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Conference Transcription

20 September 2012

Kathmandu Holdings Limited

Full Year Results – Investor Call

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Start of Transcript

Operator: This is PGi. Please standby. We are about to begin. Good day, everyone and welcome to the Kathmandu Holdings Limited full year results announcement investor call. Today’s call is being recorded. At this time, for opening remarks, I would like to turn the conference over to your moderator today, CEO of Kathmandu, Mr Peter Halkett. Please go ahead, sir.

Peter Halkett: Thank you, Maia and welcome, everybody. With me today on the call is Mark Todd, our Chief Financial Officer. We’re going to be discussing our results for the 12 months ended 31 July 2012. We will be talking to the results and the full presentation that we’ve filed this morning on the ASX and the NZX and our corporate website, and I presume most people have either got these or can access these and you can follow me while I work my way through these presentations. We will be presenting the result in New Zealand dollars. You will be familiar we do that each time. The presentation component will be approximately 30 minutes and then, we’ve allowed 30 minutes for Q & A.

Total time of one hour and I’ll just now go through the contents on page 2. We’re going to overview of the result. We’re going to talk about the key line items. Country specific results. Cash flow, balance sheet, dividend. Growth strategy update. The outlook and then it will be time for questions and Mark’s going to be presenting some of those pages, as well. This format, as many of you will be aware, is very, very standard and familiar. We’ve had positive feedback to the format, so we keep repeating it. Just looking at the results, page 4. Our view is that this is a solid result, given a pretty difficult economic environment and I’d also note that the second half performance was significantly improved, relative to the first half and it was a slight improvement in profit, compared to the second half of the previous period, which as you know is the largest portion of our annual profit, as well. It was also a year where we significantly invested our investment program to take advantage of future growth opportunities.

Sales and margin. Sales grew by $41 million or 13.4% above the previous year. Same store growth on a constant exchange rate basis was 7% or 5.7%

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at actual exchange rates. One of the topics, I’m sure, that will arise is the investment we made in our incentive - our loyalty base, our Summit Club membership base. That membership grew by over 30% and as you’ll be aware, it’s a main - a significant part of our long term strategy as we head towards 1 million Summit Club customers. Our gross margin was 63.2%. That’s within the range that we’ve been talking about as the optimum range for us.

We’ve been talking about that since we IPOd three years ago, but it is down on the previous year, which we think was a pretty stellar performance and one that wasn’t sustainable. Once again, I think we’ve mentioned that to many of you in the past, so while that will generate some questions, I can assure you, within the business; we think that’s a good level. Operating costs. Operating costs, the overall increase was 190 bases points. That was up 470 in the first half, but the second half was a much improved performance, down 30 bases points. Most of the one off that occurred in the first half.

That predominately related to our ERP or our Enterprise Resource Planning system we put in place and our warehouse management system. We did strike problems implementing those systems. Pleased to report that most of those issues were dealt with in the first half. There is a small impact in the second, but we’re through those now. The profit level, $66.5 million EBITDA, down 6.9%. Net profit after tax, $34.9 million, down 10.7%. You’ll note the depreciation was up $2.1 million or 28.5%, as we increase our investment program. CapEx went up to $21.8 million. The major projects included the new distribution centre in New Zealand, flagship stores, the rebranding and investment in our systems, particularly in the online platform, which incidentally launched last night in New Zealand and Australia, with the UK due to go live in a week’s time. If you get a chance, take a look at that and we’ll talk about that a little later in the presentation. Just going through the results on a year-on-year basis.

Covered many of these already. Total sales were $347 million, up 13.4%. The gross margin, as you see, 65.5% last year. 62.3% this year. Still within our range. As I said, last year was relatively exceptional. We had a lot of tail winds. Operating expenses, they went up 18.4% and that’s, I guess, that’s of 28

part of a contributing factor to the reduction of profit is that our sales only went up 13.4%, so that’s why the EBITDA margin goes down. EBITDA at $66.5 million compared to $71.4 million. EBIT at $57 million compared to $64 million and net profit after tax almost $35 million, down 10.7%. We’ve got 100 - we had 120 stores at the end of the financial period. I should note that there were also four temporary stores, so that made a total of 124.

The next slide, page 6, it’s worth - I thought it was worth pointing out the performance in the second half, specifically. Obviously our first half performance got a lot of attention. I think it’s worth taking this opportunity to, I guess, just have a bit of a look at the second half, because it does signify quite a turnaround from the first half, where sales increased by 12%. The gross profit performance was within our range, at the upper end of our range, of 63.6%. Operating expenses grew at 11%, so there you can see in the second half; we’re starting to get operating leverage as expenses growth was lower than sales growth. EBITDA was 49.5%, compared to 48.2% the prior period.

EBIT, 44.3%, compared to 44.1%. Then, net profit after tax, 28.9%, compared to 29.6%. So not a huge increase in profitability over the six months of the previous year, but a good trend, when you think about the first half and I’d also have to say, the second half, that was a pretty stellar performance in FY11. So just moving on to the key line items. We can see, first of all, sales - we’ve covered that off. You can see the breakdown per country. Clearly, the UK is not helping us very much. We’ll cover a little bit of that topic later in the presentation. But we’re getting very healthy growth out of New Zealand and Australia. You can see, over the years, its steady climb. Just moving to the next page, which is the same store growth. This is looking back over a number of years. I think you’ll see from that pretty clearly that we weren’t exactly coming off the back of a poor performance.

The previous same store sales at a group level were 15.7% and in a country level, New Zealand was coming off 12.3% to achieve 9.2% in the - last year and Australia was coming off the back of 14.4%, so it wasn’t as if we’d had a very poor performance, which we could build upon. We’d had a very, very positive year and I think many, many analysts were predicating that we would face a challenge to get growth on those numbers, so I’m pleased to of 28

report we have. The next page just breaks that down into half years and once again, a pretty similar picture coming off the back of some very solid half year, same store growth. You’ll see, if you go back to FY10, that we had negative comps.

That’s the year where we discussed - we had some fairly serious stock issues. We ran out of stock during - in our winter campaign. Not so much ran out of every item of stock, but ran out of key stock items. That’s been well talked about. We obviously addressed that in FY11. Hence, the significant same store sales increase and then once again, we’ve continued - so it’s just a level of detail that hopefully most of you will find useful in assessing the performance of the business. From a gross margin, point of view, we’ve broken it down by country and we’ve also gone back a number of years for you to see the trend.

Australia trades at a higher gross margin that New Zealand, partly because the cost structure in Australia is higher, in terms of both rent and salaries and just about everything else. Australia certainly, it’s probably, in simple terms, over the last four years, it’s the second highest growth margin and I think last year, as you can see, it was pretty significantly higher than the average. Certainly New Zealand is lower. New Zealand is lower than the lowest of the last four years, so it is something for us within the business to take a good hard look at and maybe the balance between sales growth and discounting and Summit Club members and clearances is something we need to realign, but overall, we’re still satisfied we took the right actions last year. UK is an area where we’ve got to increase margins, but the sum total of all that 63.2% stacks up with what we achieved two years ago and only slightly less than three years ago.

So as I said, the total outcome, we’re comfortable with. That occurred as we invested more in our Summit Club program. We believe it’s critical, given what we see happening in the online world, that we have a very solid database of customers that we can communicate with. A group of customers that are loyal to our brand, that have a benefit of continuing to shop with us. The campaign itself was very successful in driving both new membership, as well as incremental sales, but it did come at a cost of margin. The product

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cost increases were balanced by the FX hedging, so product - we had a small gain in FX, but that offset the small increase in product cost that occurred.

Each period we have a product mix movement between the categories, such as our equipment and apparel, where apparel generally gets a higher margin, so that can influence what our outcome of total margin is going to be. We certainly had a little more clearance activity, as we’d be buying more stock, so there’s more to clear. For us, that’s still a profitable business, but it is done at lower margin and as I have reiterated, mentioned, on a couple of occasions, we’re comfortable that we sit in the right area, in terms of our margins, sustainable long term margin. I’m going to pass over to Mark now. He gets the opportunity to discuss our expenses, which was a highlight of last year. Thank you, Mark.

Mark Todd: Thanks, Peter. As we’ve said already, operating expenses are tailored to halve. The second half, we actually had a reduction in operating expenses as a percentage of sales of 30 points compared to 470 points increase in the first half. We’ve highlighted the main categories where the rate of increase was greater than the rate of sales increase. Rental costs 100 basis points up. Distribution centres, 60 basis points up and retail salaries and wages, 80 basis points. Now, quite a lot of the distribution centre costs are one-offs that we talked about in the first half year. Incremental labour and - a lot of incremental and also freight dealing with the changeover in systems. Retail salaries and wages and also when you talk about spends like rent costs are also affected by the crossover in having new stores, network the new flagship stores in the year.

We’ve traded out of the existing stores, as well, and we’ve had periods we’ve been running two stores, but the overwhelming - the main reason for retail salaries and wages increasing is the continuing shift of business to Australia, to New Zealand, so part of that is one-off, but part of it is also a structural.

As we’ve said, the - when you talk about the half year split and what’s gone on, the key numbers, really, is that when you split rent and operating expenses is that rent in the first half is 13% of sales and in the second half is 10.2% and other operating expenses reduced from 38% to 29%, so highlights for you, the message we’ve given at the half year about the, you know, there

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is a substantial portion of Kathmandu spend and operating costs that is basically fixed in nature and you see that in the two half year numbers. $75 million in the first half and $78 million in the second.

Depreciation will continue to increase. I make that point for the years ahead, given the uplift we’ve got in our capital investment program over the next couple of years and I’ll talk about that in a minute. If you go on to the earnings page and you look at the long term trend in earnings, well, obviously since listing, given that the impact is distorted by the increased cost under the private equity structure in the first year. But in the three full years, we’ve had some [unclear]. In ’09, we’ve had a 37% improvement in EBITDA and a 33% improvement in the EBIT. Quite consistent.

Over the last two years in your net profit after tax, there’s an increase of 38% in the two year period, which really reinforces the point about the fact that the growth that we’re delivering in the business, simply by both same store sales growth and new stores as profitable incremental growth. Just talking briefly about the country results, the main difference in earning performance between New Zealand and Australia in that the EBITDA result in Australia is down 6.5%, whereas in New Zealand, the EBITDA result is slightly up. It's, primarily, two things. It's absolute same store sales performance being better in New Zealand than in Australia and the fact that when we talk about the incremental costs of setting up in Australia and the incidental one-off costs associated with our distribution centre challenges - most of those costs were incurred in Australia.

The 60 basis point increase in distribution costs - well, it was an 80 basis point increase in Australia and a 20 basis point increase in New Zealand. The rent and rates increases are similar between the two countries, but most of the work around new stores and cross-over of new stores and the flagship store structure, that mainly happened in Australia. Those key stores for us that are new this year are Australian domiciled stores, apart from the Wellington one. So that's the main reason for the differences between the two countries.

In the UK - the UK result would have been nearly flat, year-on-year, were it not for the fact that we took the steps to, basically, close our regional office

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in the UK and outsource our warehousing in the UK to a third party provide, and the cost of approximately $1 million - £0.6 million - relate to the redundancies, the legal costs and the costs of vacating that warehouse and office. Were it not for those costs the result would have been, approximately, flat year-on-year.

We'll just move on then to the cash flow. Then I'm talking about the balance sheet and dividends. Basically, the CapEx for the year has increased by approximately $10 million. If you talk about the cash flow performance for the year, we generated pre-capital expenditure and dividend payouts of $7 million less operating cash flow in the current year compared to FY11. The dividend outflows are equivalent in the two years, at $20 million; but the incremental $10 million worth of capital expenditure means that we had a small net increase in terms of borrowings of $7 million versus an $8 million decrease in the year before.

The capital expenditure levels which we've got this year - and we've signalled we will continue on for the next couple of years. The key costs that are changed and uplifted here are the new store spends. Most of that new store spend arises because of the investment made in our key new stores in markets like Chatswood, Perth, to come, Newmarket in Auckland, Willis Street in Wellington and Camberwell.

We've got several new stores that were open in the first quarter of the year - that we're in now - that we had carry-over costs from, so our new store CapEx was quite a lot higher than the previous year.

Our IT spend - we seem to have at least one major project going on per year, so that level of IT spend you'd expect to see continuing. The previous year it was our new warehousing management system. This year it's our online project. There are other projects to come next year.

Our other CapEx of $3.5 million in the year we probably won't be spending to quite that level in the years ahead, simply because we've done a lot of our infrastructure investment in distribution centres, relocated our Melbourne office and refreshed approximately 70% of our stores. So where much of that spend goes in future years is into more spend on existing store refurbishment

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and relocation. Our bank funding costs will decline slightly again next year as we get the full year effect of the new bank facility.

Then, just finally from me, on our balance sheet and then dividend - the key number that's changed here, over time, is, obviously, our stock and investment in inventory. In actual fact, when you look at that spend on a per store basis, considering we've increased our SKU count by 30% in the last two years - and, by the way, we can't actually deal with the timing of our stock deliveries into our warehouse - half of that movement between FY11 and FY10 is simply around timing of goods in transit.

We're really happy with how our inventory balance has looked per store. As of today, right today, we have, virtually, the same increase in clearance units in the business as we've had the rate of sales increase; so what stock we've bought, basically, we haven’t converted any more of that to clearance than the rate of sales increase itself. Those inventory levels will probably reflect - without an increase in SKU count - the relative peak on a per store basis, going forward.

Other than that, as I've just said, a slight increase in term debt, year-on-year, because of the increased - slight increase in borrowing to fund the capital investment program.

Our dividend payout ratio's met again for the year. The dividend level's been held at $0.10 a share. It represents a payout ratio of 57% for the year that's ahead.

Sorry, one other comment, obviously, in terms of hedging - our hedging profile for FY13 is very similar to that in FY12. Our hedging rate is, virtually, dollar for dollar Australian to [US] compared to just over $0.97 we achieved in FY12. New Zealand dollars also up a couple of cents on the FY12 performance, so nothing going on in the hedging profile that would change our cost of purchasing stock in the year ahead.

Thanks, Peter.

Peter Halkett: Thanks, Mark. I'm going to talk about growth strategies now. That's on page 24. I guess, once again, for many of you these five boxes are pretty consistent with the last three years.

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The first box is our new store rollout. We believe, still, as we get closer to the 150 target, we can definitely achieve 150 stores. By the end of this financial period we'll be close to 135. So, at the moment, it's very much about finding those sites. We're probably a little more cautious than we've ever been.

So our new stores continue to perform to expectation. They perform very well. They're still very, very profitable. Our target is to get 15 per annum of the new flagship stores, which was a program we indicated some time ago about in prime markets - I guess, redefining the brand between our brand refresh and our store design. That's nearing completion. We have a few stores to go, but the majority are under our belt. That has also delivered, I guess, a significantly improved impression of the brand and our products.

We're very much of the trend towards multi-channel retailing, at the same time as what's happening with the economic environment. It has made us more cautious about property. It's made us more cautious in terms of the deals, the locations and the sizes of stores and the terms and conditions and break clauses and length of term.

So, on the surface, you would say should we still be rolling out stores? I think our stores are so profitable that we certainly believe we should be continuing; but we are being a lot more careful, cautious and demanding.

We've confirmed the effectiveness. We've introduced some small format options, and they're going very, very well. They have a cut - basically, they have an edited range of our top selling lines. They tend to go in high footfall locations. They tend to have an apparel focus that's working very, very well. On that basis we think - within New Zealand and Australia - we can probably go well past 150 stores, but I'm not in a position today to confirm what that total may be.

Still opportunity to improve our performance by optimising the existing store network. We have many stores that have been around for a long time that are not necessarily in the optimum position, the optimum location, the optimum fit out, the optimum format. So each year, as we've put here, there will be a greater number of renewals. That gives us an opportunity to relocate and put in the format that we think is appropriate.

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We still believe, for our Basecamp offer, which is family camping range, in Australia we have opportunities for several more stores and the rebranding project. That doesn't get a lot of air time in relation to Kathmandu. That's gone really well. We still have a number of stores to complete, but I think that's refreshed and put another perspective on how our customers view the business.

Online and digital - our growth strategy here was to develop an online site to maximise our sales in New Zealand, Australia and the UK. It was also - and, probably, even more importantly - to give us the capability and the functionality to allow us to trade internationally - global sales opportunities in terms of international freighting or set up sites in new markets that we currently don't serve.

Our online sales growth was really strong - more than doubled. Our new platform in New Zealand and Australia - as I mentioned before, it launched yesterday, and UK launches shortly. People talk about online and retail as if we're all the same. I think we need to separate those retailers selling other brands, other people's brands, other business's brands versus those like Kathmandu, where we are our brand, we control our brand. We don't compete with others to sell Kathmandu product. We can determine pricing and promotional policies.

So the opportunity for a branded business like Kathmandu to go globally and to compete locally, successfully, is quite a different assessment than, I guess, retailers selling a variety of other brands where they could be exposed to greater competition. So we see this - the online world - as a fantastic opportunity for Kathmandu to affordably - and at a low risk - to step outside our traditional markets and sell more.

We're also looking and working and talking with marketplace sites like Amazon, Trade Me and eBay which, under certain circumstances, offer us further growth opportunity. I don't have anything to announce today about that, but I guess I'm signalling that we're well aware of that space and what that might present to Kathmandu, particularly on an overseas basis.

We also know our platforms that we've launched today need to be fully optimised for mobile, both in terms of things like hand - iPhones and iPads

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because a significant portion of purchases - non-store purchases - are being made on hand held devices; so that we have a big program of work online and a big opportunity.

Our product is something we've spent the last few years really growing the range, building the offer, giving more reasons for customers to buy, more categories. The total SKU count - the amount of stock we have in our stores - is at a peak now. Through that process we've had some big successes. We've had some things that have gone reasonably well and some things that have, probably, been quite poor.

So we're at the point where we're not growing the range anymore. It's now about maximising the sales per square metre, maximising the return on our investment and product and maximising the opportunity with smaller formats. So it's really about performance of product now rather than about growing it. Once again, I think that's going to still continue to deliver same store sales, even though the width of our offer won't be increasing.

Summit Club - which has attracted a big part of our strategy - we're targeting one million members. We think that the combination of having a group of customers that are relatively loyal to the brand as well as having email addresses and being able to contact them is a critical part of the online world. That's why we've invested to enhance the attractiveness of joining our Summit Club scheme. That's working well. We increased our numbers 30%.

These customers tend to spend more with us. The voucher scheme we introduced as worked well. People are returning to the store with their voucher and spending more. That helped us achieve same store sales. We have a number of IT developments in terms of our CRM - or customer relationship management - that are part of our core system development in the year ahead.

What I haven't really talked about within this growth strategy is - which I've discussed previously - has been about the opportunity we have to get Australia to the penetration levels of New Zealand. It's a bit ironic, isn't it, that New Zealand sales growth outperformed Australia yet again? Yet Australia's customers spend, per head of population, still approximately a third of what our New Zealand customers spend. So that's a big focus for us.

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That's about store rollout. That's about brand awareness. That's about Summit Club membership.

So even though, while it mightn’t look like there are going to be - the store rollout is nearing completion, I think from a growth, in terms of product and customer and penetration, there's still a lot more opportunity in Australia especially.

Just moving to the outlook slide - we'll be getting to questions very shortly. I know I'm slightly over time. The new stores in FY13 are coming on stream earlier than FY12. I think last year, you'd be aware, we only opened 10 stores, and they opened quite late in the period; so we get a benefit of that this year. The online sales growth continues. The new platform - I've really talked about that, so I won't repeat that.

Looking forward, our operating cost - there will be a lower rate of increase. We incurred a number of one-offs as well as took on board expenses at a rate higher than we would normally expect with our distribution centre and some of the investments we made in brand and so forth. We don't expect that to continue at that rate.

Our capital investment - without going into the detail of it, we expect to spend that $20 million level again in the coming year, based upon the program we have in terms of IT, new stores and relocations and online.

Then, just moving to slide 28 - in our view the current market conditions are really the new normal. Anybody holding their breath, waiting for things to get better, may run out of breath before that occurs.

Having said that, our outdoor category globally and locally, we think, is still strong and very resilient. I think our sales numbers in particular are testament to that. But of course, there are a lot more competitors coming into this space because of the attractiveness of it, so it's very important we maintain our market leadership, hence some of the growth initiatives and the investment we made.

So from an earnings point of view, the board and management remain very confident in the Kathmandu business model and the ongoing growth strategies. Several of the FY12 cost initiatives that affected the profit in FY13

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- sorry, in FY12 - won't be repeated in FY13. Earnings growth will almost all occur in the second half of FY13, even though we will be opening a number of stores before Christmas. The profile, the proportion of profit remains the same; first half less growth than the second half.

Providing there's no further deterioration in the economic conditions and following our investment program during FY12, we expect an improvement in performance over the next 12 months. I'm going to open up - Maya, if you're there, I'm going to open up for questions now. First cab off the rank, please.

Operator: Thank you, sir. The question and answer session will be conducted electronically. If you would like to ask a question, please press star one on your telephone keypad at this time. If you're on a speakerphone, please be sure your mute function is turned off to allow your signal to reach our equipment. Once again, that's star one to ask a question. We'll now go to our first question in queue, from the line of David Cooke from Nomura. Please go ahead, sir.

David Cooke: (Nomura, Analyst) Hi Peter and Mark. A couple of questions, if I may. Can you give us an indication, please, as to what FY12's CODB was one off in size or in nature?

Mark Todd: Yeah, the $2 million - the two numbers we've highlighted, the $2 million we talked about in the first half presentation and the $1 million worth of costs we've taken up in the UK business, they're the primary ones.

David Cooke: (Nomura, Analyst) But it seems as though you also had a number of costs that are probably not one off in nature, per se, but effectively - call it a pull forward or an expenditure that you incurred in FY12 which sets the business for growth in FY13, et cetera. Are you able to give us an indication as to how much that was?

Peter Halkett: I think, David, we need to be a bit cautious there, because most years we tend to be investing an amount of money in the following year's initiatives, so I think on a comparable like-for-like basis, we would say incrementally the profit was in fact at $3 million. I think any more than that and we're just misleading, because there'll always be those unexpected and investments made for the year ahead.

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Mark Todd: And the best example of that, David, is the new distribution centre in New Zealand. You've got the incremental lift in rent for that project in the coming year. So there's always a carry-over.

David Cooke: (Nomura, Analyst) If I look at your [fractionisation] of your leads cost and your wages cost, it looks as though there wasn't any in the first half. It looks as though it was pretty modest in the second half as well. Again, is that the new normal for you?

Mark Todd: Sorry, can you say the first part of that again?

David Cooke: (Nomura, Analyst) Your fractionisation of your leads and wages cost, so looking to the proportion of sales.

Mark Todd: So 13% in the first half and 10% in the second half. The ratio will always weight towards the first half, particularly in the year ahead with the new stores.

Peter Halkett: Essentially that's a function that we incur roughly 50% of our costs in the first half and 50% in the second half, but adding on new stores, and yet our turnover is generally 40/60 or thereabouts, and so therefore the operating leverage will always look horrible in the first half and great in the second half, and that applies on rent, store salaries, just about everything.

David Cooke: (Nomura, Analyst) And your dependence on your three sales periods, did that downweight or upweight this year compared to prior years?

Peter Halkett: No real change.

David Cooke: (Nomura, Analyst) Final one for me at the moment is in a couple of years' time, at the rate that you're rolling out new stores, you'll be at your 150 mark. Are you looking to give us an update as to whether you think you're going to be able to - or how much you'll be able to extend past that 150 in the next 12 months, or are we going to have to wait and see once you get to the 150 mark.

Peter Halkett: I would expect that within 12 months we will be able to give a bit more of an indication of where we see future growth occurring. Whether that's purely store numbers in New Zealand and Australia, whether that's in relation to penetration, whether that's in relation to online opportunities

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globally, there's a number of avenues that we're working on, and I guess we're trying to get proof of concept before we get too excited about it.

David Cook: (Nomura, Analyst) So the fact that you talk about Australia penetration being so much less than New Zealand and a way of catching up is new stores, even if I look at the vast majority of that 30 new stores is going to be Australia-related, it still suggests that there's more upsize room for new stores in Australia, over and above the 150.

Peter Halkett: Yes, I think there's different characteristics between the two markets in terms of where your stores need to be. A lot of our stores in Australia tend to be in high street locations and strip locations and destination locations, and yet, as we know, far more of the retail dollar is spent in malls in Australia than it is in New Zealand. I think it's something like 75% of every dollar spent in Australia is through a mall, and in New Zealand I think that equivalent number is about 30%, so our current portfolio isn't necessarily where the customers are.

So there's an element to we need to relocate some of our CBD stores in particular, and we've talked about flagship stores, better-located stores, high footfall stores opening in malls, so part of it - that's why we've really said part of the answer to penetration in Australia is about optimising the existing store network, which may not - our stores may not be in the right location, even though they are obviously very profitable.

Mark Todd: It's not coincidental, David, that seven of those nine stores are malls, in the first half of the year.

David Cooke: (Nomura, Analyst) Yeah, okay. Sorry, final one for me. Summit Club, are you able to give us the percentage of sales that are derived from Summit Club members?

Peter Halkett: We'd rather not. It's a fairly competitive bit of information that - as I say, competition is increasing in our space and we're always running this balance between what we disclose, because we want you to have lots of information so you can figure out what's happening in the business, but not making it easy for our competitors to try and knock us off our perch. But I can tell you it's well above 50%.

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David Cooke: (Nomura, Analyst) Okay, thanks guys. Appreciate it.

Operator: Your next question comes from the line of Adam Simpson from Macquarie Securities. Please go ahead.

Adam Simpson: (Macquarie Securities, Analyst) G'day guys. Can you maybe give a bit of commentary around how the two sales periods in the second half unfolded and whether there was much difference in the trajectory between them?

Peter Halkett: Hi Adam, how are you? The Easter sale, which I guess you're alluding to, that was pretty strong generally. New Zealand probably wasn't as good as Australia. We had some pretty seriously hot temperatures through New Zealand and we prefer Easter to be a little cooler. But overall, if you combined New Zealand and Australia, the performance at Easter sale was pretty healthy, and winter sale was possibly slightly disappointing, but you're only taking a percentage or two.

It was a funny old sale. New Zealand started really strong and finished weak, whereas Australia started weak and finished strong. A lot of that was in relation to temperature. I mean, the New Zealand ski fields opened early and then they pretty well had no snow for months on end, whereas Australia, I think, had a pretty solid season all the way through. But all in all, both those sales were pretty good, otherwise we couldn't have achieved the same store sales results in the second half, because those two sales are pretty well the second half.

Adam Simpson: (Macquarie Securities, Analyst) I guess there's been a bit of talk here with the impact of the federal government stimulus in Juneish, in July. You don't think you got much of that?

Peter Halkett: Well, first of all, the Easter sale performance was more or less the same as the winter sale performance, but I don't think you can put that amount of money into the economy and not expect us to get a benefit from it. Once again, if we compare the New Zealand performance and the Australian performance over winter sale where New Zealand didn't get that stimulus, there wasn't that much difference.

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Adam Simpson: (Macquarie Securities, Analyst) Just going back to your commentary around the first half, second half expectations into 13, should we be thinking of first the comparative period for your minimal growth off the reported number or the number x, the couple of one off costs? I guess I'm thinking that as a percentage growth you should see some growth in the first half, or am I wrong?

Mark Todd: You could take out the couple of million, but you've got to recognise that all of these stores, when you open them up, have a cost for set-up, and there are some substantial costs of set-up on some of those stores.

Adam Simpson: (Macquarie Securities, Analyst) So naturally the absolute dollar is much greater in the second half, but as a per cent, you should still see growth in the first half.

Mark Todd: Yeah, but not significantly relative to the two halves.

Adam Simpson: (Macquarie Securities, Analyst) Final one for me. Just looking at the result detail, it looks like you've put a bit more costs into your holding company line in the second half. Can you talk about - has there been any reallocation of costs out of the business, or is that the sort of go-forward number?

Mark Todd: That probably carries the provisioning costs on - I don't know, actually, I'll have to look at that. I'm not sure. I'll give you an answer to that later.

Adam Simpson: (Macquarie Securities, Analyst) It's up about 800 grand on the first half, anyway. Thanks, guys.

Operator: Your next question comes from the line of Jennifer Kruk from Deutsche Bank. Please go ahead.

Jennifer Kruk: (Deutsche Bank, Analyst) Hi, good morning, guys. Just a couple of quick ones from me. I'm just firstly online, are you able to give us a feel for what online is as a per cent of total sales, and how you're thinking about how that will look over the long term, particularly if you do take the global platform roll-out forward?

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Peter Halkett: Well, at the moment we're not giving specific detail on that. What I can tell you is that it doubled over the last 12 months and it's now pretty well - if you combine New Zealand and Australia - the biggest store we have in the business. So I guess you can probably work out that it's not that 10% remotely yet, but it's still a good size. So not providing that number.

Over time, it's a function of what percentage of online sales will we achieve in New Zealand and Australia, and then what percentage could we achieve by making Kathmandu products available internationally, and that's obviously got a big question mark. I've heard figures quoted of 10%, 15%, 20%, 30% of business from different retailers. I think it's too early to know exactly what that would be, but I'd be surprised if in three years it's not 30% of our business, but I've got no evidence. I can't justify that at this point in time. All I can see is a rate of growth of online, and I can see what's happening and the trends in both UK and US.

Jennifer Kruk: (Deutsche Bank, Analyst) Okay, great, thanks. Just one thing as well, if we could just talk a little bit, given the strong weighting to Australian store openings in the first half, just if you could talk a bit about the returns you guys are getting on the capital you're investing in these stores and how that compares to potentially a few years ago?

Peter Halkett: There's probably two stories to that, Jennifer, and it does actually depend upon where we put the stores and how much money we invest in them. It's fair to say that when you actually invest, certainly in the flagship stores and the higher-cost locations, in percentage terms you get less return, but in absolute dollar terms if you do it right you get more dollars.

When you're opening the stores around the traps and regional towns and doing refurbishments, relocations there, some of that's actually - some of that's basically protecting the business that's already there and just improving it slightly, so you're not necessarily getting anything instrumental out of it. But the relocations are a different story. When we relocate to bigger and better stores, we get bigger and better return out of them.

Jennifer Kruk: (Deutsche Bank, Analyst) Great, thanks. Just with the number of stores in the first half, was that just purely opportunistic in the sense that a lot of opportunities came up for you guys and you decided to take them?

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Peter Halkett: I think part of it is the slowdown in retail. There's just more opportunities emerging and they're not necessarily getting any more generous, but there are more vacancies, there are more opportunities. Kathman's one of the few retailers that are still growing and opening stores with the covenant we offer, so we're probably a little more attractive than we were two years ago when everyone was going berserk.

As I say, last year, FY12, was very much a year where we took a more cautious approach. We recalibrated, we thought about what online, we thought about what the slowing economy would mean in terms of where we should position our stores, what sort of terms and conditions we should have around those, and then we've sort of kick-started it again as we've got our head around that and established smaller format, mall-type stores. There's no doubt that those stores also have an emphasis on apparel, which is the highest-growth sector within outdoor as well.

Jennifer Kruk: (Deutsche Bank, Analyst) Great, thanks very much.

Operator: Your next question comes from the line of Jackie Fernley from Wilson HTM. Please go ahead.

Jacqueline Fernley: (Wilson HTM, Analyst) Good morning guys, and congratulations on that result. I have a couple of questions, if I may.

Mark Todd: Just before you do, Jackie, I know why you said that, because we almost hit your number.

Jacqueline Fernley: (Wilson HTM, Analyst) You did. Just on CODB, I know it was 153 less 3 for a base of 150. Can you just give us a feel for what your sustainable inflater is across your business, not necessarily for FY13 but how we should think of it on a normalised basis? Is it 3 or is it 5 or where does it roughly sit based on your CODB?

Mark Todd: Well, the rental cost, equation of that obviously, Jackie, is increasing to be fair, simply because of the nature - both the nature of the leases we're entering into and the locations and the fact that they're Australian domiciled rather than New Zealand domiciled. But the rest of - as you know you could go the other but we're obviously targeting to spend an equivalent percentage of advertising year on year, so [inaudible] can do that,

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[inaudible] inflationary. And you and I know the payroll costs as well each other, so yeah. So yeah, so...

Jacqueline Fernley: (Wilson HTM, Analyst) So should we assume payroll three and rents closer to five?

Mark Todd: I think that's a reasonable way of looking at it, yep.

Jacqueline Fernley: (Wilson HTM, Analyst) Okay, great. And just to confirm CapEx for 21 as you spoke, should we be running off a base of sort of 18, 19?

Mark Todd: No, I think you do 20, definitely do 20 [unclear], yep.

Jacqueline Fernley: (Wilson HTM, Analyst) Okay. And then the other question I had, just with the UK, you talked - with the restructuring that you've put through where are the normalised base that we should - assuming it's not going to improve in FY13 in a revenue sense, the losses should - the restructuring, has that allowed you to get to a breakeven level now you've exited or outsourced and shut down head offices and things?

Mark Todd: No, it doesn't allow you to get to a breakeven on that number of stores. We've got to grow the online business in that market but actually grow the business to a profitable level, but the level of losses that we've got, all things being equal, with a slightly better sales performance and slightly better margin get closer to halfway in between the million and the zero that we get - that you'd like to have if you were breakeven.

Jacqueline Fernley: (Wilson HTM, Analyst) Okay, great.

Peter Halkett: I think it's called a work in progress. It's called a work in progress. I think we'd launch our UK website next week, most of our promotional effort will go behind driving sales online. Our store network that's less significant than it has been. We won't be tending to drive people to the stores, that will be more of a showroom, a brand experience and it will all be about how quickly we can get online sales. So when we look at our budget next year in the UK, we've been conservative. We don't really know how quickly we can move the dial on online sales, but one of the things we are doing and this is hence the reason for the investment we're making in Summit Club. As we know, the more Summit Club members we have the more successful we are and that will be true in the UK as well.

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Jacqueline Fernley: (Wilson HTM, Analyst) So based on that should we expect that you - I mean, you'll obviously spend a certain amount on advertising so you know, the investment in the UK is still probably going to be a couple of million in terms of sort of an EBIT loss on the project...

Peter Halkett: I think Mark indicated it's not...

Jacqueline Fernley: (Wilson HTM, Analyst) ...on a conservative basis.

Mark Todd: Well, that is quite conservative.

Peter Halkett: I think Mark just indicated to you around the half a million mark. So...

Jackie Fernley: (Wilson HTM, Analyst) Sure, but that assumes a certain speed of online sales so...

Mark Todd: And margin improvement and all that goes…

Peter Halkett: Yeah, that's right.

Jackie Fernley: (Wilson HTM, Analyst) Okay, all right. No problem. Thank you very much.

Operator: Your next question comes from the line of George Batsakis from Goldman Sachs. Please go ahead.

George Batsakis: (Goldman Sachs, Analyst) Good morning guys. Just a question on gross margin. You gave a number of reasons there why gross margin declined in 2012, but with the vast majority of the decline attributable to the increased Summit Club sales and then going forward does that mean gross margin is also likely to decline next year because you get further benefit - or impact from the higher Summit Club sales?

Peter Halkett: George, I think where it is subject to the usual disclaimers we put on gross margin, which is a function of volume and sales and discounting, we would expect the range we're at as where it would be next year.

George Batsakis: (Goldman Sachs, Analyst) Great.

Mark Todd: And the Summit Club was - yeah, those bullet points are in order of priority, George, and the Summit Club was by far the most significant.

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George Batsakis: (Goldman Sachs, Analyst) Great, that's all from me. Thank you.

Operator^ Your next question comes from the line of Ken Wagner from Octa Phillip. Please go ahead.

Ken Wagner: (Octa Phillip, Analyst) Yes, good morning. Similar question to that of George on the gross margin. Just on the product mix side, was that a plus or a minus on the gross - for gross margin?

Peter Halkett: We're tending to increase the percentage of apparel we sell as a business, so it would generally be a positive. And the other positive we have to assist us with gross margin but not with our expense base are that the more sales we make in Australia the more Australia becomes a proportion of our business, the higher the gross margin because as you can see from the presentation Australia is a higher gross margin. But it's a higher cost structure which means every time we open another Australian store the average per cent of rent goes up a little, the average salaries go up a little but the average gross margin also goes up. So on the top line it looks great but it's also driving the bottom line.

Mark Todd: And Ken, just a little bit of a - there was a slightly different story there between Australia and New Zealand too, in the product mix, but not great, but that's why it's in there. I mean, there's always going to be 0.5% to 1% floating around just by virtue of normal trading.

Ken Wagner: (Octa Phillip, Analyst) In terms of the hedging rates you've been able to lock in, you've had I guess a reasonably sizeable benefit from that in '12 and been able to offset some increase in product cost. Is that going to be more difficult in '13 given it's just a slightly higher increase in your hedging rates?

Mark Todd: Well, in most categories the input cost increase is coming through in '13 are not that significant relative to '12 anyway.

Ken Wagner: (Octa Phillip, Analyst) Right.

Peter Halkett: Yeah, in China things are slowing down a lot, but as you probably know they're not requesting the same sort of increases as they were the previous year when things were still moving forward.

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Ken Wagner: (Octa Phillip, Analyst) Okay, and one last question, just a kind of clarification on operating costs on the outlook statement. The lower rate of costs increase in FY12, should we interpret that as being operating costs as a per cent of sales expected to increase in '13 but less than the 190 basis points we saw in '12? Is that the correct interpretation?

Mark Todd: No - yeah, no, they're going to increase as a lesser percentage and how they end up relative to the basis increase in sales will be related as much to how the sales go as the other side of the equation. I mean, they won't increase at that same rate simply because we won't have the one offs.

Ken Wagner: (Octa Phillip, Analyst) Yep, yep, understood.

Mark Todd: But we do have this trend of expenses towards Australia which does drive things like retail salaries and wages in percentage terms, and rent as well.

Ken Wagner: (Octa Phillip, Analyst) Great, thanks very much.

Operator: Your next question is from Shane Bannan from Bligh Capital. Please go ahead.

Shane Bannan: (Bligh Capital, Analyst) Good morning guys. Just Peter, I think you might have made the comment that the competition was intensifying. I was just wanting to get a sense of what the form of that is or has there been a change in form and how you are looking to mitigate that? And in conjunction with that, do you have a sense of market share and how that's moving?

Peter Halkett: Oh, well market share is very difficult because a lot of what we do sells into more the lifestyle space, the wider market, people that just want a raincoat, people that just want a pack. I guess if there was a way to have market share it would be to add up all the players' turnovers and estimate some of them where we can't give that information, and I think we'd probably find in relation terms a sales increase of 13.4. I don't think the category would have grown 13.4 over all so I would have thought we were taking market share, be it that we also opened more stores.

In terms of the nature of the competition we know in Australia that BCF or Supercheap retail are opening more BCF stores, they're opening more Ray's

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stores and within Ray's they're increasing their apparel offering and we know that Anaconda are continuing to open stores. When we go to New Zealand there's been a lot of activity from the likes of Macpac, FCO as part of the Supercheap group, opened I think ten stores. Obviously they're still in setup phase. I think they lost multi-millions on that but I guess they'd call that part of setup cost but they have taken - you know, obviously taken some business.

Mountain Designs are more active in New Zealand, they're opening bigger stores, adopting a slightly different strategy from us. And so I think we total it up, including Kathmandu stores, there were 60 more outdoor stores across New Zealand and Australia this time compared to this time last year and that's about a 20% increase in store numbers. So a lot of those are selling traditional family camping products, not the sort of range that Kathmandu does but I think most of the market would consider them our competitors even though we just think that the product overlaps.

As far as how we're offsetting that, well we're investing in our brand, we're investing in our products, we're investing in a different - I guess a go to market strategy into some of our store formats, our locations of our stores. We have a view that we obviously haven't disclosed publicly about where future growth will come from in the category and we're investing a lot in that in terms of our product and investment and inventory. So we certainly think that the sales growth we've been getting with the investments we're making will put us in a strong position to continue to compete aggressively against increase in competition.

Shane Bannan: (Bligh Capital, Analyst) Great, thank you.

Peter Halkett: I think the only thing I'd say is I've been with Kathmandu six years and since we listed that's been three years, and I think every year we've seen a significant increase in competition. So I guess over six years we've had a number of new entrants, we've had a lot more stores, we've had people like BCF and Anaconda and Macpac and we've had a lot more entrants, and all through that time we've continued to increase our sales in terms of total sales and same store, so I guess it's something we're pretty familiar with as well. So there's nothing new about increasing competition,

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it's just a fact of life and something that's worth mentioning on this call and in our presentation.

Shane Bannan: (Bligh Capital, Analyst) Many thanks.

Operator: There is one question remaining in queue. As a reminder, if you would like to ask a question please press star 1 on your telephone keypad, that's star 1 to ask a question. We'll now go to a follow up from the line of David Cooke from Nomura. Please go ahead, sir.

David Cooke: (Nomura International, Analyst) Hi Peter, it is a quick follow up. Did I hear you correctly in you're saying that you'd be surprised if your online sales were not 30% in three years' time?

Peter Halkett: Well, look, it's a really tricky area because no one actually knows, David. I mean, it's very difficult to determine what that number would be and how much of that is incremental business and how that might come from our existing stores. But I mean, a simple example, as we know Pumpkin - Pumpkin Patch have quoted publicly that they think it's going to be - 30% of their turnover is going to come from online. But they've also had a catalogue business, they've also had a catalogue business. So they had a database which is of course something we've been talking about with our Summit Club, they've had a database mail order business that they could capitalise.

So I think anybody that give you a precise number, maybe they've got more data than I have, but you know, I think it's going to be a sizeable portion and it's growing rapidly with us. If our growth - we continue to double every year for the next three years then it's going to be a pretty sizeable chunk of our business. But I can't give you a number or a percentage, I can only quote you and refer to what other retailers think. Yeah, so I'm pretty uncomfortable in this area to get numbers because I've got no basis to provide it to you.

David Cooke: (Nomura International, Analyst) Yeah, which is why I was a bit surprised when you said you'd be surprised if it weren't 30%.

Peter Halkett: Well, that's what I'd like. The other retailers I talk to that's the sort of number they're quoting publicly.

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David Cooke: (Nomura International, Analyst) Okay. The second follow up is as part of your shift in new stores to Australia, won't that then result in an uplift in your gross margin range from 62 to 64 to something north of that?

Peter Halkett: Well, I guess what I did say before, that every time we open a store in Australia it changes the weighted average, so theoretically the margin. That's why we actually put a range also between 62 and 64 that as we get a greater proportion. Same in Australia, it should go up but then our costs go up too. So in time we might have to re-calibrate what that means.

Mark Todd: David, for history, when we listed we said well, with the current mix and model that we'd be at 62 and when we were a mature portfolio we'd be at 64. So if you think about where we are today and what you think about the runway then 64 looks to be about the right mix when you have a more mature portfolio, that's how the original range targets came about.

David Cooke: (Nomura International, Analyst) But I also look at the performance that you've delivered during that time with your gross margin and your mix [swing] that you've still got to go in Australia and 64 looks as though it might to be expanded a bit.

Mark Todd: It might but we certainly would - it would certainly be an arguable point if we get past the 150 stores, yes, that's right.

David Cooke: (Nomura International, Analyst) Okay, thanks guys. I appreciate it.

Peter Halkett: Thanks, David.

Operator: And with no further questions in queue I'll hand the call back to yourself Mr Harcourt for any additional closing remarks.

Peter Halkett: Well, I'd just like to thank you to everyone for dialling in. I know we're meeting many of you over the next few days, including some of our Kiwi cousins next week, so look forward to catching up one on one and taking some more questions. Thank you.

Operator: And this does conclude our conference for today. Thank you for participating. You may all disconnect.

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END OF TRANSCRIPT

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