Full year pre-close: Material profit upgrade
Revenue and profit outperformance
Focusrite has had an excellent second half. Revenue was up c 21.6% for the year, or 13% on a constant currency basis to approximately £66m, implying c 16% revenue growth in the second half. However, the fact that both revenue and profit are now guided ahead of the first half means that second-half pre-tax profit of £4.6m is considerably ahead of our forecast, raising our expected pre-tax profit for the full year by £0.7m, or 8.8%, to £9.2m.
Exhibit 1: Summary of forecast beat
£'000 |
H116 |
H216 |
FY16 |
H117 |
H217 |
FY17e |
Revenue - forecast |
25.9 |
28.4 |
54.3 |
32.0 |
32.8 |
64.9 |
Revenue - pre-close |
34.0 |
66.0 |
Adjusted EBITDA - forecast |
4.8 |
5.4 |
10.2 |
6.1 |
5.5 |
11.6 |
Adjusted EBITDA -pre-close |
6.2 |
12.4 |
Pre-tax profit - forecast |
3.0 |
4.7 |
7.7 |
4.6 |
3.9 |
8.5 |
Pre-tax profit - pre-close |
4.6 |
9.2 |
Source: Focusrite, Edison Investment Research
Our forecast was understandably set at lower levels than the first half because, although Focusrite is not a markedly seasonal business, the first half had benefited significantly from the launch of the second-generation Scarlett range in June 2016. There was also demand strength for the Novation division’s core Launchpad product, and we questioned whether this would continue as strongly in the second half.
The reasons for the strong H2 result relate both to revenue and margin:
■
Improved sales of product: although second half revenue is only slightly higher than we expected, we understand that the improvement reflects a weighting of sales growth towards higher-margin product areas, such as Focusrite’s professional ranges and Novation products, while discounts have been actively managed.
■
Foreign exchange benefits: over 50% of Focusrite sales and close to all its cost of sales are denominated in US dollars (or related currencies), which gives the company an effective natural hedge against the currency. However, as around 25% of its revenue is in €, of which 75% is hedged, there is a small positive exposure to the €. This means that the strength of the € against sterling in the second half, compared to our cautious forecast, has driven some margin benefit.
■
Gross margin management: as well as the margin benefits of sales mix mentioned above, management continues to manage margin actively. This includes a tough attitude to discounts allowed to resellers and continuous review of pricing.
As a result of these factors working in combination, the over-performance is reflected in a net improvement in gross margin of one whole percentage point from the 38.0% we had forecast to the 39.0% we now forecast for FY17.
The company has not commented on operating costs, interest or tax and we leave these items materially unchanged in our upgraded FY17 forecast.
Exhibit 2: Revised FY17 forecast
£'000 |
H116 |
H216 |
FY16 |
H117 |
H217e |
FY17e |
H1 y-o-y |
H2 y-o-y |
FY y-o-y |
Total revenue |
25,880 |
28,421 |
54,301 |
32,020 |
34,003 |
66,023 |
23.7% |
19.6% |
21.6% |
Gross profit |
10,305 |
10,557 |
20,862 |
12,855 |
12,894 |
25,749 |
24.7% |
22.1% |
23.4% |
Gross margin (%) |
39.8% |
37.1% |
38.4% |
40.1% |
37.9% |
39.0% |
0.3% |
0.8% |
0.6% |
Adjusted EBITDA |
4,821 |
5,428 |
10,249 |
6,131 |
6,242 |
12,373 |
27.2% |
15.0% |
20.7% |
Adjusted EBITDA margin (%) |
18.6% |
19.1% |
18.9% |
19.1% |
18.4% |
18.7% |
0.5% |
-0.7% |
-0.1% |
Operating profit |
3,692 |
3,985 |
7,677 |
4,571 |
4,613 |
9,184 |
23.8% |
15.8% |
19.6% |
Pre-tax profit |
2,969 |
4,694 |
7,663 |
4,599 |
4,623 |
9,222 |
54.9% |
-1.5% |
20.3% |
EPS (p) |
4.6 |
6.9 |
11.4 |
7.0 |
6.9 |
13.9 |
52.2% |
0.6% |
21.6% |
Net cash |
3,952 |
5,606 |
5,606 |
9,391 |
14,204 |
14,204 |
137.6% |
153.4% |
153.4% |
Source: Focusrite, Edison Investment Research
Cash over-performance
Focusrite has ended its financial year with net cash of £14.2m, up from £5.6m at August 2016 and £9.4m at February 2017.
Representing net cash inflow of £8.6m compared with an outflow of £0.6m in FY16, this is a much stronger cash performance than the £5.2m we had forecast. In fact, it is 6% higher than net profit after tax for the year. This is largely the result of better working capital management, and specifically, we understand, inventory management.
Strong trading performance also naturally feeds into the cash flow, but the effect of strong demand on working capital is to run down inventory on hand to lower than planned levels. It would not be surprising to see a slight unwinding of this position in FY18.
Margin gains should be sustainable into FY18
Given the existing sales mix, Focusrite’s culture of margin management, and in the absence of an extreme sterling recovery against the €, we assume FY17 gross margin of 39.0% can be improved in FY18e to 39.2%, resulting in a 5.7% upgrade to our PBT and EPS forecast. We assume a £3m improvement to our net cash forecast, reflecting the profit over-performance for both years, but allowing for some necessary restocking.
Exhibit 3: Changes to forecasts
Year end August |
FY17e |
FY18e |
(£m) |
Old |
New |
% change |
Old |
New |
% change |
Revenues |
64.9 |
66.0 |
1.8% |
70.5 |
71.8 |
1.8% |
Gross profit |
24.7 |
25.7 |
4.4% |
27.0 |
28.1 |
4.2% |
Gross margin (%) |
38.0% |
39.0% |
1.0% |
38.3% |
39.2% |
0.9% |
Adjusted EBITDA |
11.6 |
12.4 |
6.4% |
12.6 |
13.2 |
4.4% |
Adjusted EBITDA margin (%) |
17.9% |
18.7% |
0.8% |
17.9% |
18.4% |
0.5% |
Normalised operating profit |
8.4 |
9.2 |
8.8% |
9.1 |
9.7 |
5.8% |
Normalised PBT |
8.5 |
9.2 |
8.8% |
9.2 |
9.7 |
5.7% |
Normalised EPS (c) |
12.8 |
13.9 |
8.8% |
13.9 |
14.6 |
5.7% |
Net cash |
10.8 |
14.2 |
31.1% |
15.2 |
18.1 |
19.0% |
Source: Edison Investment Research
