Uptempo

Focusrite 14 May 2020 Update
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Focusrite

Uptempo

H120 results

Consumer electricals

14 May 2020

Price

580p

Market cap

£337m

Net debt (£m) at February 2020

19.9

Shares in issue

58.1m

Free float

60%

Code

TUNE

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(2.6)

(13.6)

11.6

Rel (local)

(2.9)

10.5

35.1

52-week high/low

740p

390p

Business description

Focusrite is a global music and audio products group supplying hardware and software used by professional and amateur musicians, which enables the high-quality production of music.

Next events

FY20 results

November 2020

Analysts

Russell Pointon

+44 (0)20 3077 5757

Neil Shah

+44 (0)20 3077 5700

Focusrite is a research client of Edison Investment Research Limited

Focusrite’s revenue has been driven by acquisitions against a period of tough comparatives for the core brands. Current trading looks more encouraging for the majority of the brands, which is leading to gross margin improvements and a better outlook for EBITDA margin. We upgrade EBITDA forecasts for FY20e and FY21e by c 7%, but a higher tax rate in FY21 limits EPS upgrades in that year. For FY20e, an EV/EBITDA of 15.4x and a P/E of 24.9x are above long-term averages.

Year end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

08/18

75.1

11.3

17.8

3.3

32.6

0.6

08/19

84.7

13.8

21.4

3.8

27.1

0.7

08/20e

114.5

15.4

23.3

3.9

24.9

0.7

08/21e

126.7

17.1

23.6

4.0

24.6

0.7

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

H120 results: Profitability as expected

Headline figures for revenue (23.5% growth), including the performance of the recent acquisitions, and the improved net debt position (£19.9m) had already been reported at the trading statement in March. The full results statement highlights a strong gross margin performance, which appears sustainable. The lower EBITDA margin of 18.3% in H120 versus 22.0% in H119 partly reflects the impact of acquisitions as expected. The current trading statement has a positive tone, with ‘record levels of product registrations’, and e-commerce fulfilling demand despite retail outlets being closed in many countries. The company has deferred the decision on the announcement of the interim dividend for FY20 given the economic uncertainty due to COVID-19.

Forecasts: Improved trading leads to upgrades

We upgrade our revenue forecasts for FY20 and FY21 by 2–3%, which reflects expectations of higher growth for the non-Martin businesses, offset by a modest decline for Martin Audio given the weaker outlook for live entertainment due to COVID-19. Changes in mix, improved sourcing benefits and better management of discounts, etc, lead to gross margin improvements of 100bp+ in FY20e and FY21e. Our PBT forecasts increase by 7–10% but a higher tax rate due to the company’s increasing scale and less-favourable tax treatment of development spend, etc, ensures that our forecast for EPS in FY21 is broadly unchanged. We make no change to our dividend forecasts.

Valuation: Recent re-rating

Since the year-end trading statement, the share price has increased, and when coupled with our upgrades, the EV/EBITDA multiples have re-rated modestly to 15.4x for FY20e and 14.5x for FY21e, versus an average since IPO of 11.1x. The P/E multiples for FY20e and FY21e are 24.9x and 24.6x, respectively, versus the average since IPO of 17.8x.

H120 results: Strong revenue growth and cash flow

Focusrite has reported a reassuring trading performance in H120 with revenue growth driven by acquisitions.

Exhibit 1: Summary of results

£000s

H119

H219

FY19

H120

H120 growth
y-o-y

Revenue by brand

Focusrite

26,308

31,336

57,644

25,574

(2.8%)

Focusrite Pro

2,594

2,110

4,704

1,884

(27.4%)

Novation

9,827

7,892

17,719

9,935

1.1%

Distribution

1,696

1,152

2,848

966

(43.0%)

ADAM Audio

1,750

7,041

N/M

Martin Audio

4,526

N/M

Total

40,425

42,490

84,665

49,926

23.5%

Revenue by geography

Europe, Middle East and Africa

19,315

14,718

34,033

23,115

19.7%

North America

14,963

21,382

36,345

18,094

20.9%

Rest of World

6,147

8,140

14,287

8,717

41.8%

Total

40,425

44,240

84,665

49,926

23.5%

Gross profit

17,921

17,845

35,766

23,006

28.4%

Gross margin

44.3%

42.0%

43.1%

46.1%

EBITDA

8,881

8,316

17,197

9,139

2.9%

EBITDA margin

22.0%

19.6%

20.7%

18.3%

Operating profit (reported)

7,251

5,561

12,812

3,015

(58.4%)

Operating margin

17.9%

13.1%

15.5%

6.0%

Operating profit (adjusted)

7,251

6,298

13,549

6,382

(12.0%)

Operating margin

17.9%

14.8%

16.3%

12.8%

Profit before tax (adjusted)

7,150

6,600

13,750

6,057

(15.3%)

Profit after tax (adjusted)

6,360

6,041

12,401

5,418

(14.8%)

Adjusted diluted EPS (p)

11.0

10.4

21.4

9.3

(15.1%)

DPS (p)

1.2

2.6

3.8

0.0

Net cash/(debt)

26,172

14,878

(19,873)

Source: Focusrite accounts

Revenue increased by 23.5% to £49.9m, which represents growth of 25.3% in constant currency terms. Currency had less of an impact on reported results than in recent periods as exchange rates versus sterling were relatively stable year-on-year: the average US dollar rate was 1.28 in H120 versus 1.29 in H119, and the effective hedged euro rate was 1.13 in H120 versus 1.11 in H119.

The results include the first-time contributions from the acquisitions of ADAM Audio (six months) and Martin Audio (two months), which contributed revenue of c £7m and c £4.5m respectively. As highlighted previously in the trading statement in March, excluding these acquisitions, underlying revenue declined by c 5% due to the tough comparative of H119, when it benefited from tariff-related price increases in the US. In addition, the outbreak of COVID-19 led to orders for c £2m not being able to be fulfilled during the period, but they will move into H220. Therefore, the results are reassuring once these items are taken into account.

The gross margin increased substantially from 44.3% in H119 to 46.1% in H120. Excluding the one-off benefit to the gross margin in H119 of one percentage point due to the US price rises to reflect tariff increases versus cost of sales of pre-tariff products, the underlying improvement in gross margin was 280bp. The gross margin of 46.1% also compares favourably with H118 gross margin of 41.7%. The strong gross margin performance was due to: mix changes (higher margins of the acquired businesses eg ADAM Audio’s 54% gross margin replacing the Distribution sales with a gross margin of c 28%); lower royalties and better management of discounts; and benefits from the higher prices of improved new product launches. We believe that these are mostly sustainable.

EBITDA increased by 2.9% but the reported EBITDA margin fell from 22.0% in H119 to 18.3% in H120. Drivers included the lower margins generated by the acquired companies and higher operating costs in Focusrite, which management is dealing with. H119 included a one-off benefit of c £0.7m due to US tariff increases, and H120 includes a benefit of £0.4m due to the adoption of IFRS 16.

Focusrite’s reported operating profit now includes the amortisation of intangibles that arise from the recent acquisitions of £1.1m in H120, as well as one-off acquisitions costs of £1.8m and one-off redundancy costs of £0.4m, which will help to improve operating costs from H220. Depreciation increased due to the adoption of IFRS 16 and higher depreciation following the launch of Scarlett third-generation products.

Given the economic uncertainty due to the COVID-19 pandemic, management has chosen to defer the declaration of an interim dividend until later in 2020. The interim and final dividends will both be reconsidered later in 2020. We assume that the absolute level of dividend declared for FY20 is maintained from our prior forecast, but that payment occurs in FY21. In the last four financial years, the interim dividend has represented between 27% and 32% of the total annual dividend, and in the current financial year would represent a deferred ‘saving’ of c £0.7m from an expected total dividend cost for FY20 of c £2.3m.

Product categories: Divergent growth

It is very encouraging that the acquisitions, ADAM Audio and Martin Audio, have performed in line with or better than management’s expectations with growth of 13% and 22% y-o-y respectively. The tone of the outlook for ADAM Audio is very encouraging as the group looks to increase cross-selling opportunities.

Performance in the Focusrite group brands was mixed during the interim period. The core Focusrite brand was flat year-on-year as it transitioned to the newer generation of Scarlett products, which required clearance of the older products that affected the early sales of the newer products. Net-net the number of registrations increased significantly, which provides comfort for the outlook of the products. Focusrite Pro had a more challenging H120 as it declined by 27% due to new product releases being delayed into H220, and a restructuring in the division. Novation increased by 1% driven by new launches of Launchpad and Launchkey.

Revenue from third-party brands fell by 43% and will be fully discontinued by the end of FY20, as management focuses on the greater opportunities from its own brands.

Consistent geographic trends

There is no disclosure of constant currency growth by geography as in recent years, but as previously highlighted the impact of exchange rates on H120 performance is relatively low given the stable exchange rates year-on-year.

Revenue from Europe, the Middle East and Africa grew by c 20% in H120, but the underlying growth for the core Focusrite group of brands, ie excluding ADAM Audio and Martin Audio, fell by c 4%. The decline was due to distribution changes in Scandinavia and Italy that led to either no orders or reduced orders, and a tough comparative in H119 due to distributors stocking up ahead of potential Brexit disruption. ADAM Audio and Martin Audio produced double-digit growth, which is stated to be in line with expectations.

North American revenue increased by c 21% in H120, with the core Focusrite group of brands, ie excluding ADAM Audio and Martin Audio, falling by 3.5%, and the latter growing since their acquisitions by 14% and 17% y-o-y. Excluding the one-off benefit from tariff increases in H119, the underlying growth for the core Focusrite brands was roughly flat.

Revenue from the rest of the world increased by c 42%, with ADAM Audio growing by 26% y-o-y and Martin Audio growing by 30% y-o-y since their acquisitions. The core Focusrite brands declined by 7%, with all of the decline in Asia due to the COVID-19 outbreak, and changes in management, which should help to improve growth going forward. ADAM Audio, which grew by 21% in Asia, was not affected by the pandemic, and the narrative for Martin Audio highlights that Asia was strong for it too. Latin America was very strong across the board, in particular for the core Focusrite brands, which grew by 48% y-o-y.

Cash flow: Modest deterioration

On a reported basis, the company’s free cash flow (FCF) generation (relative to sales) deteriorated from 12.0% in H119 to 8.8% in H120, with forex excluded from the calculation of operating cash flow and excluding the one-off costs due to acquisitions etc. This was close to the company’s long-term average of c 10% since the IPO. The key drivers to FCF generation were: the lower EBITDA margin; working capital representing a cash inflow versus an outflow in the comparative period; and increased investment in tangibles and intangibles.

Focusrite has moved from a net cash position at the end of August 2019 of £22.8m to a net debt position of £19.9m at the end of February 2020, having been c £25m on completing the acquisition of Martin Audio in December 2019. By the end of April, the net debt position has improved by a further £4m to £16m, so cash generation remains strong.

Current trading: Encouraging outlook

The current trading statement points to continued strength in consumer demand as previously highlighted in the trading statement in March, and the short-term supply disruptions in China are behind the company.

In particular, e-commerce demand is strong for the Focusrite and ADAM Audio brands. The record levels of product registrations of Focusrite products by customers indicate that demand in parts of the supply chain where the company typically has more limited visibility is strong.

As expected, the lockdowns due to COVID-19 and halting of live music events in most countries is having an impact on demand for Martin Audio products. It is likely that demand will be affected for the rest of the FY20 and into FY21.

At the time of the trading statement we highlighted that the outbreak of COVID-19 could have both a positive and negative influence on supply and demand. On the positive side, enforced isolation could increase demand as musicians and hobbyists have more time to devote to music. On the negative side, fulfilment of orders from online retailers, etc, could be more challenging, halting the live performance market could negatively affect demand, and there could be further supply disruptions from sourcing. Therefore, it is relatively pleasing that only one of these potential risks, ie the halting of live performances has materialised.

Forecast changes

We upgrade our revenue forecasts for FY20 and FY21 by 2–3% and our EBITDA forecasts by c 7%.

Exhibit 2: Changes to forecasts

£000s

FY20e old

FY20e new

Change %

FY21e old

FY21e new

Change %

Revenue

111,594

114,468

2.6%

123,714

126,716

2.4%

Gross profit

47,316

49,679

5.0%

52,702

55,501

5.3%

Gross margin

42.4%

43.4%

1.0%

42.6%

43.8%

1.2%

EBITDA

20,432

21,823

6.8%

22,219

23,750

6.9%

Adjusted PBT

14,425

15,406

6.8%

15,563

17,089

9.8%

Adjusted EPS (p)

21.9

23.3

6.6%

23.5

23.6

0.2%

Net cash/(debt)

(15,292)

(11,957)

(21.8%)

(4,903)

(2,585)

(47.3%)

Source: Focusrite accounts, Edison Investment Research

Our revenue forecasts increase by c 2–3% in both FY20 and FY21 to reflect better trading at Focusrite and ADAM Audio offset, in part, by a weaker outlook for Martin Audio, for which we assume a modest decline in FY20 and some continuation of weakness in the live performance market in FY21.

We increase our gross margin assumption by 1.0–1.2% in FY20 and FY21 to reflect the continuation of trends from H120, including improved mix with greater growth from ADAM Audio while Distribution winds down. This leads to an increase in our estimates for EBITDA of 7% in FY20 and FY21.

From FY21, the company highlights that due to its increasing scale the underlying tax rate will increase as the tax treatment of non-underlying costs and tax relief on development costs becomes less favourable. Therefore, in FY21 we assume that the tax rate increases from 11.5% to 19%.

At the adjusted EPS level, the higher profitability translates to a 6% upgrade in FY20e and a very modest increase in FY21e given the increase in tax rate. This produces EPS growth of 9% in FY20e and 1% growth in FY21e.

Our forecast for net debt at the end of FY20 and FY21 improve due to the growth in profit, improved working capital and the timing of payments of dividends (FY20e only).

Valuation

Following the recent rally in the share price, on our new forecasts, at 580p the shares are trading at EV/EBITDA multiples of 15.4x for FY20e and 14.5x for FY21e. These multiples compare with the average multiple since the IPO of 11.1x, and the all-time high multiple of 17.8x that was reached in FY19.

The P/E multiples are 24.9x for FY20e and 24.6x for FY21e, which compare with the average multiple since the IPO of 17.8x, and the all-time high reached in FY18 of 28.3x.

As highlighted earlier we hold our dividend forecasts as they were previously, ie 3.9p in FY20e and 4.0p in FY21e; therefore the dividend yield is 0.7%, which is below its average historical dividend yield of 1%.

Exhibit 3: Financial summary

£000s

2017

2018

2019

2020e

2021e

Year end 31 August

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

66,055

75,121

84,665

114,468

126,716

Cost of Sales

(39,704)

(43,447)

(48,899)

(64,789)

(71,214)

Gross Profit

26,351

31,674

35,766

49,679

55,501

EBITDA

 

 

13,109

15,485

17,197

21,823

23,750

Operating profit (before amort. and except).

 

 

9,470

11,613

13,549

16,206

17,189

Amortisation of acquired intangibles

0

0

0

(3,075)

(3,690)

Exceptionals

0

329

(737)

(2,400)

0

Share-based payments

0

0

0

0

0

Reported operating profit

9,470

11,942

12,812

10,731

13,499

Net Interest

42

(270)

201

(800)

(100)

Joint ventures & associates (post tax)

0

0

0

0

0

Exceptionals

0

0

0

0

0

Profit Before Tax (norm)

 

 

9,512

11,343

13,750

15,406

17,089

Profit Before Tax (reported)

 

 

9,512

11,672

13,013

9,931

13,399

Reported tax

(959)

(1,199)

(1,349)

(1,772)

(3,247)

Profit After Tax (norm)

8,553

10,144

12,401

13,634

13,842

Profit After Tax (reported)

8,553

10,473

11,664

8,159

10,152

Minority interests

0

0

0

0

0

Discontinued operations

0

0

0

0

0

Net income (normalised)

8,553

10,207

12,401

13,634

13,842

Net income (reported)

8,553

10,473

11,664

8,159

10,152

Average number of Shares Outstanding (m)

54.6

56.2

57.2

57.7

58.0

EPS - normalised (p)

 

 

15.7

18.1

21.7

23.6

23.9

EPS - normalised fully diluted (p)

 

 

14.7

17.8

21.4

23.3

23.6

EPS - basic reported (p)

 

 

15.7

18.6

20.4

14.1

17.5

Dividend per share (p)

2.7

3.3

3.8

3.9

4.0

Revenue growth (%)

21.6

13.7

12.7

35.2

10.7

Gross Margin (%)

39.9

42.2

42.2

43.4

43.8

EBITDA Margin (%)

19.8

20.6

20.3

19.1

18.7

Normalised Operating Margin

14.3

15.5

16.0

14.2

13.6

BALANCE SHEET

Fixed Assets

 

 

6,332

7,314

25,705

59,002

56,266

Intangible Assets

4,963

6,039

24,103

57,015

53,952

Tangible Assets

1,369

1,275

1,602

1,987

2,313

Investments & other

0

0

0

0

0

Current Assets

 

 

36,126

47,612

48,875

38,342

43,267

Stocks

9,000

11,391

15,182

19,525

22,437

Debtors

12,952

13,310

18,188

18,817

20,830

Cash & cash equivalents

14,174

22,811

15,505

0

0

Other

0

100

0

0

0

Current Liabilities

 

 

(8,663)

(11,136)

(16,909)

(18,562)

(20,998)

Creditors

(8,204)

(10,709)

(15,664)

(17,750)

(19,511)

Tax and social security

(459)

(427)

(618)

(812)

(1,487)

Short term borrowings

0

0

(627)

0

0

Other

0

0

0

0

0

Long Term Liabilities

 

 

(245)

(300)

(4,284)

(21,316)

(11,248)

Long term borrowings

0

0

0

(11,957)

(2,585)

Other long term liabilities

(245)

(300)

(4,284)

(9,360)

(8,663)

Net Assets

 

 

33,550

43,490

53,387

57,465

67,287

Minority interests

0

0

0

0

0

Shareholders' equity

 

 

33,550

43,490

53,387

57,465

67,287

CASH FLOW

Op Cash Flow before WC and tax

13,109

15,485

17,197

21,823

23,750

Working capital

407

(426)

(2,218)

(2,886)

(3,165)

Exceptional & other

137

203

(386)

1,125

4,140

Tax

(633)

(478)

(825)

(1,772)

(3,247)

Operating Cash Flow

 

 

13,020

14,784

13,768

18,291

21,478

Capex

(3,614)

(4,512)

(4,943)

(7,624)

(7,435)

Acquisitions (net of acquired working capital)

0

0

(14,996)

(35,200)

0

Net interest

(42)

(36)

58

(800)

(100)

Equity financing

258

306

0

0

0

Dividends

(1,138)

(1,679)

(2,005)

(1,501)

(4,571)

Other

84

(226)

185

0

0

Net Cash Flow

8,568

8,637

(7,933)

(26,835)

9,372

Opening net debt/(cash)

 

 

(5,606)

(14,174)

(22,811)

(14,878)

11,957

FX

0

0

0

0

0

Other non-cash movements

0

0

0

0

0

Closing net debt/(cash)

 

 

(14,174)

(22,811)

(14,878)

11,957

2,585

Source: Focusrite accounts, Edison Investment Research

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Germany

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United Kingdom

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United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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New Zealand

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United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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