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Edited Transcript of BBN.AX earnings conference call or presentation 15-Aug-19 11:15pm GMT

Full Year 2019 Baby Bunting Group Ltd Earnings Call

Aug 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Baby Bunting Group Ltd earnings conference call or presentation Thursday, August 15, 2019 at 11:15:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Darin Hoekman

Baby Bunting Group Limited - CFO & Company Secretary

* Matthew Spencer

Baby Bunting Group Limited - CEO, MD & Director

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Conference Call Participants

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* James Bales

Morgan Stanley, Research Division - Equity Analyst

* Josephine Little

Morgans Financial Limited, Research Division - Senior Analyst

* Sam Teeger

Citigroup Inc, Research Division - Analyst

* Shaun Weick

Macquarie Research - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Baby Bunting full year results release presentation. (Operator Instructions) Please be advised that today's conference is being recorded.

And I would now like to hand the conference over to your first speaker today, Matt Spencer. Thank you. Please go ahead.

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [2]

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Thank you very much, and good morning, everyone, and welcome to the FY '19 Full Year Results Presentation for the Baby Bunting Group. Joining me today is Darin Hoekman, Baby Bunting's Chief Financial Officer. Good morning, Darin. We'll be taking questions at the conclusion of the presentation. I'll be referring to the FY '19 full year results presentation lodged with ASX earlier this morning.

Let's start on Slide 4. It gives me great pleasure to be presenting today's results in our 40th year of operation, servicing the needs of parents and parents to be. We've had a really strong year that continue to build on our solid first half performance. To recap, we started the year in unsettled trading times. There was a major competitor disruption, and Toys R Us/Babies R Us was in administration. As a team, we developed a plan to capture market share, stabilize gross margin and invest in our businesses to support the future growth opportunity, and we have achieved what we needed to do.

Just a point of clarification. FY '19 was a 53-week retail trading year. To give like-for-like numbers, our results have been pro forma-ed to reflect a 52-week period. The reconciliation of the pro forma income statement can be found on Page 32 of the presentation.

I'm very happy to say that all key metrics of our business trended in the right direction. Sales for the year were up 19% to $362.3 million, with a strong comparable store sales number of 8.7%. In conjunction with this market share growth, we have seen a significant and sustained lift in gross margins, which were up 190 basis points on the prior year to 35%. Gross profit income was up a very healthy 25.6% to $126.7 million.

Pro forma EBITDA for the period was slightly above the top end of guidance at $27.1 million, a growth of 45.9%. EBITDA margin, as measured under the lease accounting standard applied in FY '19, continues to track towards our long-term goal of 10% and ended the year at 7.5% of sales. Pro forma NPAT was up 58.2% to end the year at $15.1 million. We finished the full year with balance sheet in sound position, including net cash of $2.7 million, operating cash flow was $25.4 million and return on funds employed of 23.5%. In summary, it is a year that our team is very proud of, and I thank all members of the Baby Bunting team for their contributions in delivering such a positive result.

Now let's look at the results in a bit more detail. Turning to Slide 5. To ensure we restore long-term growth and profitability to the business following challenging market conditions in FY '18, we focused on 5 clear areas for the financial year: one, to capitalize on the market share opportunity that arose due to competitor closures; two, to secure any potential property opportunities from the Toys R Us/Babies R Us store network; three, to stabilize gross margin, which had been eroded due to distressed retailing in FY '18, without compromising our commitment to value to the consumer; and four, to drive and invest in our private label and exclusive product expansion program; and finally, to bring forward some investment in capability, people and systems to support the market share opportunity that is available now.

I'm pleased to say that we have delivered what we set out to achieve. In terms of market share growth, we estimate that we have captured market share of around 30% in catchments where there were both a Babies R Us store and Baby Bunting store. We opened stores in Bankstown, New South Wales, and relocated the former Babies R Us store in Cannington, Western Australia. These are the 2 sites that we understand were among the top-performing locations for Babies R Us. We've also secured the former TRU site in Westfield Doncaster, which will open in October. This was another strong-performing location for the TRU/BRU business.

Gross margin percentage is 190 basis points higher than the prior corresponding period. The unsustainable deep discounting driven by distressed retailing has largely reduced and we have, in some instances, remodeled or reduced our promotional offers. But as we said before, I don't want anyone to mistake our intentions. We remain totally committed to providing great value to our consumers every day and every visit, and we continue to focus on our EDLP, or everyday low price, and Best Buy strategy to deliver a compelling and competitive offer in the market.

The work with our supplier partners to deliver exclusive products continues to be a focus for our buying team. We made significant progress towards our goal of having 50% of sales coming from private label and exclusive products. We lifted these sales by 57% during the year, such that it now makes up 27.6% of sales. And finally, we made important investments in our in-store technology to improve the customer experience. We have commenced the transformation journey to implement a new merchandise system which will progress through the coming year. All of this investment is essential for us to support the future growth of Baby Bunting.

Turning to Slide #7. Our headline sales grew by 19%. Contributing to the strong market share and sales growth were: strong comparable store sales growth of 8.7%; online sales growth, which grew 46%; 6 new stores we opened during the year; and we saw the annualization of the first full year of sales from stores opened in FY '18. A very encouraging aspect to note is that the new stores we opened in FY '19 are trading ahead of historical averages.

On Slide 8. Gross margin for the year finished at 35%, up 190 basis points. The second half gross margin was 35.3%. This is despite the deterioration in the Australian dollar as well as at the time when we were increased our Best Buy range and delivered more value to the consumer. Another important point to note is that our purchases in U.S. dollars still remain under 10% of total purchases. Our entire business is focusing -- focused on delivering gross margin improvement. This will be achieved through a more efficient supply chain, through better buying, expanding our private label and exclusive products towards our long-term target of 50% of sales and through better management of stock and shrinkage in our stores.

We continue to look at gross margin expansion opportunities without compromising value to our customers every day and every visit. Our investment slate in systems will play an important role in the margin expansion program. In FY '20, we expect gross margin to exceed 36%.

Turning to Slide 10. The cost of doing business is running at 27.5% of total sales on a pro forma basis. This is up 50 basis points on the prior year. We achieved leverage of 60 basis points in store expenses in the second half. Marketing expenses remain broadly in line with the prior year, and we continue to invest more into digital marketing. Our overheads of 5.7% of sales grew by $4.9 million, reflecting our investment to support growth and from the annualization of roles from the prior year.

Skipping ahead now to Slide 12. The Baby Bunting market opportunity remains significant in a changing and evolving retail landscape. We are the only specialty retailer of baby goods to operate across state boundaries. A reminder that it is only in August 2019 that both Babies R Us and Baby Bounce closed all of their stores. There is still a significant number of small single-site operators in the specialty baby goods retailing market against whom we compete.

We also continue to compete against the likes of Amazon; Catch, which is now part of Wesfarmers; Kogan; and other retailers on eBay. We are confident that we can differentiate our offer from the online-only retailers. We focus on our in-store and service execution and other services to distinguish us from the department stores, discount department stores and online pure plays.

Moving ahead to Slide 14. Our long-term strategy to grow market share remains unchanged. We're focused on the following: first, investing in digital to deliver the best possible customer experience across channels; second, investment to grow sales from existing stores; third, growth from new markets and new stores; and lastly, EBITDA margin improvement.

On Slide 15, we continue to invest in digital as an important driver of growth. With around 20 million visits to the website last year, our online store had sales growth of 46%, and now this channel makes up for around 11.8% of all of our sales. Click and collect, where customers buy online and pick up in stores, grew 55%. Online traffic and conversion continue to grow with website sessions up 22% on the prior corresponding period.

We've made a significant investment in a new web platform which is intended to deliver to the consumer a more engaging experience with more information and content. The project experienced some delay with the site launching in early July. We -- work continues to improve and optimize the customer experience on the platform. With many consumers utilizing the web to pre-shop and research on products and price across retailers and marketplaces, we are very well placed. Of our top-selling 250 SKUs, around 75% or 187 products are not for sale on the Amazon platform and around 80% or 200 products are not available on Catch. Importantly, the second -- in the second half, 37% of our top-selling 250 products are exclusive to Baby Bunting.

Our investment in digital is ongoing. We will continue to develop and enhance our app and our gift registry experience. We have plans to expand into a drop ship model and work with key suppliers on endless aisle opportunities to grow our product range.

Turning to Slide 16. We continue to invest in our existing fleet of stores to drive growth. 32% of our stores are less than 3 years old and on average, stores in our network take 4 years to reach maturity. We therefore have a significant part of our store network in the growth phase. During FY '19, we invested further on in-store technology and communication systems to facilitate a better customer experience and sales process. We've also made a substantial investment in our team to improve our leadership in the store and area management level. The investment in these areas is driving customer advocacy measure, being our NPS score, which continues to improve. Our NPS score is around 75, up from 70 from the same period last year.

We have acquired the businesses of some of our third-party car seat in stores as a means to grow this revenue through our store network and differentiate ourselves from others and to standardize the car seat installation experience for the consumer. I'll talk about this a little more later in the presentation. We have also commenced online fulfillment from our hub store in Tasmania with the long-term ambition that we can fulfill 90% of online orders in metro areas on the same day, further leveraging our existing store network. This will differentiate our offer even further.

Over to Slide 17. Through the course of FY '19, we opened 6 new stores and relocated our Cannington store in Western Australia. We have 53 stores and a store network [plan] for 80-plus stores. We aim to open between 4 and 8 stores each year, of which around 50% of future new store builds will be in regional locations. In the first half, we opened our first shopping center format store in Chadstone, Victoria. The Chadstone store is our highest transaction volume store in the network. We plan to open our next shopping center store in Westfield Doncaster in Melbourne. Our pipeline is looking positive for the coming year, and we have already committed to 2 further new store locations in Sydney at Casula and Wetherill Park.

I'll pause and hand you over to Darin, our CFO, who can run you through our new store economics slide on Page 18, and he will elaborate a bit further in our shopping center format experience at Chadstone. Thank you. Darin?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [3]

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Thanks, Matt, and good morning to everybody on the call.

The new store economics slide shows the average historical financial performance of our large format destination stores and regional stores. The definition of return on invested capital is noted on the slide, and we should also call out that these numbers exclude any allocation of corporate overheads. Also, we show the store economics over 4 years because we find on average, our stores take plus 4 years to mature. Some mature quicker, others slower and the ramp-up profile of individual stores changes based on individual catchment dynamics. Nevertheless, these numbers give a good representation of sales and EBITDA growth. In terms of the sample size, since 2008, we have traded 39 stores for 1 full year, 35 stores for 2 full years and there are currently 25 mature stores in our network. We should also note that the slide data has been updated for FY '19 trading.

As you can see, our new stores have on average achieved $4.8 million in year 1 trade, delivering an EBITDA margin of 7%. From year 1, sales on average will ramp up to $7.8 million and achieve EBITDA margins of 15% and returning on average plus 70% on invested capital. Drilling into that mature store sample of 25, 10 stores are below 70%, being 5 at over 60% and 4 at over 50%. The lowest in the sample is at 37%.

Moving now to Slide 19. It was incredibly exciting for the business to successfully introduce a third format into our network planning in 2019 with the addition of our first shopping center format store at Chadstone, Australia's premier retail destination. The store is standard size at 1,500 square meters with all the service attributes of our large-format stores being dedicated car seat fitting bays, dedicated parcel pickup area, layby facilities as well as parenting amenities within the store.

Having just ticked over 7 full months of trade, the key callout is it's by far and away our highest transaction volume store in the network and we're getting terrific penetration in higher gross margin categories, such as feeding, manchester, babywear and toys as well as the larger hard good categories of car seats and prams. The store is extremely busy, and we believe, in addition to its own sales, it is delivering referral sales to our suburban large-format center stores for customers who have visited Chadstone. The store was EBITDA positive for the 6 months to June with the forward outlook encouraging.

As Matt stated, we have now commenced building our second shopping center store in Doncaster Westfield in a former Toys R Us site. This store will be a new catchment for us and one we have been looking to enter for many years. We are thrilled to secure our large-format store with the right economics in a significant center with a 15 million annual footfall. Looking beyond Doncaster, the immediate opportunity for Baby Bunting with regard to shopping centers is for openings in identified catchments where we currently don't have stores, if the economics are right.

Thank you.

Matt, I'll now hand you -- back over to you, who will update you on the recent acquisitions of 4 car seat installation businesses.

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [4]

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Thank you, Darin. I'm on -- really excited about what the opportunity the shopping center format brings to our business. I am on Slide 20, by the way.

During the last quarter of the year, we purchased 4 of the car seat installation businesses that were servicing our customers and store networks across Victoria, New South Wales, Queensland and South Australia. Bringing these services in-house is a strategic move for us to standardize the offer across the country and enable us to take a consistent approach to childcare -- to child car seat safety throughout Australia. We believe and we are confident that we can grow car seat installation revenue, grow the service aspect of the business, including building the higher business in the nursery sector. We also see an opportunity to enter the B2B market with products and services into different channels.

The total cost of the acquisition is $1.3 million, and we are already experiencing positive revenue growth and returns in line with our internal rate of return hurdles. It is through the services sector that we can differentiate ourselves from others in the market, especially the online pure plays.

Turning to Slide 21. Over the past year and over the next 2 years, we will continue to invest in transformational projects to grow profitability and support future growth. This is a very exciting time for our business. An important point to note, our policy is to pay dividends from pro forma NPAT. The one-off project expenses and related amortization from our slate of projects will be pro forma-ed out of our profit results for this period.

The program started this year with the website replatform, the rollout of our first online fulfillment hub and the acquisition of our car seat installation partner businesses. Over the coming year, we will launch a new loyalty program; modernize the brand, including the expansion of our private label brands; and we are looking at ways to manage our online, telephone and live chat customer care model, which will improve the customer experience in-store and across all channels. Our core systems project is underway with focus on merchandise planning, replenishment and forecasting, and this will continue over the next 2 years. This project goes hand in glove with our supply chain strategy work which will leverage the new systems. As highlighted on the previous slide, we will evolve the car seat installation business and services offer over the next couple of years, and we will organically grow the services revenue stream in our business.

Over to Slide 22. Slide 22 sets out the elements of our long-term strategy to grow market share. Our strategy around profit margin improvement is to be achieved through our program of business initiatives and managed investment in costs aimed to support scale and deliver profit margin improvement through gross margin expansion and leverage through scale over time. As we grow and evolve our supply chain, we are constantly looking at ways to deliver margin improvement and availability through optimized product routing. We are working with our supplier partners to improve availability and to reduce the cost of goods, hence improve margin and still deliver value to the consumer.

Apart from supply chain opportunities, margin improvement is able to be achieved by working with supplier partners on exclusive products and introducing exclusive brands to the Australian market. The expansion of our private label brands and exclusive products is also key to margin expansion. As the business is growing, we have been able to leverage our scale to buy better and to work with our suppliers to deliver mutually beneficial trading terms afforded by scale. Scale also allows us to gain operating leverage, the other side of the margin improvement equation. We will continue to invest in the business ahead of the curve at the necessary pace to support the long-term growth and health of our business. And when we do invest, we do so in a measured and sustainable way. It is our expectation that we will see leverage in overhead return to the business.

I'll now hand you back to Darin who will talk you through the financial information and also address some of the recent changes in accounting standards. Thanks. Darin?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [5]

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Thanks, Matt. Slide 24. We are presenting the income statement on a pro forma basis to clearly demonstrate the underlying trading performance of the business. There is a reconciliation explaining the differences between the pro forma profit and statutory profit on Slide 32 and in the annual report. But in summary, the current and prior year differences relate to the exclusion of employee equity expenses, business acquisition costs and business project costs as well as Week 53. I should note that when we gave an earnings guidance back in August 2018, these were costs excluded from that range.

The key callouts are, again: sales growth driven by strong comp sales, new stores and annualizing stores; increasing gross margins delivered through the year; and investment in our cost base to support future growth. I think Matt has sufficiently covered the important discussions around sales and gross margin earlier in the presentation, so we might just jump straight to cost where we have seen cost of doing business as a percentage of sales increase from 27% to 27.5% this year. This might be better analyzed by breaking the year into halves where the first half cost of doing business was 28.1%, impacted by increased Afterpay sales of 3 new store openings late in the half; and second half cost of doing business was 26.8% of sales, 130 basis points improvement on the first half and a 30 basis point improvement on the prior year. These benefits were achieved as Afterpay was annualizing in the second half and as those new stores started to trade. Also, both our comp stores and new stores all traded at the top end of sales expectation, which helped deliver the leverage described.

On a full year basis, the key cost callouts are: maintaining our store cost ratio despite the introduction and growth in Afterpay and Zip Pay, plus the 3.5% award wage increases; leverage of our marketing expenses as we see the benefits of scale from our increased store network and the $5 million investment in our cost base, basically people and systems, to deliver future growth, an amount we previously projected back in August 2018.

Summarizing earnings, EBITDA of $27.1 million was $500,000 ahead of consensus EBITDA of $26.6 million and 45.9% up on the prior year, delivered with 140 basis point improvement in EBITDA margin from 6.1% up to 7.5%. Finally, it was great to see the sales and margin gains flowing all the way down the P&L to deliver pro forma profit growth of 58.2% year-on-year.

Slide 25. Looking at the balance sheet, the key highlights have been the investment in stores and improvement in our working capital ratios to deliver us into a $2.7 million net cash position. The $3.2 million increase in our goodwill and intangibles can be split between our $2 million investment in software, including the new website, and $1 million of goodwill associated with those car seat installation businesses acquired. Inventory levels increased $5.2 million from the prior year, primarily from the investment in new store inventory. Relative to our inventory balance, our payables balance increased by $8.1 million for the year, noting $4 million of this is attributable to that 1 additional trading week in June this year relative to the prior financial year.

Moving to the cash flow statement on Slide 26. We had net operating cash flow of $13.6 million after taking into account $10.5 million of capital expenditure and a $1.3 million business acquisition. We have described the movement in working capital being net uplift in inventory more than offset by an increase in payables, including that additional week of trade. And finally, taking into account the final dividend of $0.051 and an interim dividend of $0.033 paid back in March, the total FY '19 dividend of $0.084 equates to 70% of pro forma NPAT for the year.

And now Slide 27, impacts to reporting driven by changes in accounting standards. After surviving the transition to changes in revenue accounting standards in FY '19, we look towards FY '20 as we introduce operating leases onto the balance sheet as right-of-use assets and an associated lease liability. The relevant commercial contracts underlying these new assets and liabilities are our store and warehouse property leases, plus a further 80-or-so leases from material handling equipment.

The leases standard first applies to FY '20. However, if we would apply the standards for FY '19, looking at our current store and equipment portfolio, would see us taking up liabilities around $80 million to $100 million. The method of retrospective application is currently being finalized, and depending on the method applied, the net effect of the new lease liabilities and right of use assets adjusted for deferred tax and the reversal of the existing straight-line leasing and incentive liability may have an impact on opening retained earnings.

As the market transitions into this new reporting regime, Baby Bunting will continue to provide EBITDA guidance using historical measures and also provide NPAT earnings guidance under the new lease accounting standards. However, I can say we expect the impact to be moderately beneficial next year after taking out rent expense and adding in right of use asset depreciations and lease liability interest charges.

I'll now hand back to Matt to discuss the outlook for the year.

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [6]

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Slide 29. Thank you, Darin. I'd like to provide you with a trading update and outlook for FY '20. As at 9 August 2019, comparable store sales growth was 5.2%. We expect pro forma NPAT for FY '20 to be in the range of $20 million to $22 million. Pro forma EBITDA, as measured under the old lease accounting standard, is expected to be in the range of $34 million to $37 million. Guidance assumes comparable store sales growth to be in the mid-single digits for the year and for gross margin to exceed 36%. Guidance also assumes the opening of between 5 and 6 stores for the year, the first being the opening of the store at Westfield Doncaster in October, with a further 2 major metro stores opening in New South Wales in the first half of the year.

A final note of thanks to all our team members who have contributed to the delivery of this very, very strong result and to all members of the Baby Bunting family who have serviced our customers for over the past 40 years. It's through the hard work of the team and each individual's passion that sees us moving towards our vision of being the most loved baby retailer for every family everywhere. Thank you all for your time.

I'll now open the floor to questions. (Operator Instructions) Thanks very much.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question we have is from the line Sam Teeger from Citi.

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Sam Teeger, Citigroup Inc, Research Division - Analyst [2]

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Just wondering how are you guys thinking about the 80-store target given the success you're having in shopping centers and just wanting to see if there's any prospect for any metro store closures outside the shopping centers as a result.

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [3]

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Very happy with how all of our store network is trading, Sam. Darin here. And what I can say is when -- we are going to be doing an update on our network plan over the next few months. And so when that's completed, we'll then come back probably in February and give an update on that one there. But at this stage, we're not contemplating any change until that review is complete.

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [4]

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I think you should also note, Sam, just the Westfield Doncaster store is actually in a network gap for us and is a destination format store.

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Sam Teeger, Citigroup Inc, Research Division - Analyst [5]

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Got it. Okay. And how should we think about the amount of EBITDA this car seat installation business is going to bring in FY '20 and at what margin? And I just want to confirm if I heard it correctly, did you say you paid $1.3 million for it?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [6]

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Yes, $1.3 million, which included $1.1 million of goodwill. So essentially, acquiring the businesses and the network across a number of car seating stores. In terms of EBITDA margin, I mean, we're not going to call that out separately. But what I can say is the investment is sort of subject to the same kind of ROI hurdle that a new store has.

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Sam Teeger, Citigroup Inc, Research Division - Analyst [7]

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Right. And just for future service opportunities, how do you balance the decision between buy or build? And then also, how do you compare the services opportunity which you guys are pursuing now versus an offshore rollout?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [8]

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So the first question, when you say buy or build, I mean, the services opportunity is really hire and then cleaning, and I think that we've got the sort of store infrastructure and it's only a moderate sort of adjustment or investment to sort of then roll that out to a then hire and then a cleaning business. And we are already hiring car seats [for catchments] in Queensland.

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [9]

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So I think also what we're looking at there, Sam, is it gives us a platform to enter the services market, but it also differentiates us very much so from others in the marketplace. And therefore, it's making sure that at Baby Bunting, you get a complete rounded offer of service services and as well as all the best range and the largest range available and great value.

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [10]

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And if you think about hire, they are existing active markets today and some of the things that we don't play in. And so it's an opportunity to go and leverage those store assets that are conveniently located for our customers around the country.

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Sam Teeger, Citigroup Inc, Research Division - Analyst [11]

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Right. And yes, the second part of that question was just comparing this opportunity in services versus an offshore store rollout?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [12]

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I don't think that they're mutually exclusive. But to that point, nor had we discussed anything with regards to international rollout. We've still got another 30 stores to go. We opened 4 to 8 stores in the current market, and there's a lot of things that we need to work on. We need to work through the transformation projects over the next 2 years and really embed them and make sure that they are successful, and that's the focus of the management team. Matt, is there anything you want to add there?

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [13]

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No, I think you've covered it all there, Darin.

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Sam Teeger, Citigroup Inc, Research Division - Analyst [14]

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Got it. And sorry, just lastly, just want to clarify something on Slide 21. It says $20 million in CapEx. Is that in FY '20 and FY '21? Or is that both years combined?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [15]

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It's spread over the 2 years.

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Operator [16]

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And the next question we have is from the line of Shaun Weick from Macquarie.

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Shaun Weick, Macquarie Research - Analyst [17]

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First question, just could you talk a bit about the evolution of the trading trends through that second half '19 period but in the context of like-for-like? And I guess the exit trends around gross margins, and I'd be keen to understand what you're seeing from that perspective in current trading as well?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [18]

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Yes, so from a comp sales perspective, we -- first 6 weeks post the half year, we're at 5.9%. And then for the remainder of the half, we were running at 9%. Gross margin, I think the 35.3% for the second half is reasonably indicative from an exit rate perspective. And then with regards to the start of the new financial year...

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [19]

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We said 5.2% up until the 9th. We're [just lapping] on some significant comps from last year during that period, and it's also our lowest sort of trading period. July is our smallest trading period and the amount of the sample size is quite small.

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Shaun Weick, Macquarie Research - Analyst [20]

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Okay. And then maybe just on the profitability of online channel then. What percentage of your sales now online delivery versus click and collect? And how -- what initiatives do you have underway to try and manage down that cost to serve?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [21]

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Well, I can tell you that online is a very profitable channel to market for us. So it sits above that sort of 15% EBITDA. The online and click and collect in combination is 11.8% of sales, and click and collect would be around a quarter of that. Where we have a store -- obviously our online store is servicing markets where we don't have stores. And so where we have a store, click and collect is 50% of online sales in those catchments.

With regards to what we are doing to continue to sort of grow that channel, obviously, we've just gone live with the new website platform. And then beyond that, there's some opportunity to sort of further monetize that site's drop ship, so product [that goes]. So we can actually build that out our range, our SKU range, and supply, I mean, direct to customers without us having (inaudible).

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [22]

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Well, our long-term aim is to service our metro customers 90% of the time in the same day. We've launched our first fulfillment hub in -- through our store in Tasmania, and that's fulfilling orders there and ramping product appropriately. That also gives us leverage around how we can get calibrated products to a location in domestic or local transport, et cetera. So there's some opportunity from a cost perspective in that space as well.

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [23]

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So that fulfillment hub in Hobart means that -- and so that's operating at the back of our Glenorchy store, means that we're shipping online orders at, if not the same day, then the next day for those customers in Tasmania, which is an increased service level that they haven't previously enjoyed. And so we expect the same when we go live with the fulfillment hub over in Perth in Cannington.

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Shaun Weick, Macquarie Research - Analyst [24]

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Okay. Great. And then maybe just one final one, which I guess leads on (inaudible). I mean what are you seeing out there from a competition standpoint? You've obviously called out there that you're [ranging store] remains very strong relative to some of the online-only retailers, in particular. But what's your expectations there around the evolution of competition over the coming 12 months? And then what's your views around Toys R Us or Babies R Us entering the market -- reentering the market? If you could just share some color around how you think about that, that'd be great.

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [25]

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Yes, so just -- what we have seen is we have seen a moderation in our price matching. So the extent of product that we have to price match has come down, we continue to focus on value in our businesses that we've grown, grown our Best Buy program, which is EDLP. The Toys R Us business, I think it's Hobby Warehouse that's acquired the license, I guess, or brand, and they've sort of indicated that they will open an online offer for babies, but I haven't actually seen that come to life as yet. They do sell toys at the moment. But we're always very respectful of what our competition is doing.

We are very focused on delivering our private label and exclusive agenda and said long term, we want to get that to 50%. So we're working hard at that and actively working with our supplier partners to deliver on that. And things such as -- doing things that others can't do, such as the services model, doing things such as hub stores, same-day fulfillment into Tasmania, et cetera, are all things that are differentiating us from others in the market. And we continue to focus on how we can improve that customer and how we can -- that customer experience and how we can improve on value for the consumer every day and every visit.

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Shaun Weick, Macquarie Research - Analyst [26]

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And just final one, sorry, on the consumer. I mean are you seeing any trade up or trade down behavior across your key kind of product line?

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [27]

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It's interesting you say that. I mean we get this question every year. And I guess from our perspective, we see baby as probably a less discretionary market. People always want to do the right thing for their child, and we will always try and provide the best for it. What we can see is that we're seeing growth at all parts of the market. But the products that the mid-tier, et cetera, are offering a lot of value to the consumer, now it's very hard to actually determine whether that's an economic factor or it's just that the products are actually offering a lot of value in that mid-tier range. But we're certainly seeing some really good growth in our -- those exclusive car seats as well.

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Operator [28]

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And the next question we have is from the line of James Bales from Morgan Stanley.

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James Bales, Morgan Stanley, Research Division - Equity Analyst [29]

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Firstly, just on the online sales. The improvement there in the second half in terms of penetration was 30 bps. So a big deceleration from what we've seen. And the growth rate in absolute terms came off as well, and that was when you were replatforming a lot of the digital offer. Can you talk us through the moving parts there and what targets you guys have internally for where you can take that?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [30]

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Yes, so our -- the growth rate was sort of still high 30s in the second half from a percentage growth of online sales. What we were annualizing was we're annualizing significant growth in the Afterpay -- introduction of Afterpay in the business in the prior year. With the replatforming of the website, we went live on the 3rd of July, so post year-end. And so the opportunity to sort of maintain that first half momentum wasn't there because that was really what was going to drive it. So the expectation with regards to that web replatform, James, is that will -- it will increase engagement from the customer, and we're expecting to sort of lift up conversion and get -- sort of improve our average transaction rate as well.

And so we needed to take our time to get the website right. We're still sort of doing some work around that, but that's probably where I sort of put my finger on it and say, well, whilst there was a deceleration, still very strong growth. And that first half growth rate was reflective of the introduction of that Afterpay in the -- which was introduced into the business in February 2018.

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [31]

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But just to reconfirm, that was purely online that was introduced. That's -- so it wasn't in the stores at that point.

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [32]

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Yes. And so yes, we also have seen some migration of Afterpay sales from click and collect across the sort of in-store piece in the second half because we did introduce Afterpay into the stores this year.

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James Bales, Morgan Stanley, Research Division - Equity Analyst [33]

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And just to clarify, you're saying that the impact of the replatforming on your own site has a greater impact in FY '20?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [34]

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Yes.

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James Bales, Morgan Stanley, Research Division - Equity Analyst [35]

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Right. Okay. And then I wanted to understand, back on the mall opportunity, how -- I know you sort of said you'll release some store targets at some time in the future once you've done that reassessment of the rollout opportunity. But how do you sort of -- how many malls in Australia do you think fit the profile for what you're after? And the cannibalization, how should we think about that? It seemed like Chadstone had a 1.3% impact on comps across the network. What happened to the sales in the stores around it?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [36]

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Well, the cannibalization is -- so Chadstone, we dropped Chadstone in the middle of 3 existing store catchments, but with $23 million -- 23 million footfall per annum. I think if you can't make it work there, then you're not going to make it work anywhere. And so it was a great test to sort of see what was going to occur. The sales redirection, the sales redirection was below what we thought it would be. And so they're all on very high trading stores, but the net benefit is very much still in our favor with regard to the introduction of that store.

Now we look ahead to Doncaster and we say, well, what's going to happen there? Well, Doncaster is a caption -- is a catchment gap for our network plan. So you're not going to see that same effect. That is primarily going to be organic sales. It's going to be a little bit of redirection away from the Ringwood store, the Preston store. But fundamentally, nothing relevant to the size of the impact of that Chadstone store, which was 5 kilometers away from our heritage flagship store, Bentleigh, and 8 kilometers away from our Hawthorn store. And they're both big traders. So -- but I think what we said, what you can't measure is you can't measure that sort of halo effect. The store's incredibly busy. It's a great brand opportunity for the business as well, and we're picking up a lot of sales in categories where we have -- we don't perform as strongly in, in those destination or stores. So I think that they're all very encouraging for us.

If we look to -- one of the immediate opportunities, I think we should -- whilst Doncaster [is just still 7] -- sorry, Chadstone is 7 months in, Doncaster will be opening in couple of months. So we still need to -- whilst we build those stores into the network, I think we should focus on looking at the opportunity in catchments we're not in today and then do our network planning and then see what happens after that. But at this stage, I don't think that we'd be saying that we should be sort of dropping stores into existing catchments. So yes, I think that's the most appropriate approach. There was a second part of the question?

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James Bales, Morgan Stanley, Research Division - Equity Analyst [37]

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Yes, it was about how we think about the rollout and the impact of the stores around Chadstone and how it's impacted their trading?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [38]

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Chadstone was atypical. And absolutely, it was below what we expected. So we're expecting a hit. But certainly, on a net profit basis to the business, it's accretive and it will -- it was factored into our feasibility assumptions. So when we do a feasibility for a new store, they have to hit a hurdle rate on a net basis.

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James Bales, Morgan Stanley, Research Division - Equity Analyst [39]

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Okay. And then I just wanted to cover off on the cost of doing business into FY '20 and what's in guidance. Are you sort of suggesting that if we extrapolate that 26.8% in the second half into next year, that's the way to sort of think about how we build that bridge from -- to your EBITDA number?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [40]

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Look, we will get some leverage in store costs and marketing, but we will -- we're going to continue on the investment path in our overheads and that may -- that will range between $4 million and $6 million next year. It's a combination of annualizing roles, new roles and also just some structural changes as well within the sort of how the P&L presents. And so we're investing in commercial-facing roles around business development, product development. So we're going to be launching our private label premium [brand] during the course of the next financial year. And also, we're going to be introducing an online business manager.

So these are all very commercial-facing roles. There's a number of roles that we need to sort of introduce to sort of support the scale sort of -- and that's in around DC pickers, HR and also in finance. And then there's also a couple of structural changes. So the acquisition of the car seat installation business has got an area management component, and so there's some costs that were previously a component of gross margin. So you're going to see higher gross margin, but it does introduce cost into the overhead structure as a result.

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Operator [41]

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The next question we have is from the line of Jo Little from Morgans Financial.

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Josephine Little, Morgans Financial Limited, Research Division - Senior Analyst [42]

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Just firstly, on the 5 new stores you've guided to in FY '20, just any timing issues we should be aware of this year, first half versus second half, and maybe just metro versus regional splits, too?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [43]

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At this stage, we've got a -- it'll either be 3 metro, 2 regional or 4 metro, 1 regional. It's just or. So that's kind of the blend, and it will be -- Doncaster is opening around late September and then the other 2 will be at the back end of this first half, so November, December. And then I just think the sort of phase -- the other 2 in the second half will just be phased across the second half.

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Josephine Little, Morgans Financial Limited, Research Division - Senior Analyst [44]

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Yes, okay. So we might have a bit of front-loading in the store cost again versus first half -- second half again. Okay. And just on the AASB 16, because that's incorporated into your NPAT but you haven't kind of quantified what that will be at the bottom line. Can we get some kind of rough guide just so we're completely understanding what you've incorporated there?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [45]

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Yes, sure. Yes. So it will -- Within that NPAT guidance, at this stage, we're still finalizing the treatment there. But at this stage, that guidance sort of reflects a benefit of below $0.5 million from an NPAT perspective when you bring in the new AASB (inaudible).

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Josephine Little, Morgans Financial Limited, Research Division - Senior Analyst [46]

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So quite small, yes. And just the transformation program there, that [$5 million and the $4 million of accelerated amortization. Can we just get a little bit more of a feel, particularly on the $5 million, what that kind of is going to relate to just given you are putting it below the line?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [47]

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Yes, so the $5 million in project expenses is -- so they're the cash costs and the amortization with regards to rebranding and store signage. So that will be around sort of $2.5 million. And then also there's -- we're looking at what we need to do at the head office level and DC level as well and whether or not there will be some sort of amortization of that [at our] DC. I just made an allowance for it as DC comes up for lease renewal in F '21. With regards to that type of project costs in the -- we're talking about project governance.

And so there's a big slate of projects here. And so we've introduced roles to work within the business and sort of lead the business sort of transforming through those. And then you've got process transformation costs, and so you bring in business analysts and change project managers to support that. And then there's also, when you're sort of standing up core systems, there is costs that will be incurred in the standing up of that project, but you're not able to capitalize those costs. And so that will actually just be cash costs. And so when you're sort of in the lead up and doing testing and things like that, they're not costs so they're able to be capitalized.

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Josephine Little, Morgans Financial Limited, Research Division - Senior Analyst [48]

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Okay. Great. That's helpful. And just lastly for me, I suppose if you look at your [landscape] now and you're kind of the last major group standing, a couple of online players and Amazon, just thinking about that there's a whole range of kind of local wholesalers in the picture. Are there more opportunities to go direct to some of these large global suppliers and cut out the middleman?

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [49]

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Look, Jo, I think we're working with our supplier partners on how we can work to be mutually beneficial to buy better and route product better. We do obviously get approached by some of the global brands about bringing new product to market, et cetera, but it's about how best and how effectively we can work with our partners at the moment. And some of the -- in the big categories, we are working with some of the major global brands direct anyway at the moment.

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Operator [50]

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The last question we have is from the line of [Trevor Wu from CLS].

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Unidentified Analyst, [51]

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Can I just ask, how is it that you're able to expand direct importation and keep your FX exposure to below 10%?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [52]

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Yes, thanks for the question. So we're -- essentially, what we're talking about is a more efficient routing to market. And so our local supplier partners, we're buying [SOB] but in Aussie dollars with those guys. But then instead of running through their supply chain and then into [warehouse], it's coming from port and then directly into our supply chain. So we consider that as direct importation, if you like.

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Unidentified Analyst, [53]

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Okay. But it just doesn't make sense because if -- that still kind of have currency exposure, right? Because if the dollar falls, the cost of that increases.

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [54]

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Look, there's a secondary impact. That's a consistent theme across the market, right? So we buy -- look, at the moment, we've got (inaudible) U.S. dollar exposure of less than 10% of our purchases. We've got trading terms with our suppliers they need to notify us of a pricing change 90 days ahead of going through. I mean [I suppose] -- and if you then (inaudible) okay, well, FX, what's occurred this year versus last year, for the first, the FX is right on average at 71 this financial year relative to last financial year, which was running around 77 for the first 9 months of the year. [That used to] increase our margin. So there's [10,000] products that we run. It's not straightforward in terms of sort of analyzing that FX piece. But by and large, it's managed.

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Unidentified Analyst, [55]

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Okay. And with your shopping center format stores, specifically Chadstone, you mentioned that it's the highest volume. But is it the most profitable? Or will it become the most profitable over time?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [56]

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It's been trading for 7 months, and I wish I had a crystal ball on that one. But certainly it's very encouraging signs from a profit perspective in that store. Is it going to be our most profitable? We're not going to go into calling out sort of individual profit on individual stores across any of our network.

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Unidentified Analyst, [57]

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Okay. And just one final one, how long will it take you to get to your 10% EBITDA margin? And I just note that your corporate EBITDA margin is 7.5% versus your store margin of 15%. So does that kind of imply that you need to raise your store margin -- sorry, your mature stores margin by another 250 basis points to get to that?

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Darin Hoekman, Baby Bunting Group Limited - CFO & Company Secretary [58]

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So our overheads are currently 5.7% of sales, and our mature stores are 15%. So if we had a more mature store network, we'd be very close to already being at that 10% EBITDA margin. So we will achieve cost leverage through scale, and we expect to -- like we forecast this financial year, we expect our 35% margin to exceed 36% in the current financial year. So that will certainly help us along that journey.

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Operator [59]

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There are no further questions at this time. I would now like to hand the conference back to today's presenters. Please continue.

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Matthew Spencer, Baby Bunting Group Limited - CEO, MD & Director [60]

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Okay. Just to sort of say thank you all very much for attending today's presentation. Have a great day.

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Operator [61]

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Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating, you may all disconnect.