, I guess, order conversion at the moment. It's been quite volatile in the last -- obviously, in the last half. Is -- I mean do you look at ratios just -- and can you maybe give us a little bit more color on that to see if things are improving? Or you're having to work harder for orders?

Well, yes, we are working much harder for orders. The conversion has improved because the store traffic is a lot further down. In fact, even if we were down, we actually got positive growth. And that's because we've been able to -- the conversions improve. [ Constantly ] -- we get a read on that week by week by store. Their conversion percentage of traffic is improved -- has improved.